-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, K2A8JfmE8ojXPOBoSfoy5eD/gNBkHdkaqljbn9hUHTdJZguckEisdQOlBS9LU5UE sXuxWMTuwqZioGgZzX9eAg== 0001012870-99-000681.txt : 19990304 0001012870-99-000681.hdr.sgml : 19990304 ACCESSION NUMBER: 0001012870-99-000681 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 6 FILED AS OF DATE: 19990303 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CRITICAL PATH INC CENTRAL INDEX KEY: 0001060801 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-BUSINESS SERVICES, NEC [7389] IRS NUMBER: 911788300 STATE OF INCORPORATION: CA FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-71499 FILM NUMBER: 99556620 BUSINESS ADDRESS: STREET 1: 320 FIRST STREET CITY: SAN FRANCISCO STATE: CA ZIP: 94105 BUSINESS PHONE: 6502334512 MAIL ADDRESS: STREET 1: 320 FIRST STREET CITY: SAN FRNACISCO STATE: CA ZIP: 94105 S-1/A 1 AMENDMENT NO. 2 As filed with the Securities and Exchange Commission on March 3, 1999 Registration No. 333-71499 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- AMENDMENT NO. 2 FORM S-1 REGISTRATION STATEMENT Under The Securities Act of 1933 ---------------- CRITICAL PATH, INC. (Exact name of registrant as specified in its charter) California 7389 91-1788300 (State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer of incorporation or Classification Code Number) Identification No.) organization) 320 1st Street San Francisco, California 94105 (415) 808-8800 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) ---------------- DOUGLAS T. HICKEY President and Chief Executive Officer CRITICAL PATH, INC. 320 1st Street San Francisco, California 94105 (415) 808-8800 (Name, address, including zip code, and telephone number, including area code, of agent for service of process) ---------------- Copies to: Jorge del Calvo, Esq. Alan K. Austin, Esq. Stanley F. Pierson, Esq. Mark L. Reinstra, Esq. Davina K. Kaile, Esq. Clay B. Simpson, Esq. James J. Masetti, Esq. Wilson Sonsini Goodrich & Rosati Pillsbury Madison & Sutro LLP 650 Page Mill Road 2550 Hanover Street Palo Alto, CA 94304 Palo Alto, CA 94304 ---------------- Approximate date of commencement of proposed sale to the public: As soon as practicable after the Registration Statement becomes effective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement numbers of the earlier effective registration statement for the same offering. [_] If this form is a post-effective amendment filed pursuant to 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. ================================================================================ ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +The information in this prospectus is not complete and may be changed. We may + +not sell these securities until the registration statement filed with the + +Securities and Exchange Commission is effective. This prospectus is not an + +offer to sell securities, and we are not soliciting offers to buy these + +securities, in any state where the offer or sale is not permitted. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION, DATED March 3, 1999 (logo) CRITICAL PATH, INC. 4,500,000 Shares Common Stock Critical Path, Inc. is offering 4,500,000 shares of its common stock. This is Critical Path's initial public offering and no public market currently exists for its shares. We have applied for approval for quotation on the Nasdaq National Market under the symbol "CPTH" for the shares we are offering. We anticipate that the initial public offering price will be between $9.00 and $11.00 per share. --------------- Investing in the common stock involves risks. See "Risk Factors" beginning on page 5. ---------------
Per Share Total --------- ----- Public Offering Price........................................... $ $ Underwriting Discounts and Commissions.......................... $ $ Proceeds to Critical Path....................................... $ $
The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. Critical Path has granted the underwriters a 30-day option to purchase up to an additional shares of common stock to cover over-allotments. --------------- BancBoston Robertson Stephens Hambrecht & Quist --------------- Dain Rauscher Wessels FAC/Equities a division of Dain Rauscher Incorporated --------------- The date of this prospectus is , 1999. INSIDE FRONT COVER EMAIL Questions Need Answers is your email always up and running? Can you upgrade your email quickly and easily to support additional users? is your email operation the most cost-effective? Will you be able to keep up with the internet messaging demands of tomorrow? [Logos of Strategic partners appear here] GATEFOLD Critical Path The email messaging service enterprise services Software Solution future capabilities including Branding Service basic secure ecommerce unified messaging email email services directions 24x7 hosting hosting Scalable calendaring spam SSL-based future blocking messaging capabilities including anti-virus billing transactions security You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. In this prospectus, the "Company," "Critical Path," "we," "us," and "our" refer to Critical Path, Inc., a California company (unless the context otherwise requires). ---------------- TABLE OF CONTENTS
Page ---- Summary................................................................. 3 Risk Factors............................................................ 5 Forward Looking Statements.............................................. 16 Use of Proceeds......................................................... 17 Dividend Policy......................................................... 17 Capitalization.......................................................... 18 Dilution................................................................ 19 Selected Consolidated Financial Information............................. 20 Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................................... 21 Business................................................................ 30 Management.............................................................. 48 Certain Transactions.................................................... 57 Principal Shareholders.................................................. 59 Description of Capital Stock............................................ 61 Shares Eligible for Future Sale......................................... 64 Underwriting............................................................ 66 Legal Matters........................................................... 68 Experts................................................................. 68 Where You Can Find More Information..................................... 69 Index to Consolidated Financial Statements.............................. F-1
---------------- This prospectus contains trademarks and trade names of other companies. ---------------- Unless otherwise noted, the information in this prospectus assumes that all of the outstanding preferred stock of Critical Path will be converted into common stock, that a 1 for 2.2 reverse stock split will have been effected, that certain warrants for the purchase of Series A and Series B Preferred Stock will be exercised on a net basis and that the underwriters will not exercise their overallotment option. 3 SUMMARY This summary highlights information contained elsewhere in this prospectus. You should read the entire prospectus, including "Risk Factors" and the Financial Statements, carefully before making an investment decision. The Company We are a leading provider of email hosting services designed to allow a wide range of organizations, including Internet service providers, web hosting companies, web portals and corporations, to reduce costs and improve customer service by outsourcing their email systems. Our services are designed to facilitate scalability and reliability, allow access to advanced technologies and provide greater access with high levels of security. In addition, our service is designed so that our customers can enhance their brand recognition by maintaining their existing "look and feel" while improving the functionality of their email service. We intend to build on our expertise in email services to provide additional Internet messaging services in the future. At December 31, 1998, we had over 100 customers. We have strategic agreements with ICQ, a subsidiary of America Online, E*TRADE, Network Solutions, Sprint and US West. Email, one of the most popular Internet applications, has broadened from a simple messaging tool to a widely accepted form of communication for both personal and business use. According to Electronic Mail & Messaging Systems, there were 263 million electronic mailboxes worldwide as of September 30, 1998. Electronic Mail & Messaging Systems estimates that there could be as many as 400 million electronic mailboxes worldwide by the end of 1999. According to the Gartner Group, approximately 300 billion electronic mail messages were sent in 1998. In addition, the complexity of the individual messages is increasing, allowing email to become a more functional communications tool for both personal and business use. At the same time, we believe that customers are increasingly expecting the same reliability from their email service that they are accustomed to receiving from their telephone service, commonly referred to as web-tone reliability. Due to this expectation and the expense and expertise required to maintain a reliable email system, organizations are increasingly seeking to outsource their email systems. Our services provide the following benefits to our customers: . reduced costs associated with acquiring and maintaining hardware and software and with recruiting and retaining systems engineering and administrative support; . a scalable and reliable system architecture designed to support global service over hundreds of millions of mailboxes across millions of domains with web-tone reliability; . access to advanced technologies based on our expertise in rapidly deploying new technologies, combating system failures and maintaining network and system security; . easy access by customers and end-users by designing our services on open Internet-based standards; and . control over their own brand and functionality through customized web- based email interfaces. Our headquarters are located at 320 1st Street, San Francisco, California 94105 and our telephone number is (415) 808-8800. Our website address is www.cp.net. The information on our website is not a part of this prospectus. 4 The Offering Common stock offered by Critical Path.............. 4,500,000 shares Common stock to be outstanding after the offering.. 34,075,388 shares Use of proceeds.................................... Expand sales and marketing activities, open additional data centers, expand international operations and for general corporate purposes and working capital. Proposed Nasdaq National Market symbol............. CPTH
Summary Consolidated Financial Data (in thousands, except per share data) Please see Note 1 of Notes to Consolidated Financial Statements for an explanation of the determination of the number of shares used in computing per share data. The As Adjusted Consolidated Balance Sheet Data summarized below reflects the application of the net proceeds from the sale of the 4,500,000 shares of common stock offered by Critical Path at an assumed initial public offering price of $10.00 per share and after deducting the underwriting discounts and commissions and our estimated offering expenses.
Period from February 19, 1997 Year Ended (Inception) to December 31, December 31, 1997 1998 ----------------- ------------ Consolidated Statement of Operations Data: Net revenues..................................... $ -- $ 897 Loss from operations............................. (1,056) (11,448) Net loss......................................... (1,074) (11,461) Net loss per share -- basic and diluted.......... $ (0.54) $ (2.94) Weighted average shares -- basic and diluted..... 1,994 3,889 Pro forma net loss per share (unaudited): Net loss per share -- basic and diluted........ $ (0.81) Weighted average shares -- basic and diluted... 14,914
December 31, 1998 ------------------- Actual As Adjusted ------- ----------- Consolidated Balance Sheet Data: Cash and cash equivalents................................... $14,791 $55,841 Working capital............................................. 12,524 53,574 Total assets................................................ 20,663 61,713 Capital lease obligations, long-term........................ 2,454 2,454 Shareholders' equity........................................ 15,358 56,408
5 RISK FACTORS This offering involves a high degree of risk. You should carefully consider the risks described below and the other information in this prospectus before deciding to invest in shares of our common stock. The risks described below are not the only ones that we face. Additional risks that generally apply to publicly traded companies, that are not yet identified or that we currently think are immaterial, may also impair our business operations. Our business, operating results and financial condition could be adversely affected by any of the following risks. The trading price of our common stock could decline due to any of these risks, and you could lose all or part of your investment. You should also refer to the other information set forth in this prospectus, including our financial statements and the related notes. This prospectus also contains certain forward-looking statements that involve risks and uncertainties. These statements relate to our future plans, objectives, expectations and intentions, and the assumptions underlying or relating to any of these statements. These statements may be identified by the use of words such as "expects," "anticipates," "intends," and "plans" and similar expressions. Our actual results could differ materially from those discussed in these statements. Factors that could contribute to such differences include, but are not limited to, those discussed below and elsewhere in this prospectus. Because we have a limited operating history, it is difficult to evaluate our business Because we have only a limited operating history upon which you can evaluate our business and prospects, you should consider the risks, expenses and difficulties that we may encounter when making your investment decision. These risks include our ability to: . expand our sales and marketing activities; . create and maintain strategic relationships; . expand our customer base and retain key clients; . introduce new services; . manage growing operations; . compete in a highly competitive market; . upgrade our systems and infrastructure to handle any increases in messaging traffic; . reduce service interruptions; and . recruit and retain key personnel. We expect that our operating expenses will increase and that this increase may have a negative effect on our operating results and financial condition We have spent heavily on technology and infrastructure development. We expect to continue to spend substantial financial and other resources on developing and introducing new service offerings, and expanding 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 will continue to increase in absolute dollars and may increase as a percent of revenues. If our revenues do not correspondingly increase, our operating results and financial condition could be negatively affected. 6 We have a history of losses and may never achieve profitability We incurred net losses of approximately $1.1 million for the period from February 19, 1997 (inception) through December 31, 1997 and $11.5 million for the year ended December 31, 1998. As of December 31, 1998, we had an accumulated deficit of approximately $12.5 million. We have not achieved profitability in any period, and we expect to continue to incur net losses for the foreseeable future. Should we continue to incur net losses in future periods, we may not be able to increase our number of employees or our investment in capital equipment, sales and marketing programs, and research and development in accordance with our present plans. Continuation of our net losses may also require us to secure additional financing sooner than anticipated. Such financing may not be available in sufficient amounts, or on terms acceptable to us, and may dilute existing shareholders. We may never obtain sufficient revenues to achieve profitability. If we do achieve profitability, we may not sustain or increase profitability in the future. This may, in turn, cause our stock price to decline. 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 and the emerging nature of the Internet-based email services market. Our revenues could fall short of our expectations if we experience delays or cancellations of even a small number of orders. We often offer volume-based pricing, which may affect our operating margins. A number of factors are likely to cause fluctuations in our operating results, including, but not limited to: . continued growth of the Internet in general and of email usage in particular; . demand for outsourced email services; . our ability to attract and retain customers and maintain customer satisfaction; . our ability to upgrade, develop and maintain our systems and infrastructure; . the amount and timing of operating costs and capital expenditures relating to expansion of our business and infrastructure; . technical difficulties or system outages; . the announcement or introduction of new or enhanced services by our competitors; . our ability to attract and retain qualified personnel with Internet industry expertise, particularly sales and marketing personnel; . the pricing policies of our competitors; . failure to increase our international sales; and . governmental regulation surrounding the Internet and email in particular. In addition to the factors set forth above, our operating results will be impacted by the extent to which we incur non-cash charges associated with stock-based arrangements with employees and non-employees. In particular, we expect to incur substantial non-cash charges associated with the grant of a warrant to America Online. In addition to amortization of the initial fair value of this warrant, which totaled $14.473 million, we expect that future changes in the trading price of our common stock at the end of each quarter and at the date certain milestones are achieved, will cause additional substantial changes in the ultimate amount of such amortization. Due to lead times required to purchase, install and test equipment, we typically need to purchase equipment well in advance of the receipt of any expected revenues. Delays in obtaining this equipment could result in unexpected revenue shortfalls. Small variations in the timing of the recognition of specific revenues could cause significant variations in operating results from quarter to quarter. 7 Period-to-period comparisons of our operating results are not a good indication of our future performance. It is likely that our operating results in some quarters will be below market expectations. In this event, the price of our common stock is likely to decline. If we fail to expand our sales and marketing activities, we may be unable to expand our business Our ability to increase our revenues will depend on our ability to successfully recruit, train and retain sales and marketing personnel. As of February 28, 1999, we had 38 sales and marketing personnel. We plan to continue to invest significant resources to expand our sales and marketing organizations. Competition for additional qualified personnel is intense and we may not be able to hire and retain personnel with relevant experience. We have recently hired most of our sales and marketing personnel, including our Vice President of Sales, who joined us in November 1998. The complexity and implementation of our Internet messaging services require highly trained sales and marketing personnel to educate prospective customers regarding the use and benefits of our services. Our current and prospective customers, in turn, must be able to educate their end-users. Because the majority of our sales and marketing personnel have recently joined Critical Path and have limited experience working together, our sales and marketing organizations may not be able to compete successfully against bigger and more experienced sales and marketing organizations of our competitors. If we do not successfully expand our sales and marketing activities, our business could suffer and our stock price could decline. Unplanned system interruptions and capacity constraints could harm our business Our customers have in the past experienced some interruptions in our email 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. For example, in October 1998, our customers experienced a four-hour service interruption due to an operating system failure. Our revenues depend on the number of end-users who use our email services. Our business will suffer if we experience frequent or long system interruptions that result in the unavailability or reduced performance of our 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 service agreements with some of our customers that require certain minimum performance standards, including standards regarding the availability and response time of our email 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. Any unplanned interruption of services may adversely affect our ability to attract and retain customers. We depend on strategic relationships and other sales channels We depend on our strategic relationships to expand our distribution channels and to undertake joint product development and marketing efforts. Our ability to increase revenues depends upon marketing our services through new and existing strategic relationships. We have entered into written agreements with ICQ, a subsidiary of America Online, Inc., E*TRADE Group, Inc., Network Solutions, Inc., Sprint Communications Company L.P. and US West Communications Services, Inc., 8 among others. We depend on a broad acceptance of outsourced email services on the part of potential partners and acceptance of Critical Path as the supplier for these outsourced email services. We also depend on joint marketing and product development with our strategic partners to achieve market acceptance and brand recognition. For example, through our relationship with E*TRADE, we can conduct shared advertising campaigns and include our messaging services in E*TRADE's international strategic relationships. Our agreements with our strategic partners typically do not restrict them from introducing competing services and may be terminated by either party without cause. Our agreements with our strategic partners 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. If we lose any of our strategic partners, fail to renew these agreements or relationships or fail to develop new strategic relationships, our business will suffer. The loss of any of our key strategic partners would have an adverse impact on our current and future revenue. For example, E*TRADE accounted for approximately 62% of our 1998 net revenues, excluding the value of stock purchase rights received by E*TRADE. In addition to our strategic relationships, we also depend on the ability of our customers to sell and market our services to their end-users. Our failure to manage our growth could cause our business to suffer We recently began to expand our operations rapidly and intend to continue this expansion. The number of our employees increased from 17 on December 31, 1997 to 93 on December 31, 1998. As of February 28, 1999, we had 133 exmployees. This expansion has placed, and is expected to continue to place, a significant strain on our managerial, operational and financial resources. To manage any further growth, we will need to improve or replace our existing operational, customer service and financial systems, procedures and controls. We will also need to continue the expansion of our operations and employee base. 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 effectively, our business and operating results could suffer. If we fail to respond to rapid technological change, our business could suffer The Internet messaging 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 our prospective customers. The development of proprietary technology and necessary service enhancements entail significant technical and business risks and require substantial expenditures and lead-time. We may not be able to keep pace with the latest technological developments. We may also not be able to use new technologies effectively or adapt our services to customer requirements or emerging industry standards. If we cannot, for technical, legal, financial or other reasons, adapt or respond in a cost-effective and timely manner to changing market conditions or customer requirements, our business and operating results would suffer. 9 If our system security is breached, our business could 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 they are successful, they could obtain our customers' confidential information, including our customers' profiles, passwords, financial account information, credit card numbers or other personal information. We may be liable to our customers for any breach in our security and any breach could harm our reputation. We rely on encryption technology licensed from third parties. Despite our implementation of network security measures, our servers are 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. Our failure to prevent security breaches may have a material adverse effect on our business and operating results. We depend on broad market acceptance for outsourced Internet-based email service The market for outsourced Internet-based email service is new and rapidly evolving. Concerns over the security of online services and the privacy of users may inhibit the growth of the Internet and commercial online services. We cannot estimate the size or growth rate of the potential market for our service offerings, and we do not know whether our service will achieve broad market acceptance. To date, substantially all of our revenues have been derived from sales of our email service offerings and we currently expect that our email service offerings will account for substantially all of our revenues for the foreseeable future. We depend on the widespread acceptance and use of outsourcing as an effective solution for email. If the market for outsourced email fails to grow or grows more slowly than we currently anticipate, our business would suffer dramatically. If we do not compete successfully, our operating results and business could suffer We expect that the market for Internet-based email service will be intensely competitive. In addition to competing with companies that develop and maintain in-house solutions, we compete with email service providers, such as USA.NET, Inc., and iName, and with product-based companies, such as Software.com, Inc. and Lotus Development Corporation. We believe that competition will increase and that companies such as Microsoft Corporation and Netscape Communications Corp., which currently offer email products primarily to Internet service providers, or ISPs, web hosting companies, web portals and corporations, may leverage their existing relationships and capabilities to offer email services. We believe competition will increase as our 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. Increased competition could result in pricing pressures, reduced operating margins and loss of market share, any of which could cause our business to suffer. A limited number of customers account for a high percentage of our revenues and the loss of a major customer could harm our business In 1998, E*TRADE accounted for approximately 62% and TABNet, a wholly owned subsidiary of Verio, accounted for approximately 30% of our net revenues, excluding the value of stock purchase rights received by customers. We expect that sales of our services to a limited number of 10 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 attract new customers in our target markets. The loss of a major customer or our inability to attract new customers could have a material adverse effect on our business. Our agreements with our customers have terms of one to three years with automatic one year renewals and can be terminated without cause upon 30-120 days' notice. We may encounter service design risks which could harm our business We must accurately forecast the features and functionality required by target customers. In addition, we must design and implement service enhancements that meet customer requirements in a timely and efficient manner. We may not successfully determine customer requirements and we may be unable to satisfy customer demands. Furthermore, we may not be able to design and implement a service incorporating desired features in a timely and efficient manner. In addition, if any new service we launch is not favorably received by customers and end-users, our reputation could be damaged. If we fail to accurately determine customer feature requirements or service enhancements or to market services containing such features or enhancements in a timely and efficient manner, our business and operating results could suffer materially. We need to upgrade our systems and infrastructure to accommodate increases in email traffic We must continue to expand and adapt our network infrastructure as the number of users and the amount of information they wish to transmit increases, and as their requirements change. The expansion and adaptation of our network infrastructure will require substantial financial, operational and management resources. Due to the limited deployment of our services to date, the ability of our network to connect and manage a substantially larger number of customers at high transmission speeds is unknown, and we face risks related to the network's ability to operate with higher customer levels while maintaining expected performance. As the frequency and complexity of messaging increases, we will need to make additional investments in our infrastructure, which may be expensive. In addition, we may not be able to accurately project the rate or timing of email traffic increases or upgrade our systems and infrastructure to accommodate future traffic levels. We may also not be able to achieve or maintain a sufficiently high capacity of data transmission as customer usage increases. Customer demand for our services could be greatly reduced if we fail to maintain high capacity data transmission. In addition, as we upgrade our network infrastructure to increase capacity available to our customers, we are likely to encounter equipment or software incompatibility which may cause delays in implementations. We may not be able to expand or adapt our network infrastructure to meet additional demand or our customers' changing requirements in a timely manner or at all. If we fail to do so, our business and operating results could suffer materially. If we fail to successfully expand our international operations, our business could suffer We intend to continue to expand into international markets and to spend significant financial and managerial resources to do so. If our revenues from international operations do not exceed the expense of establishing and maintaining these operations, our business, financial condition and operating results will suffer. We have limited experience in international operations and may not be able to compete effectively in international markets. We face certain risks inherent in conducting business internationally, such as: . unexpected changes in regulatory requirements; . difficulties and costs of staffing and managing international operations; 11 . differing technology standards; . difficulties in collecting accounts receivable and longer collection periods; . political and economic instability; . fluctuations in currency exchange rates; . imposition of currency exchange controls; . potentially adverse tax consequences; and . reduced protection for intellectual property rights in certain countries. Any of these factors could adversely affect our international operations and, consequently, our business and operating results. Our business could suffer if efficient transmission of data over the Internet is interrupted The recent growth in the use of the Internet has caused frequent interruptions and delays in accessing the Internet and transmitting data over the Internet. To date we have not experienced a significant adverse effect from these interruptions. However, because we provide email messaging services over the Internet, interruptions or delays in Internet transmissions will adversely affect our customers' ability to send or receive their email messages. We rely on the speed and reliability of the networks operated by third parties. Therefore, our market depends on improvements being made to the entire Internet infrastructure to alleviate overloading and congestion. We depend on telecommunications network suppliers such as MCI WorldCom and Sprint to transmit email messages across their networks. In addition, to deliver our services, we rely on a number of public and private peering interconnections, which are arrangements among access providers to carry traffic of each other. If these providers were to discontinue these arrangements, and alternative providers did not emerge or were to increase the cost of providing access, our ability to transmit our email traffic would be reduced. If we were to increase our current prices to accommodate any increase in the cost of providing access, it could negatively impact our sales. If we did not increase our prices in response to rising access costs, our margins would be negatively affected. Furthermore, if additional capacity is not added as traffic increases, our ability to distribute content rapidly and reliably through these networks will be adversely affected. If we encounter system failure, our business and reputation could be damaged Our ability to successfully receive and send email messages and provide acceptable levels of customer service largely depends on the efficient and uninterrupted operation of our computer and communications hardware and network systems. Substantially all of our computer and communications systems are located in Palo Alto and San Francisco, California and Laurel, Maryland. Our systems and operations are vulnerable to damage or interruption from fire, flood, earthquake, power loss, telecommunications failure and similar events. The occurrence of any of the foregoing risks could subject us to contractual monetary penalties if we fail to meet our minimum performance standards, and could have a material adverse effect on our business and operating results and damage our reputation. We must recruit and retain our key employees to expand our business Our success depends on the skills, experience and performance of our senior management and other key personnel, many of whom have worked together for only a short period of time. For 12 example, our Chief Executive Officer, Chief Financial Officer, Vice President of Sales and Vice President and Chief Information Officer have joined us within the past six months. The loss of the services of any of our senior management or other key personnel, including our founder, David Hayden, and our President and Chief Executive Officer, Douglas Hickey, could materially and adversely affect our business. We do not have long-term employment agreements with any of our senior management and other key personnel. Our success also depends on our ability to recruit, retain and motivate other highly skilled sales and marketing, technical and managerial personnel. Competition for these people is intense, and we may not be able to successfully recruit, train or retain qualified personnel. In particular, we may not be able to hire a sufficient number of qualified software developers for our email services. If we fail to retain and recruit necessary sales and marketing, technical and managerial personnel, our business and our ability to develop new services and to provide acceptable levels of customer service could suffer. Our services may be adversely affected by unknown software defects Our service offerings depend on complex software, both internally developed and licensed from third parties. Complex software often contains defects, particularly when first introduced or when new versions are released. Although we conduct extensive testing, we may not discover software defects that affect our 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 by us, defects may occur in the software. These defects could cause service interruptions, which could damage our reputation or increase our service costs, cause us to lose revenue, delay market acceptance or divert our development resources, any of which could cause our business to suffer. We may need additional capital and raising additional capital may dilute existing shareholders We believe that our existing capital resources, including the anticipated proceeds of this offering, will enable us to maintain our current and planned operations for at least the next 12 months. However, we may be required to raise additional funds due to unforeseen circumstances. If our capital requirements vary materially from those currently planned, we may require additional financing sooner than anticipated. Such financing may not be available in sufficient amounts or on terms acceptable to us and may be dilutive to existing shareholders. Unsuccessful acquisitions could harm our operating results and our business We may acquire businesses, products and technologies that complement or augment our existing businesses, services and technologies. Integrating any newly acquired businesses or technologies may be expensive and time-consuming. We do not know if we will be able to complete any future acquisitions or that we will be able to successfully integrate any acquired business. To finance any acquisitions, it may be necessary for us to raise additional funds through public or private financings. Any equity or debt financings, if available at all, may be on terms that are not favorable to us and, in the case of equity financings, may result in dilution to our shareholders. We may not be able to operate any acquired businesses profitably or otherwise implement our growth strategy successfully. If we are unable to integrate any newly acquired entities or technologies effectively, our results of operations could suffer. We may not be able to protect our intellectual property and proprietary rights We regard our copyrights, service marks, trademarks, trade secrets and similar intellectual property as critical to our success, and rely on trademark and copyright law, trade secret protection 13 and confidentiality and/or license agreements with our employees, customers and partners to protect our proprietary rights. Despite our precautions, unauthorized third parties may copy certain portions of our services or reverse engineer or obtain and use information that we regard as proprietary. End-user license provisions protecting against unauthorized use, copying, transfer and disclosure of the licensed program may be unenforceable under the laws of certain jurisdictions and foreign countries. 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 have one patent pending in the United States and we may seek additional patents in the future. We do not know if our patent application or any future patent application will be issued with the scope of the claims we seek, if at all, or whether any patents we receive will be challenged or invalidated. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States. Our means of protecting our proprietary rights in the United States or abroad may not be adequate and competitors may independently develop similar technology. Third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights. In addition, other parties may assert infringement claims against us. Although we have not received notice of any alleged infringement, 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. We may be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties. Intellectual property litigation is expensive and time-consuming and could divert management's attention away from running our business. We may need to license third party technologies and we face risks in doing so We also intend to continue to license certain technology from third parties, including our web server 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. 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 with the integration of new technology, the diversion of resources from the development of our own proprietary technology, our inability to generate revenues from new technology sufficient to offset associated acquisition and maintenance costs. Our inability to obtain any of these licenses could delay product and service development until equivalent technology can be identified, licensed and integrated. Any such delays in services could cause our business and operating results to suffer. Governmental regulation and legal uncertainties could harm our business Although there are currently few laws and regulations directly applicable to the Internet and commercial email services, a number of laws have been proposed involving the Internet, including laws addressing user privacy, pricing, content, copyrights, distribution, antitrust and characteristics and quality of products and services. Further, the growth and development of the market for online email may prompt calls for more stringent consumer protection laws that may impose additional burdens on those companies conducting business online. The adoption of any additional laws or regulations may impair the growth of the Internet or commercial online services which could decrease the demand for our services and increase our cost of doing business, or otherwise harm our business and operating results. Moreover, the applicability to the Internet of existing laws in various 14 jurisdictions governing issues such as property ownership, sales and other taxes, libel and personal privacy is uncertain and may take years to resolve. If we do not adequately address "Year 2000" issues, we may incur significant costs and our business could suffer The Year 2000 issue is the result of computer programs and embedded hardware systems having been developed using two digits rather than four to define the applicable year. These computer programs or hardware that have date-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations causing disruptions of operations including, among other things, a temporary inability to process transactions, send invoices or engage in normal business activities. As a result, many companies' computer systems may need to be upgraded or replaced in order to comply with the "Year 2000." We are in the process of testing our internally developed software. Many of our customers maintain their Internet operations on commercially available operating systems, which may be impacted by Year 2000 complications. In addition, we rely on third-party vendors for certain software and hardware included within our services, which may not be Year 2000 compliant. Failure of our internal computer systems or third-party equipment or software, or of systems maintained by our suppliers, to operate properly with regard to the year 2000 and thereafter could require us to incur significant unanticipated expenses to remedy any problems and could cause system interruptions and loss of data. Any of these events could harm our reputation, business and operating results. We have not yet developed a comprehensive contingency plan to address the issues that could result from Year 2000 complications. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Year 2000 Issues." We may have liability for Internet content and we may not have adequate liability insurance As a provider of email 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 email. 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. 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 is also a risk that 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 may need to be used in order to settle claims. Any imposition of liability, particularly liability that is not covered by insurance or is in excess of insurance coverage could have a material adverse effect on our reputation and our business and operating results, or could result in the imposition of criminal penalties. Our stock has not been publicly traded before this offering and our stock price may be volatile Our common stock has not been publicly traded, and an active trading market may not develop or be sustained after this offering. Critical Path and the underwriters will determine the initial public 15 offering price. The price at which our common stock will trade after this offering is likely to be highly volatile and may fluctuate substantially due to factors such as: . actual or anticipated fluctuations in our results of operations; . changes in or failure by us to meet securities analysts' expectations; . announcements of technological innovations; . introduction of new services by us or our competitors; . developments with respect to intellectual property rights; . conditions and trends in the Internet and other technology industries; and . general market conditions. In addition, the stock market has from time to time experienced significant price and volume fluctuations that have affected the market prices for the common stocks of technology companies, particularly Internet companies. These broad market fluctuations may result in a material decline in the market price of our common stock. In the past, following periods of volatility in the market price of a particular company's securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation is often expensive and diverts management's attention and resources, which could have a material adverse effect upon our business and operating results. Future sales of our common stock may depress our stock price After this offering, we will have 34,075,388 shares of common stock outstanding. All the shares sold in this offering will be freely tradable. The remaining 29,575,388 shares of common stock outstanding after this offering are subject to lock-up agreements that prohibit the sale of the shares for 180 days after the date of this prospectus. Immediately after the 180 day lockup period, 26,348,136 shares which will be outstanding after the offering will become available for sale. The remaining shares of our common stock will become available at various times thereafter upon the expiration of one-year holding periods. Sales of a substantial number of shares of common stock in the public market after this offering or after the expiration of the lockup and holding periods could cause the market price of our common stock to decline. Purchasers of our common stock will suffer immediate and substantial dilution The initial public offering price is expected to be substantially higher than the book value per share of our common stock. Some elements of our market value do not originate from measurable transactions. Therefore there is not a corresponding rise in "book" or historical cost accounting, value for our rise in market value, if any. Examples of these elements include the perceived value associated with our strategic relationships, perceived growth prospects of our core commercial market and our perceived competitive position within that market. Purchasers of our common stock in this offering will experience immediate dilution of $8.08 in the pro forma net tangible book value per share of common stock assuming a public offering price of $10.00 per share. Purchasers will also experience additional dilution upon the exercise of outstanding stock options and warrants. Our directors, executive officers and principal shareholders will be able to exert significant influence over us After this offering, our directors, executive officers and our shareholders who currently own over 5% of our common stock will beneficially own approximately 51.6% of our outstanding 16 common stock. These shareholders, if they vote together, will be able to exercise significant influence over all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may also delay or prevent a change in control of Critical Path. Our articles of incorporation and bylaws contain provisions which could delay or prevent a change in control of Critical Path Our articles of incorporation and bylaws will contain provisions that could delay or prevent a change in control of Critical Path. 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 which can be created and issued by the board of directors without prior shareholder approval, commonly referred to as "blank check" preferred stock, with rights senior to those of common stock; . prohibit shareholder action by written consent; and . establish advance notice requirements for submitting nominations for election to the board of directors and for proposing matters that can be acted upon by shareholders at a meeting. See "Description of Capital Stock" for additional discussion of these provisions. If we do not use the proceeds in a manner beneficial to Critical Path, our business could suffer We intend to use the net proceeds from this offering to expand our sales and marketing activities, open additional data centers, expand our international operations and for general corporate purposes, including working capital and strategic investments. The amounts and timing of these expenditures will vary significantly depending on a number of factors, including, but not limited to, the amount of cash generated by our operations and the market response to the introduction of any new service offerings. Depending on future developments and circumstances, we may use some of the proceeds for uses other than those described above. Our management will therefore have significant flexibility in applying the net proceeds of this offering. If the proceeds are not used in a manner beneficial to Critical Path, our business could suffer and our stock price could decline. FORWARD LOOKING STATEMENTS Certain statements under the captions "Prospectus Summary," "Risk Factors," "Use of Proceeds," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business," and elsewhere in this prospectus are "forward-looking statements." These forward-looking statements include, but are not limited to, statements about our plans, objectives, expectations, intentions and assumptions and other statements contained in the prospectus that are not historical facts. When used in this prospectus, the words "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates" and similar expressions are generally intended to identify forward-looking statements. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including our plans, objectives, expectations and intentions and other factors discussed under "Risk Factors." 17 USE OF PROCEEDS The net proceeds we will receive from the sale of the 4,500,000 shares of common stock offered by us are estimated to be $41,050,000 after deducting the underwriting discounts and commissions and the estimated offering expenses payable by us and assuming a public offering price of $10.00 per share. We intend to use the proceeds of this offering for the following: . expansion of our sales and marketing activities; . opening of additional data centers; . expansion of our international operations; and . working capital and other general corporate purposes. The amounts and timing of these expenditures will vary significantly depending on a number of factors, including, but not limited to, the amount of cash generated by our operations and the market response to the introduction of any new service offerings. In addition, we may use a portion of the net proceeds of this offering to acquire or invest in businesses, products, services or technologies complementary to our current business, through mergers, acquisitions, joint ventures or otherwise. However, we have no specific agreements or commitments and are not currently engaged in any negotiations with respect to these transactions. Accordingly, our management will retain broad discretion as to the allocation of the net proceeds of this offering. We intend to invest the net proceeds of this offering in short-term, interest-bearing investment grade securities pending the above uses. The principal purposes of this offering are: to create a public market for our common stock, to increase our visibility and credibility, to facilitate future access to the public capital markets and to obtain additional capital. DIVIDEND POLICY We have never declared or paid dividends on our capital stock and do not anticipate paying any dividends in the foreseeable future. We currently intend to retain any future earnings for the expansion and operation of our business. Furthermore, our line of credit agreement with Silicon Valley Bank prohibits the payment of dividends. 18 CAPITALIZATION The following table sets forth the capitalization of Critical Path as of December 31, 1998: (i) on an actual basis; (ii) on a pro forma basis after giving effect to the conversion of all outstanding shares of preferred stock into common stock upon completion of this offering and the assumed exercise on a net basis of certain warrants for the purchase of Series A and Series B Preferred Stock; and (iii) and on a pro forma basis as adjusted to reflect the sale by Critical Path of 4,500,000 shares of common stock offered hereby at an assumed initial public offering price of $10.00 per share and the receipt of the estimated net proceeds therefrom after deducting underwriting discounts and commissions and estimated offering expenses payable by Critical Path. See "Use of Proceeds."
December 31, 1998 -------------------------------- Pro Forma Actual Pro Forma As Adjusted -------- --------- ----------- (in thousands) Capital lease obligations, less current portion....................................... $ 2,454 $ 2,454 $ 2,454 -------- -------- -------- Shareholders' equity: Series A Convertible Preferred Stock, $0.001 par value; 13,288,519 shares authorized, 12,725,864 shares issued and outstanding, actual; no shares issued and outstanding pro forma and pro forma as adjusted............. 13 -- Series B Convertible Preferred Stock, $0.001 par value; 10,000,000 shares authorized, 3,636,739 shares issued and outstanding, actual; no shares issued and outstanding pro forma and pro forma as adjusted............. 4 -- Common stock, $0.001 par value; 38,636,363 shares authorized; 8,294,338 shares issued and outstanding, actual; 24,921,049 shares issued, pro forma; 29,421,049 shares issued and outstanding, pro forma as adjusted(1)... 8 25 30 Additional paid-in capital................... 41,901 41,901 82,946 Notes receivable from shareholders........... (1,151) (1,151) (1,151) Unearned compensation........................ (12,882) (12,882) (12,882) Accumulated deficit.......................... (12,535) (12,535) (12,535) -------- -------- -------- Total shareholders' equity................. 15,358 15,358 56,408 -------- -------- -------- Total capitalization..................... $ 17,812 $ 17,812 $ 58,862 ======== ======== ========
- -------- (1) The number of shares of common stock to be outstanding after this offering is based on the number of shares outstanding as of December 31, 1998 and does not include the following: . 7,752,556 shares subject to options outstanding as of December 31, 1998 at a weighted average exercise price of $0.86 per share; . 2,611,462 additional shares that could be issued under Critical Path's 1998 Stock Plan as of December 31, 1998; . 794,066 shares that could be issued upon exercise of outstanding warrants and stock purchase rights as of December 31, 1998; . 600,000 shares that could be issued under Critical Path's Employee Stock Purchase Plan; and . 2,494,130 shares that could be issued upon exercise of warrants granted subsequent to December 31, 1998. 19 DILUTION Our pro forma net tangible book value as of December 31, 1998 was $15,358,000, or $0.62 per share of common stock. Pro forma net tangible book value per share is determined by dividing the amount of our total tangible assets less total liabilities by the number of shares of common stock outstanding at that date, assuming conversion of all outstanding shares of preferred stock and the exercise on a net basis of certain warrants relating to Series A and Series B Preferred Stock. Dilution in net tangible book value per share represents the difference between the amount per share paid by purchasers of shares of common stock in the offering made hereby and the net tangible book value per share of common stock immediately after the completion of this offering. After giving effect to the sale of the 4,500,000 shares of common stock offered by Critical Path hereby (at an assumed public offering price of $10.00 per share and after deducting the underwriting discounts and commissions and our estimated offering expenses), our pro forma as adjusted net tangible book value of Critical Path at December 31, 1998 would have been $56,408,000, or $1.92 per share. This represents an immediate increase in pro forma net tangible book value of $1.30 per share to the existing shareholder and an immediate dilution of $8.08 per share to new investors purchasing shares in this offering. The following table illustrates this per share dilution: Assumed initial public offering price per share.................. $10.00 ------ Pro forma net tangible book value per share as of December 31, 1998............................................................ $0.62 Increase in pro forma net tangible book value per share attributable to this offering................................... 1.30 ----- Pro forma net tangible book value per share after the offering... 1.92 ------ Dilution per share to new investors.............................. $ 8.08 ======
The following table summarizes, on a pro forma basis as of December 31, 1998, the total number of shares of common stock purchased from Critical Path, the total consideration paid to Critical Path and the average price per share paid by existing shareholders and by new investors purchasing shares in this offering (based upon an assumed initial public offering price of $ per share and before deducting the underwriting discounts and commissions and our estimated offering expenses):
Shares Purchased Total Consideration ------------------ ------------------- Average Price Number Percent Amount Percent Per Share ---------- ------- ----------- ------- ------------- Existing shareholders...... 24,921,049 85% $26,915,000 37% $ 1.08 New investors.............. 4,500,000 15% 45,000,000 63% $10.00 ---------- --- ----------- --- Total.................... 29,421,049 100% $71,915,000 100% ========== === =========== ===
The foregoing table assumes no exercise of the underwriters' over-allotment option or of any outstanding stock options or warrants after December 31, 1998. As of December 31, 1998, there were outstanding options to purchase an aggregate of 7,752,556 shares of common stock at a weighted average exercise price of $0.86 per share and warrants to purchase an aggregate of 794,066 shares at a weighted average purchase price of $2.74 per share. To the extent any of these options or warrants are exercised, there will be further dilution to new investors. See "Management--1998 Stock Plan" and Notes 6, 7 and 8 of the Notes to Consolidated Financial Statements. 20 SELECTED CONSOLIDATED FINANCIAL INFORMATION The selected consolidated balance sheet data as of December 31, 1997 and 1998 and the selected consolidated statement of operations data for the period from February 19, 1997 (Inception) to December 31, 1997 and for the year ended December 31, 1998 have been derived from the Consolidated Financial Statements of Critical Path, Inc., included elsewhere in this prospectus. The data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and the Notes thereto included elsewhere in this prospectus (in thousands, except per share data).
Period from February 19, 1997 Year Ended (Inception) to December 31, December 31, 1997 1998 ----------------- ------------ Consolidated Statement of Operations Data: Net revenues..................................... $ -- $ 897 Cost of net revenues............................. -- (2,346) ------- -------- Gross profit (loss)............................ -- (1,449) ------- -------- Operating expenses: Research and development........................ 454 2,246 Sales and marketing............................. 244 2,318 General and administrative...................... 358 5,435 ------- -------- Total operating expenses....................... 1,056 9,999 ------- -------- Loss from operations............................. (1,056) (11,448) Interest and other income........................ -- 375 Interest expense................................. (18) (388) ------- -------- Net loss......................................... $(1,074) $(11,461) ======= ======== Net loss per share--basic and diluted............ $(0.54) $ (2.94) ======= ======== Weighted average shares--basic and diluted....... 1,994 3,899 ======= ======== Pro forma net loss per share (unaudited): Net loss per share--basic and diluted.......... $ (0.81) ======== Weighted average shares--basic and diluted..... 14,194 ========
December 31, ---------------- 1997 1998 ------- ------- Consolidated Balance Sheet Data: Cash and cash equivalents..................................... $ 1 $14,791 Working capital (deficit)..................................... (1,524) 12,524 Total assets.................................................. 550 20,663 Capital lease obligations, long-term.......................... 42 2,454 Shareholders' equity (deficit)................................ (1,021) 15,358
- -------- (1) Computed on the basis described in Note 1 of Notes to Consolidated Financial Statements. 21 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this prospectus. The following discussion contains forward-looking statements. Critical Path's actual results may differ significantly from those projected in the forward- looking statements. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed in "Risk Factors" and elsewhere in this prospectus. Overview Critical Path was founded in February 1997 to deliver email hosting solutions to Internet service providers who provide access to the Internet, web hosting companies, web portals, which are World Wide Web sites intended to be major starting sites for users when they connect to the World Wide Web, and corporations. From its inception to October 1997, Critical Path's operating activities related primarily to the planning and developing of our proprietary technological solution, recruiting personnel, raising capital and purchasing operating assets. Critical Path initiated service in October 1997. We have since continued making investments to improve the quality of our services. In December 1997, we enhanced our initial service offering, a hosting service based on Post Office Protocol 3, a standard protocol for receiving email commonly referred to as "POP3," with the addition of a web mail interface. More recently, in January 1999, we enhanced service with the addition of an offering based on the Lightweight Directory Access Protocol, or LDAP, a directory software protocol. At December 31, 1998, Critical Path had over 100 customers. In early 1999, we intend to further enhance our service offering with the inclusion of IMAP4, a new hosting service based on the Internet Message Access Protocol, a standard protocol for accessing and storing email from a user's server. We derive substantially all of our revenues through the sale of email hosting services. Our service revenues are derived primarily from contractual relationships providing revenues on a per mailbox basis. These contracts are typically one to three years in length. Agreements with some of our customers require minimum performance standards regarding the availability and response time of our email 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. Service revenues are recognized and billed on a monthly basis as the service is performed. We expect to expand our operations and employee base, including our sales, marketing, technical, operational and customer support resources. In particular, we intend to expand our sales force to deliver our email outsourcing services to customers in our four target markets: ISPs, web hosting companies, web portals and corporations. We also intend to further develop new and existing strategic relationships to expand our distribution channels and to undertake joint product development and marketing efforts. We intend to develop worldwide sales offices and data centers. We currently have sales offices in the United States and Germany and expect to open additional data centers in the United States, Europe and Asia. Future investments in technology may involve the development, acquisition or licensing of technologies that complement or augment our existing services and technologies. 22 During 1998, the Company recorded aggregate unearned compensation totaling approximately $15.4 million in connection with the certain sales of stock and the grant of certain options to employees, directors and consultants, which amount is being amortized over the four-year vesting period of such options. Of the total unearned compensation, approximately $366,000, $217,000, $269,000 and $1.7 million were amortized in the quarters ended March 31, June 30, September 30, and December 31, 1998, respectively. In January 1999, the Company granted options resulting in an additional $3.4 million of unearned compensation. The Company expects per quarter amortization related to unearned compensation of between $2.2 million and $1.6 million during 1999, between $1.2 million and $820,000 during 2000, between $620,000 and $390,000 during 2001, and between $200,000 and $45,000 during 2002. These amortization amounts were allocated among the operating expense categories based upon the primary activity of the individuals who received the option grants. In January 1999, we entered into an agreement with ICQ, a subsidiary of America Online, Inc., pursuant to which we will provide email hosting services that will be integrated with ICQ's instant messaging service provided to ICQ's customers. The ICQ instant messaging service is designed to allow users to communicate in real time over the Internet. As part of the agreement, ICQ agreed to provide sub-branded advertising for Critical Path in exchange for a warrant to purchase 2,442,766 shares of Series B Preferred Stock, issuable upon attainment of each of five milestones. The following table summarizes the shares underlying each milestone and the related exercise price:
Shares Underlying Exercise Warrant Price ---------- -------- Milestone 1............................................. 814,254 $ 4.26 Milestone 2............................................. 407,128 5.50 Milestone 3............................................. 407,128 6.60 Milestone 4............................................. 407,128 8.80 Milestone 5............................................. 407,128 11.00 --------- Totals................................................ 2,442,766 =========
The shares underlying the first milestone were immediately vested on the effective date of the agreement. The shares underlying the remaining milestones vest on the dates that ICQ completes registration of the specified number of sub-branded ICQ mailboxes applicable to each milestone. Using the Black-Scholes option pricing model and assuming a term of seven years and expected volatility of 90%, the initial fair value of the warrant on the effective date of the agreement approximated $14.473 million, which is being amortized to advertising expense using the straight-line method over four years. The shares underlying the second through fifth milestones will be remeasured at each subsequent reporting date until each sub-branded ICQ mailbox registration threshold is achieved. In the event such remeasurement results in increases or decreases from the initial fair value, which could be substantial, such increases or decreases will be recognized immediately, in the event the fair value of the shares underlying the milestone has been previously recognized, or over the remaining term. We expect to incur substantial non-cash charges associated with the grant of the warrant to America Online. In addition to amortization of the initial fair value of this warrant, which totaled $14.473 million, we expect that future changes in the trading price of our common stock at the end of each quarter and at the date certain milestones are achieved, will cause additional substantial changes in the ultimate amount of such amortization. We have incurred significant losses since our inception, and as of December 31, 1998 had an accumulated deficit of approximately $12.5 million. We intend to invest heavily in sales and 23 marketing, continued development of our network infrastructure and continued technology developments. We expect to continue to incur substantial operating losses for the foreseeable future. In view of the rapidly evolving nature of our business and our limited operating history, we believe that period-to-period comparisons of our revenues and operating results, including our 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. We do not believe that our historical growth rates are indicative of future results. Results of Operations The following table sets forth financial data for the year ended December 31, 1998. Data for the inception period are not presented as Critical Path had no revenues in that period. Further, amounts from the inception period are not comparable to those for the year ended December 31, 1998 due to the different duration of the periods and the acceleration of Critical Path's activities and related expenses throughout 1998. We believe that operating expenses will continue to increase in the future as we continue to expand our operations.
Year Ended December 31, 1998 ---------------------- (dollars in thousands) % of $ net revenues -------- ------------ Net Revenues.......................................... $ 897 100.0% Cost of revenues...................................... (2,346) (261.5) -------- -------- Gross profit......................................... (1,449) (161.5) -------- -------- Operating expenses: Research and development............................. 2,246 250.4 Sales and marketing.................................. 2,318 258.4 General and administrative........................... 5,435 605.9 -------- -------- Total operating expenses............................ 9,999 1,114.7 -------- -------- Loss from operations.................................. (11,448) (1,276.2) Interest and other income............................. 375 41.8 Interest expense...................................... (388) (43.3) -------- -------- Net loss.............................................. $(11,461) (1,277.7%) ======== ========
Net Revenues Net revenues include charges relating to the amortization of fair value of warrants issued to certain customers. In January 1998, we began to recognize revenues from the sale of our email hosting services. Net revenues for 1998 were $897,000. In early 1998, we executed agreements with E*TRADE, an on-line brokerage services company, and Verio, a web hosting organization, pursuant to which we began to derive revenue for providing email services. For 1998, E*TRADE and Verio accounted for approximately 62% and 30%, respectively, of our net revenues, excluding the value of stock purchase rights received by customers. A substantial portion of those revenues occurred during the quarter ended December 31, 1998. Net revenues during the quarter ended December 31, 1998, were $605,000, or 68% of net revenues for 1998. Cost of Net Revenues Cost of net revenues consists primarily of costs incurred in the delivery and support of our email services, including depreciation of capital equipment used in our network infrastructure and 24 personnel costs in our operations and customer support functions. During 1998, these costs were approximately $2.3 million, or 261.5% of net revenues. We made significant acquisitions of equipment for our data centers at the beginning of the quarter ended September 30, 1998, and, as a result, our depreciation expense increased significantly in the final two quarters of 1998. Additionally, we significantly increased our headcount in operations and customer support throughout the year. From January 1, 1998 to December 31, 1998, operations and customer support personnel increased from zero to 25. Operating Expenses Research and Development. Our research and development expenses consist primarily of compensation for our technical staff, payments to outside contractors, and, to a lesser extent, allocated occupancy costs and related overhead. We expense research and development expenses as they are incurred. Research and development expenses amounted to $2.2 million, or 250.4% of net revenues, during 1998, and increased substantially each quarter throughout the year as we increased personnel and our use of outside contractors. From January 1, 1998 to December 31, 1998, our research and development personnel increased from 11 to 27. Sales and Marketing. Our sales and marketing expenses consist primarily of compensation for our sales and marketing personnel, advertising, trade show and other promotional costs, and, to a lesser extent, allocated occupancy costs and related overhead. Sales and marketing expenses amounted to $2.3 million or 258.4% of net revenue during 1998, and increased substantially in the final two quarters of the year as we expanded our sales force and significantly increased the promotion of our email hosting services. Increases in compensation associated with additional headcount, incentive compensation payments, and increases in advertising and promotional expenses accounted for the increases to sales and marketing expense in the second half of 1998. From January 1, 1998 to December 31, 1998, our sales and marketing personnel increased from 2 to 30. General and Administrative. Our general and administrative expenses consist primarily of compensation for personnel, fees for outside professional services, and, to a lesser extent, allocated occupancy costs and related overhead. General and administrative expenses amounted to $5.4 million, or 605.9% of net revenues, during 1998, and increased substantially in the quarter ended December 31, 1998. Increases in compensation associated with additional headcount, higher fees for outside professional services, and the amortization of unearned compensation related to stock and stock option grants accounted for this increase. From January 1, 1998 to December 31, 1998, general and administrative personnel increased from 4 to 11. Interest and Other Income and Interest Expense Interest and other income consist primarily of interest earnings on our cash and cash equivalents. Interest and other income amounted to $375,000 during 1998. We concluded a private placement of equity securities in September 1998. As a result, interest income increased significantly in the final quarter of the year. To date, we have incurred interest expense on notes payable and capital lease obligations. For 1998, interest expense amounted to $388,000. Income Taxes No provision for federal and state income taxes was recorded as we incurred net operating losses from inception through December 31, 1998. At December 31, 1998, we had approximately $8.8 million of federal and state net operating loss carryforwards available to offset future taxable 25 income which expire in varying amounts beginning in 2012. Under the Tax Reform Act of 1986, the amounts of and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. For example, the amount of net operating losses that we may utilize in any one year would be limited in the presence of a cumulative ownership change of more than 50% over a three year period. Because there is significant doubt as to whether we will realize any benefit from this deferred tax asset, we have established a full valuation allowance as of December 31, 1998. Stock-Based Compensation During 1998, we recorded aggregate unearned compensation in the amount of $15.4 million in connection with the grant of certain stock options during 1998. Amortization of such compensation is allocated among operating expense categories based upon the principal activity of the individuals who received the option grants and totaled $3.314 million during 1998. See Notes 8 and 9 of Notes to Consolidated Financial Statements. Quarterly Results of Operations The following table sets forth certain unaudited quarterly statements of operations data for the four quarters ended December 31, 1998. This information has been derived from Critical Path's consolidated unaudited financial statements, which, in management's opinion, have been prepared on the same basis as the audited consolidated financial statements, and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information for the quarters presented. This information should be read in conjunction with the audited consolidated financial statements of Critical Path and the notes thereto included elsewhere in this prospectus. The operating results for any quarter are not necessarily indicative of the operating results for any future period.
Three Months Ended -------------------------------------------------------- Mar. 31, 1998 June 30, 1998 Sept. 30, 1998 Dec. 31, 1998 ------------- ------------- -------------- ------------- (in thousands) Net revenues............ $ 70 $ 66 $ 156 $ 605 Cost of revenues........ (82) (230) (941) (1,093) ------- ------- ------- ------- Gross profit (loss)... (12) (164) (785) (488) ------- ------- ------- ------- Operating expenses: Research and development........... 298 420 590 938 Sales and marketing.... 266 236 660 1,156 General and administrative........ 594 978 987 2,876 ------- ------- ------- ------- Total operating expenses............. 1,158 1,634 2,237 4,970 ------- ------- ------- ------- Loss from operations.... (1,170) (1,798) (3,022) (5,458) Interest and other income (expense), net.. (150) 47 (39) 129 ------- ------- ------- ------- Net loss................ $(1,320) $(1,751) $(3,061) $(5,329) ======= ======= ======= =======
Revenues increased substantially in the quarter ended December 31, 1998, as revenues from E*TRADE rose significantly during this period relative to prior periods. General and administrative expenses increased substantially during the quarter ended December 31, 1998, due to increases in compensation associated with additional headcount, higher fees for outside professional services, and the amortization of unearned compensation. 26 Fluctuations in Quarterly Results We have incurred operating losses since inception, and we cannot be certain that we will achieve profitability on a quarterly or annual basis in the future. Critical Path believes that future operating results will be subject to quarterly fluctuations due to a variety of factors, including, but not limited to: . continued growth of the Internet and of email usage; . demand for outsourced email services; . our ability to attract and retain customers and maintain customer satisfaction; . our ability to upgrade, develop and maintain our systems and infrastructure; . the amount and timing of operating costs and capital expenditures relating to expansion of our business and infrastructure; . technical difficulties or system outages; . the announcement or introduction of new or enhanced services by our competitors; . our ability to attract and retain qualified personnel with Internet industry expertise, particularly sales and marketing personnel; . the pricing policies of our competitors; . failure to increase our international sales; and . governmental regulation surrounding the Internet and email in particular. In addition to the factors set forth above, our operating results will be impacted by the extent to which we incur non-cash charges associated with stock-based arrangements with the employees and non-employees. In particular, we expect to incur substantial non-cash charges associated with the grant of a warrant to America Online. In addition to amortization of the initial fair value of this warrant, which totaled $14.473 million, we expect that future changes in the trading price of our common stock at the end of each quarter and at the date certain milestones are achieved, will cause additional substantial changes in the ultimate amount of such amortization. Due to lead times required to purchase, install and test equipment, we typically need to purchase equipment well in advance of the receipt of any expected revenues. Delays in obtaining this equipment could result in unexpected revenue shortfalls. Liquidity and Capital Resources Our cash and cash equivalents increased by approximately $14.8 million during 1998. This net change occurred as we raised approximately $23.4 million in proceeds from the sale of equity securities, and incurred a net loss of approximately $11.5 million during the year as we expanded our organization and operations. Net of depreciation, our investment in property and equipment increased approximately $4.2 million during 1998. Installation of network infrastructure equipment in our data centers, purchases of furniture and equipment for new employees, and leasehold improvements related to office expansions accounted for this increase. We have a credit agreement with a bank which provides a line of credit for working capital advances of up to $1.0 million. There were no borrowings under this line of credit at December 31, 1998. Outstanding borrowings accrue interest at a rate equal to the bank's prime rate plus 2.0%. During 1998, we retired approximately $1.3 million in convertible promissory notes payable by 27 converting approximately $1.1 million of the outstanding notes into equity securities and paying cash for the remainder. Capital lease obligations, including both short-term and long-term portions, increased approximately $4.0 million during fiscal year 1998 as we secured financing for a substantial share of our additions to property and equipment. Deferred revenue increased $500,000 during 1998 as we received payment from one customer as an advance for future services. Our line of credit and capital lease obligations contain no provisions that would limit our future borrowing ability. In January 1999, we completed the second round of the Series B Convertible Preferred Stock financing through the issuance of approximately 3.7 million shares, including 454,544 shares issued pursuant to outstanding stock purchase rights, for gross proceeds of $15.6 million. Also in January 1999, we sold 1,090,909 shares of common stock for gross proceeds of $2.4 million. We believe that the net proceeds from the sale of common stock offered hereby, together with our current cash balances, proceeds from the January equity sales and cash available under our line of credit, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. As of February 28, 1999, we had purchased or were committed over the next 12 months to purchase approximately $2.0 million of property and equipment. We expect that our investment in property and equipment will continue to grow as we seek to increase our capacity to provide email hosting services. Further, we anticipate that further expansion of our operations will cause us to incur negative cash flows for at least the forthcoming fiscal year, and therefore require us to consume our cash and other liquid resources to support our growth in operations. Our operating and investing activities may require us to obtain additional equity or debt financing. In addition, although there are no present understandings, commitments or agreements with respect to any acquisition of other businesses, products, or technologies, we may, from time to time, evaluate potential acquisitions of other businesses, products, and technologies. In order to consummate potential acquisitions, we may need additional equity or debt financings in the future. Year 2000 Issues The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any computer programs or hardware that have date-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations causing disruptions of operations for any company using such computer programs or hardware, including, among other things, a temporary inability to process transactions, send invoices or engage in normal business activities. As a result, many companies' computer systems may need to be upgraded or replaced in order to avoid "Year 2000" issues. We are a comparatively new enterprise, and, accordingly, the software and hardware we use to manage our business has all been purchased or developed by us within the last 24 months. While this fact pattern does not uniformly protect us against Year 2000 exposure, we believe we gain some mitigation from the fact that the information technology ("IT") we use to manage our business is not based upon "legacy" hardware and software systems. "Legacy system" is a term often used to describe hardware and software systems which were developed in previous decades when there was less awareness of Year 2000 issues. Generally, hardware and software design within the current decade and the past several years in particular has given greater consideration to Year 2000 issues. All of the software code we have internally developed to manage our network traffic, for example, is written with four digits to define the applicable year. 28 We are in the process of testing our internal IT and non-IT systems. To date, we have only completed preliminary testing of our internally developed IT and non-IT systems. All of the testing we have completed has been performed by our own personnel; to date, we have not retained any outside service or consultants to test or review our systems for Year 2000 compliance. Based on the testing we have performed, we believe that such software is Year 2000 compliant; however, we intend to complete more extensive testing by mid 1999. In addition to our internally developed software, we utilize software and hardware developed by third parties both for our network and internal information systems. To date, we have not done any testing of such third-party software or hardware to determine Year 2000 compliance. We have, however, obtained certifications from our key suppliers of hardware and networking equipment for our data centers that such hardware and networking equipment is Year 2000 compliant. Additionally, we have received assurances from the providers of key software applications for our internal operations that their software is Year 2000 compliant. Based upon an initial evaluation of our broader list of software and hardware providers, we are aware that all of these providers are in the process of reviewing and implementing their own Year 2000 compliance programs, and we will work with these providers to address the Year 2000 issue and continue to seek assurances from them that their products are Year 2000 compliant. In addition, we rely on third party network infrastructure providers to gain access to the Internet. If such providers experience business interruptions as a result of their failure to achieve Year 2000 compliance, our ability to provide Internet connectivity could be impaired, which could have a material adverse effect on our business, results of operations and financial condition. Our customers' success in maintaining Year 2000 compliance is also significant to our ability to generate revenues and execute our business plan. We currently derive revenue either by charging a fixed fee per month for each mailbox we host, or by sharing advertising revenues with our customers. In either case, interruptions in our customers' services and on-line activities caused by Year 2000 problems could have a material, adverse effect on our revenues to the extent that such interruptions limit or delay our customers' ability to expand their base of email users. We have not incurred any significant expenses to date, and we do not anticipate that any future costs associated with our Year 2000 remediation efforts will be material. However, if we, our customers, our providers of hardware and software, or our third party network providers fail to remedy any Year 2000 issues, our service could be interrupted and we could experience a material loss of revenues that could have a material, adverse effect on our business, results of operations, and financial condition. We would consider such an interruption to be the most reasonably likely unfavorable result of any failure by us, or failure by the third parties upon whom we rely, to achieve Year 2000 compliance. Presently, we believe we are unable to reasonably estimate the duration and extent of any such interruption, or quantify the effect it may have on our future revenues. We have yet to develop a comprehensive contingency plan to address the issues which could result from such an event. We are prepared to develop such a plan if our ongoing assessment leads us to conclude we have significant exposure based upon the likelihood of such an event. See "Risk Factors--We Face Year 2000 Risks." Recent Accounting Pronouncements In March 1998, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") No. 98-1, "Software for Internal Use," which provides guidance on accounting 29 for the cost of computer software developed or obtained for internal use. SOP No. 98-1 is effective for financial statements for fiscal years beginning after December 15, 1998. Critical Path does not expect that the adoption of SOP No. 98-1 will have a material impact on its consolidated financial statements. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). Critical Path is required to adopt SFAS 133 in fiscal 2000. SFAS 133 established methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities. Critical Path has not yet determined what the effect of SFAS 133 will be on its operations and financial position. 30 BUSINESS Company Overview We are a leading provider of email hosting services. Our email services are designed to allow a wide range of organizations, including Internet service providers, web hosting companies, web portals and corporations, to reduce costs and improve customer service by outsourcing their email systems. Our services are designed to facilitate scalability and reliability, allow access to advanced technologies and provide greater access with high levels of security. In addition, our service is designed to allow our customers to enhance their brand recognition by maintaining their "look and feel" while improving the functionality of their email service. We intend to build on our expertise in email services to provide additional Internet messaging services in the future. At December 31, 1998, we had over 100 customers and intend to further develop new and existing strategic relationships to expand our distribution channels and to undertake joint product development and marketing efforts. Our strategic partners to date include ICQ, a subsidiary of America Online, E*TRADE, Network Solutions, Sprint and US West. Industry Background Growth of the Internet and Email The Internet has experienced rapid growth and has developed into a significant tool for global communications, commerce and media, enabling millions of people to share information and transact business electronically. International Data Corporation ("IDC") estimates that there were over 38 million web users in the United States and over 68 million worldwide at the end of 1997. IDC projects these numbers to increase to over 135 million web users in the United States and over 319 million worldwide by the end of 2002. Internet-based businesses have emerged to offer a variety of products and services over the Internet. Additionally, many traditional businesses now use the Internet for a growing number of applications, including advertising, sales, customer service and training. Advances in on-line security and payment mechanisms have also prompted more businesses and consumers to engage in electronic commerce. IDC estimates that the number of customers buying goods and services on the Internet will grow from 17.6 million worldwide in 1997 to 128.4 million worldwide in 2002. The growth of the Internet is the result of a number of factors, including the extensive and growing installed base of advanced personal computers in the home and workplace, increasingly faster and cheaper access to the Internet, improvements in network infrastructure and an increased awareness of the Internet among consumer and business users. Alternative access devices, including television set-top boxes, personal digital assistants, pagers, Internet capable telephones and wireless phones are also contributing to the increasing use of the Internet. Further, the development of applications for the Internet platform has helped fuel the growth of the Internet. Email, one of the most popular Internet applications, has broadened from a simple personal messaging tool to a strategic business tool. According to Electronic Mail & Messaging Systems, there were 263 million electronic mailboxes worldwide as of September 30, 1998. Electronic Mail & Messaging Systems estimates that there could be as many as 400 million electronic mailboxes worldwide by the end of 1999. According to the Gartner Group, approximately 300 billion electronic mail messages were sent in 1998. Email messages have increased in volume and functionality, and this trend is expected to continue. For example, email is expected to become a major vehicle for e- commerce transactions. Forrester Research predicts that the typical online consumer will participate 31 in eight to ten commerce-related exchanges via email per week by 2001. Furthermore, the electronic mailbox as a locating and delivering device has enabled additional applications such as directory services, scheduling, document sharing, work-flow and unified messaging. This increased functionality, along with the widespread acceptance of email, positions the electronic mailbox as a platform for other forms of electronic messaging. Development of Email Email was initially developed for isolated groups of people working on single mainframe computers or on small networks of homogeneous computers. Early email implementations were based on proprietary technologies, incompatible with other systems and limited to single local area networks ("LANs"). Mail transfer standards were subsequently developed to carry mail traffic between LANs but did not allow for communication outside of the user's corporation or service. While these systems were limited when compared to current email systems, they became an increasingly important communication tool within many organizations. Users have migrated to open-standards mail systems, such as Lotus Notes and Microsoft Exchange, that allow communication with any email user on the Internet, from proprietary systems, such as Lotus cc:mail and Microsoft Mail. Simple Mail Transport Protocol ("SMTP"), currently the most widely used mail standard on the Internet, allows users of proprietary mail systems to communicate over the Internet by converting messages' internal mail formats to SMTP before transmission. In addition, new open standards are emerging to enhance the functionality of email. For example, Post Office Protocol ("POP"), which has been adopted by most ISPs, allows users to connect to a shared mail server and download mail to their PC or alternative access device. In addition, Internet Messaging Access Protocol ("IMAP"), one of the latest email standards, allows users to access their mailboxes at the server rather than at the desktop level. This flexibility is particularly valuable for users who access their mail from a variety of different computers with different email clients such as Microsoft Outlook, Eudora and HyperText Markup Language ("HTML"), more commonly known as web-based email. Current Trends in Email As the importance of email grows, customers increasingly expect their email service to meet the same standards of carrier-class reliability and availability that consumers have traditionally received from their telephone service providers. For example, email customers expect reliability from their email service similar to the dial tone they hear when they pick up the telephone, commonly referred to as web-tone reliability. Similarly, customers want email access to be as ubiquitous as their telephone access by being able to download their email from anywhere in the world, at anytime and through a variety of devices. Just as many individuals have multiple phone numbers for home and business use, a growing number of people have multiple email accounts. As a result, domain names, which are the Internet identities that correlate to unique electronic addresses such as user@domain.com, are proliferating. Companies use multiple domains to build awareness of their brands in electronic communication, and individuals increasingly use domains to express personal identity. To address this growth, a wide range of businesses, including ISPs, web hosting companies, web portals and corporations, are finding that providing their customers or employees with email access is a necessity. ISPs, web hosting companies and telecommunication carriers offer email to enhance their services offerings and to maintain competitiveness with other companies in their industry. Many web portals offer email service to increase web traffic on their sites and strengthen their brand due to 32 repeat traffic from users checking for messages. In addition, corporations increasingly view email as a means to decrease costs and increase productivity. Email messages have increased not only in volume but also in complexity. The use of graphics and multimedia elements is becoming more common and requires greater functionality on the part of the email service. As organizations and the numbers of users grow, the ability to accommodate thousands, or millions, of additional mailboxes in a single domain requires substantial investment in hardware, software and personnel. Further, in the largest email implementations, such as ISPs or web portals, the design architecture must handle complex networking and scale issues across many domains. Web organizations that implement and host multiple domains for customers incur substantial additional expenses because of the complexity associated with hosting multiple domains. There is no unified email service standard, and online service providers must continually enhance and maintain email applications for existing standards, as well as seek to develop new features and functionality for emerging standards. For example, LDAP is an emerging standard that is the foundation for adding additional applications to login and access features of email service. Moreover, ISPs and corporations running their own email must make substantial investments in backup systems and networking equipment if they are to meet the growing expectation of email service with carrier class access, availability and reliability. Today, most organizations are using internal hardware and software solutions to address their email needs. Many companies attempting to manage expanding and increasingly sophisticated email systems lack the resources and expertise to cost-effectively implement, maintain, scale, enhance and service the hardware and software components of an email system. Businesses often find it difficult to implement state-of-the-art technology in their own infrastructure and individuals with the expertise to maintain a sophisticated email system can be scarce and costly to hire, train and retain. As a result, organizations seeking to lower their costs and to quicken time to market with complex technologies are increasingly looking to outsource non-core competencies to maintain competitiveness. Critical Path Solution We deliver advanced email services to ISPs, web hosting companies, web portals and corporations, giving them the ability to provide a feature-rich email service to their customers and employees. Our services are designed to provide the following key benefits: Lower Total Cost of Ownership Our customers do not need to lease, buy or continually upgrade existing hardware and software, or recruit and retain systems engineers and administrative personnel for their email services. Our service is designed to reduce customers' administrative burden by eliminating the cycle of purchasing, installing, testing, debugging and deploying email systems. The software is maintained at our facilities, not at customer facilities, and we employ a team of systems administrators to monitor the service 24 hours a day, seven days a week. By having the capability to host millions of mailboxes, we provide customers a cost savings over in-house email solutions through economies of scale. Scalability; Web-Tone Reliability Our system's architecture and infrastructure are designed to facilitate scalability and reliability. While existing email software solutions can scale to support millions of users at a single domain (user@domain.com), we have designed our architecture to support our service over hundreds of 33 millions of mailboxes across millions of domains (user@domain1.com, user@domain2.com, user@domain3.com, etc.), allowing each customer to create email addresses at his or her own domain. Our hardware and software infrastructure consists of multiple servers running software in a manner that balances the use of the servers. This infrastructure allows multiple domain hosting while reducing the amount of required equipment and capacity. We have created a global network strategy to provide the type of continuous service that individuals have come to expect from their telephone service providers. We provide our customers improved performance through our multiple peering relationships, agreements with companies with existing peering relationships and the purchase of additional access to telecommunication paths from national Internet access providers. For redundancy purposes, we maintain two data centers in the United States and plan to open additional data centers in the United States, Europe and Asia. Leading-Edge Technology We provide our customers with access to advanced technologies. We eliminate the need for customers and partners to maintain a core competency in email by having experts with experience in rapidly deploying new technologies, combating system failures due to unsolicited commercial email traffic and maintaining network and system security. Our services include POP3, web-based email and, in the near future, IMAP4, which enables customers to choose the option that suits their end-users' needs. Customers rely on us to evaluate, test and implement the leading features to maintain a leading email solution. Our technological capabilities enable us to quickly implement competitive new technologies for our customers and end-users, reducing their time to market for leading technologies. Anytime, Anywhere Accessibility We have designed our services to allow easy access by customers and end- users. Designed and built on open Internet-based standards, our services are compatible with leading desktop software such as Microsoft Outlook and Eudora. In addition, we have developed a web-based email interface that is compatible with leading web browsers, including Microsoft Internet Explorer and Netscape Navigator. Our email services are designed to allow administrators and end- users to access their email system anywhere at any time. Our technology is designed to support innovations in standards-based access devices, such as hand-held computers, cellular and personal communications services ("PCS") telephones and pagers. Enhanced Security We have created a custom firewall solution to enhance network and data center security. Using a combination of licensed software technology, internally developed software and sophisticated third-party hardware, we reduce the potential for network breaches. We have network and data center surveillance 24 hours a day, seven days a week to identify and curtail potential security breaches. We are not aware of any security breaches to our network. Branding; Customer Control Our messaging service solution enables our customers to maintain control over their own brand and desired functionality. Our fully customized web-based "brandable" email interfaces include customer logos and preserve the existing "look and feel" of the customers' brands. Our web-based Mail Administration Center is designed to give customers control via a secure Account Provisioning Protocol, a software interface into our platform which allows customers to integrate their existing functionality with our mail system. This enables customers to add and delete accounts and functionality either at the domain level, or at the individual end-user level. 34 Strategy Our objective is to be the premier provider of comprehensive, advanced Internet messaging services. We plan to attain this goal by pursuing the following key strategies: Extend Technology Leadership in Messaging Applications We intend to capitalize on our expertise in email services to deliver industry-leading functionality to other types of electronic messaging. Building upon our Internet-based email architecture, we plan to deliver industry-leading functionality, including global and local directories and other capabilities, and to deliver new applications that will extend the core functionality of email and integrate smoothly with existing back office applications. Our services development team regularly meets with customers and participates in research projects with leading industry groups and analysts to anticipate future customer needs. We also participate in open standards organizations and Internet technology leadership groups, such as IETF (Internet Engineering Task Force), the North American Network Operators Group and the Coalition Against Unsolicited Commercial Email, a spam control organization. Develop and Leverage Strategic Relationships We intend to expand our marketing and distribution channels through strategic relationships with key ISPs, web hosting companies, web portals and corporations to increase quickly the number of electronic mailboxes we host. Our strategic partners include ICQ, a subsidiary of America Online, E*TRADE, Network Solutions, Sprint and US West. We intend to further develop new and existing strategic relationships to expand our distribution channels and to undertake joint product development and marketing efforts, such as integrating email into e-commerce applications. Increase Sales and Marketing Efforts We intend to significantly expand our sales and marketing activities while focusing on four target markets: ISPs, web hosting companies, web portals and corporations. In this expansion, we plan to target and hire seasoned sales professionals with specific expertise and contacts within our focused markets. We also intend to expand our indirect sales channel by teaming with leading distributors, resellers and system integrators with strong backgrounds and market presence. As of February 28, 1999, we had 38 sales and marketing personnel. Develop Value-Added Services We intend to extend our services beyond email by offering additional value- added services. These services are intended to extend our relationships with current customers, to attract new customers and to allow us to differentiate ourselves in the email service provider market. We believe that our email hosting solution can form the foundation of a wide range of Internet messaging applications for which we intend to provide solutions. Examples of value-added services or applications that can be leveraged are secure email, e-commerce and enterprise services. Expand International Presence In addition to expanding our U.S. presence, we believe there is substantial opportunity for outsourcing messaging services in non-U.S. markets. We intend to capitalize by developing worldwide sales offices, data centers and strategic relationships. We have established a sales office in Germany, and we plan to open additional sales offices and data centers in Europe and Asia. In 35 addition, we intend to support our worldwide operations by offering localized web-based email interfaces. For example, we have already developed web-based email interfaces in Spanish, Portuguese, German, French and English. Services We offer multiple email services to ISPs, web hosting companies, web portals and corporations. Our "all-in" service model pricing includes all enhancements, upgrades and new standard features. Pricing is based on a per mailbox, per month charge that varies depending on functionality and volume. Web portal market pricing is based on a minimal per mailbox, per month charge plus a share of revenue generated by advertising on the web-based email interface. Our standard service offering includes our basic services as part of the monthly mailbox fee. Our add-ons are included in the basic mailbox offering or offered as an optional premium service. Our premium services are optional add-ons to the basic mailbox charge and are offered for an additional charge. Our service offering includes web-based end-user support. Additional support through customer help desks is provided 24 hours a day, seven days a week by contractual agreement. Professional implementation and transitioning support for new customers is also included in the basic offering. [VALUE-FUNCTIONALITY CHART APPEARS HERE] 36 Current Services We have introduced to market a variety of email services. Information concerning our current email services is summarized in the following table: Class of Target Service Description Benefits Service Markets - ---------------------------------------------------------------------------------------------------- Web-Based . Hosting service based on a . Requires no software Basic All Email web mail interface downloads or configurations . End-users simply point any browser to http://mail.userdomain.com, enter account name and password for full email access - ---------------------------------------------------------------------------------------------------- POP3 Hosting . Hosting service based . Allows users to connect to a Basic ISPs, web on Post Office Protocol shared mail server and (Premium hosting, download email to their add-on corporate desktop client (Microsoft for Outlook, Eudora), which portals) stores the message on the user's hard drive each time the inbox is accessed - ---------------------------------------------------------------------------------------------------- Web-Based . Mail Administration Center . Allows email administrators Basic All Administration (MAC) to add, delete and modify Add-On has Secure Socket Layer- accounts online based brandable web interface - ---------------------------------------------------------------------------------------------------- Spam . Utilizes comprehensive . Protects users from Basic All Blocking/UBE filtering unsolicited bulk email, Add-On Filtering system commonly referred to as "spam" or "junk mail" . Identifies and eliminates spam - ---------------------------------------------------------------------------------------------------- Directory . Common directory layer to . Search capabilities Premium All Services share information between Add-On (LDAP) various independent software applications . LDAP services allow . End-users can update their publishing of directory own directory entries, and information for user domain administrators to communities update, add and delete entries . Key component of many collabora- tive applications such as certified delivery and calendaring - ---------------------------------------------------------------------------------------------------- Additional . Additional storage in . Provides expandability of Premium All Data Storage increments of 5 megabytes storage Add-On space - ---------------------------------------------------------------------------------------------------- Unified . Private-label unified . Allows users to retrieve Premium Portal Messaging messaging service through faxes and voice messages by Add-On JFAX, a company that logging into their email provides a unified messaging solution . Allows users to retrieve faxes and emails via voicemail and universal telephone number
37 Planned Services We intend to develop several new Internet messaging services to complement our existing services. Class of Target Service Description Benefits Service Markets - ------------------------------------------------------------------------------------------------------ IMAP4 . Hosting service that . Email messages and files hosted Basic All Hosting bridges the gap between on an IMAP server can be POP3 functionality and web- manipulated from multiple email based email accessibility environments without the need to transfer data - ------------------------------------------------------------------------------------------------------ Double-Byte . Web mail interface in . Allows display of web-based Basic All Localization double-byte languages: email interface in double-byte Add-On and Traffic Chinese and Japanese languages and transfer and storage of messages containing double-byte message data - ------------------------------------------------------------------------------------------------------ Permanent . Archives up to 5 megabytes of . Stores and backs up daily Basic All Archiving data per mailbox included archived documents on its Add-On in basic service servers - ------------------------------------------------------------------------------------------------------ ETRN . Email access that does not . Allows store and forward Basic ISP, require a dedicated access service for some or all Add-On Corporate line to the Internet messages at a specific domain . Provides ability to send email through the Internet while maintaining the existing groupware functionality of a local mailserver - ------------------------------------------------------------------------------------------------------ Mailing List . Supports custom-generated . Allows for user specified list Premium All Management lists, digest formats, list management Add-On filters, auto-subscribe and unsubscribe, and confirmation of subscriptions - ------------------------------------------------------------------------------------------------------ Calendar and . On-line calendars which . Integrates scheduling function Premium Corporate Schedule provide groupware with the ability to access the Add-On Functionality functionality user's schedule and those of colleagues - ------------------------------------------------------------------------------------------------------ SSL-Based . SSL-based encryption of . Provides enhanced security of Premium All Email POP3, IMAP4 and web-based email Add-On email messages messages - ------------------------------------------------------------------------------------------------------ USENET/ . Public and private . Facilitates participation in Premium All Newsgroup newsgroups which give the newsgroup in a web-friendly Add-On enterprise a platform for manner discussion outside the mailing list functionality . Allows access to messages stored on a news server - ------------------------------------------------------------------------------------------------------ Digital . Receipt verification . Verifies that message was Premium All Certificates service received by the authenticated Add-On recipient . Sends a confirmation notice to sender that the intended recipient has picked up the message when both sender and recipient are hosted on our system - ------------------------------------------------------------------------------------------------------ Certified . More sophisticated receipt . In addition to verifying that Premium Corporate Delivery verification service the message was delivered, Add-On users return encrypted digital certificates that identify them as the recipient
The statements in this prospectus regarding planned service offerings and anticipated features of such planned service offerings are forward-looking statements. Actual service offerings and benefits could differ materially from those projected as a result of a variety of factors, some or all of which may be out of our control. For a discussion of some of these factors, see "Risk Factors." 38 Customers We currently have the opportunity to offer email services to millions of mailboxes across our four target markets. The following is a list of companies with whom we have email services agreements and which have the greatest number of mailboxes within their respective categories: Internet Service Providers Web Hosting Companies - -------------------------- --------------------- DSL Networks CardSecure Isp.net Data 2 Info Las Vegas Digital Internet Navisite Network Solutions, Inc. NetConX TABNet Surfree.com, Inc. Tonic Domains Corporation US Online Network True Media Solutions Verio Texas Ultima Networks WNC Net Worldport Online
Web Portals Corporations - ----------- ------------ E*TRADE Bank Law Services Gayweb Birkenstock ifan (San Francisco Giants) California Family Health Council, Inc. The Mountain Zone CompareNet Inc. The Password (a division of Password Internet ICT Financial Publishing) Raging Bull Partech International Ventures C.V. Third Age Media, Inc. Photonetics US West Sprint
Target Markets We intend to expand our marketing and distribution channels through strategic relationships to rapidly increase the number of electronic mailboxes hosted. We have developed strategic relationships within four target markets: ISPs, web hosting companies, web portals and corporations. Internet Service Providers (ISPs) Internet service providers are companies that provide access to the Internet. Email has become an integral part of ISP service offerings. ISPs provide service via dial-up and ISDN as well as dedicated private-line hookups. For a monthly fee, customers receive a software package, username, password and access phone number. Many ISPs offer free home-page hosting to members at the ISP's domain name (for example, www.ispname.com/~username). Some ISPs are also providing commercial web hosting (hosting sites at a domain name registered by the user). ISPs serve large companies by providing a direct connection from the companies' networks to the Internet. Web Hosting Companies Web hosting companies offer corporate customers and individual consumers hosting of their website on a commercial web server (at a unique domain registered to the customer). In addition, web hosting companies are increasingly offering web design, domain name registration service and email services to their customers. We believe that most business customers are looking for a full-service web hosting company that can provide domain name registration, basic website services and enhanced website services including e- commerce and messaging. 39 Web Portals Web portals include online communities and search engines which offer a one- stop source of information to a broad range of users, and vertical portals, such as E*TRADE, which cater to the needs of a specific audience. The goal of portal sites is to develop a sense of community in order to draw large online audiences, encourage repeat visits, and keep users engaged. Portals are accomplishing this goal by providing users with value-rich content and services such as search engines, free individual homepages and free email. The majority of a portal's revenue comes from advertising targeting its large, demographic- specific audience and repeat website visits. Corporations Email has become a mission-critical application for businesses. Many U.S.- based corporations of varying sizes use email as a primary form of communication. In addition, the ability to access Internet-based email from outside the office has added to email's appeal and utility for corporations. A large percentage of the corporate market's email is supplied internally via LAN mail systems. Companies are struggling with aging LAN-based systems designed in the late 1980s and early 1990s when email was used on a much more casual basis and by a smaller user population. Until recently, Internet standards-based email has accounted for only a small portion of corporate messaging systems, but according to Internet Week, that portion will increase to one-third of the corporate market by the end of the decade. Strategic Relationships A key element of our strategy is to expand our marketing and distribution channels through strategic relationships with entities that are both commercial partners and/or equity investors. We believe that these strategic relationships will enable us to expand our distribution channels and to undertake joint product development and marketing efforts. The following are examples of our existing strategic relationships. America Online, Inc./ICQ In January 1999, we entered into an agreement with ICQ, a subsidiary of America Online, Inc., pursuant to which we will provide email hosting services that will be integrated with ICQ's instant messaging service provided to ICQ's customers. The ICQ instant messaging service allows users to communicate in real time over the Internet. Our agreement with ICQ also provides for our integration of features of the ICQ instant messaging service with our standard email services and our offering of these integrated services to our other customers. E*TRADE Group, Inc. In September 1998, we entered into an agreement with E*TRADE, an on-line brokerage services company, pursuant to which each party will include the other in certain advertising campaigns, including E*TRADE's international and strategic partner relationships. We will also provide email services to users of E*TRADE's Internet access services. E*TRADE uses our email services to extend its brand and value-added services to its fast-growing customer base. As online trading grows, the need for secure transmissions of trade confirmations grows. In addition, we are in the process of developing an electronic order confirmation system designed to be SEC compliant, which could allow online brokerages to conduct most of their customer communications electronically. 40 Network Solutions, Inc. In May 1998, we entered into an agreement with Network Solutions, currently the exclusive registrar of Internet domain names, pursuant to which we provide email outsourcing services to users of Network Solutions' website. In exchange for our services, Network Solutions will provide domain name registration services for our customers. Through this agreement, a Network Solutions customer is able to extend its brand using its unique domain name for its email address instead of the domain name of its Internet access provider. Sprint Communications Company L.P. In September 1998, we entered into an agreement with Sprint's IP Business Services pursuant to which we provide email services to Sprint's corporate IP customers. Sprint has over 7,000 sales representatives who can now offer hosted email services to their business customers at their own domain name. We provide a dedicated customer support number and a sales support center to support Sprint's sales representatives. It is expected that Sprint will integrate our brand and bill email services under the Sprint name. US West Communications Services, Inc. In December 1998, we entered into an agreement with US West pursuant to which we provide email services to US West's telephone customers. We believe that US West views web mail as part of its strategy to offer its telephone customers value-added Internet services. Web mail is a user-friendly, simple vehicle to transition telephone customers from dial-tone to web-tone. The agreement also provides for the enhanced email functionality of US West's !nterprise Internet customers through an email viewer. Our agreements with our strategic partners 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 of the agreements are terminable by us without cause, 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. These strategic agreements may be terminated upon short notice. Sales and Marketing Sales Strategy Our sales efforts target all market segment audiences through direct and indirect channels. We maintain our own direct sales force to introduce and educate prospective customers and partners about our service. The direct sales group targets larger ISPs, telecommunications companies, medium to large corporate customers, large web hosting companies and high-trafficked web portals. As of February 28, 1999, we had 21 account executives in the direct sales group, and we plan to significantly expand this group in the next 12 months. Offices in the United States currently include San Francisco, Irvine, San Jose, Seattle and New York, and are planned to include Denver and Washington D.C. We currently have an international office in Munich, Germany. Within our direct sales group, a subgroup is responsible for retaining and increasing use by existing customers. This group is critical to ensuring customer satisfaction and selling existing customers new add-on services as they become available in our service offering. 41 A telesales group is being formed and will be located in Tempe, Arizona, beginning in the first quarter of 1999. The target markets of the telesales group will be smaller ISPs, web hosting companies and corporations. The vast majority of the activity generated through this channel will be outbound in nature with prospective leads contacted by an outbound call. The telesales group will also handle outbound calls to a specific list of contacts provided by our marketing organization. In addition, the telesales group will handle all in-bound leads generated through the web and telephone and qualify those leads by placing additional calls or referring them to the direct sales group. The indirect sales channel will use the sales forces of our partners to offer our services to their end-users. We share revenue with our partners to achieve this purpose. To gain market presence and market share overseas, we plan to team with leading distributors, resellers and system integrators that have strong industry backgrounds and market presence in their respective markets and geographic regions. Marketing Strategy Our marketing strategy includes a media relations and public speaking focus to develop a reputation as an industry leader for email services and messaging. We will use narrowly focused, co-branded print and online advertising campaigns for lead generation. Direct marketing will be used to target specific ISP and web hosting firms. Co-branded and cooperative direct mail will be the cornerstone of the direct marketing efforts. Event, forum and trade show participation will also be used to promote our business-to-business brand presence. Enhanced Services Development Our application management and marketing organizations focus on marketing and service development. Our application management team monitors new email and messaging service introductions by our competitors. This in turn assists our marketing group in determining our application pipeline and feature development schedules and provides direction for our engineering, operations, sales and support teams. We also have segment managers for each of our four target markets who are responsible for defining strategies to address specific needs within each market. These segment managers work with our technical service managers, who are in turn responsible for service strategies and development plans. Our service management team focuses on provisioning and billing, mail and directory services and mail center technology. In addition, the services management team manages cross-departmental service development effort. The development process also includes quality-control steps such as reviews, walk- throughs and post-implementation audits. The services development process incorporates input from a variety of sources, including our current and potential customers, and refines this information through a business prioritization process. The service management team prepares a marketing requirements document, which is reviewed by our change control board. The change control board, which is attended by a cross-department management team, prioritizes and schedules our development efforts and assigns resources to the development project team. Our services development process involves coordination among our application management, marketing and service management teams. To support our service development and marketing functions, we conduct an ongoing analysis of competitive intelligence, product forecasting, financial analysis and pricing strategies. 42 Technology In offering email services, we employ advanced software and hardware, combining internal expertise with industry standard technology to create a proprietary infrastructure. Mail Center Technology We have created a proprietary email system, Mail Center Technology ("MCT"), designed to ensure access to hundreds of millions of mailboxes across millions of domains. MCT is able to handle high-volume loads for complex and diverse mail environments such as those required for ISPs, web hosting companies, web portals and corporations providing email accounts to their end-users for activities such as trading securities, shopping or participating in online communities. We have written proprietary load-balancing and email software, and Oracle Corporation databases are used in account provisioning and management. MCT is made up of multiple groups of servers and routers acting as a single, virtual point of contact to customers for email services. Our MCT hardware consists of Sun Microsystems, Inc. Ultra Enterprise servers, Cisco Systems, Inc. routers, Network Appliance, Inc. RAID array storage and rackmounted Intel processor-based servers running Solaris and FreeBSD, a free operating language. All aspects of MCT are deployed in pairs with the goal of ensuring that if any process or system goes down, another will be available to handle customer traffic seamlessly. This behavior is called "transparent failover," and is designed to increase the availability of email services to the customer. MCT also includes a dynamic load-balancing system that acts as proxy servers for firewall safety. The load balancers are configured in parallel to ensure that if one goes down, the load is transferred to the remaining systems. MCT currently hosts SMTP, POP3 and web-based email services and will also host IMAP4 and other services as they are released. Both the hardware capacity and the services hosted by the mail center can be expanded based on customer demand. Simple Mail Transfer Protocol (SMTP) SMTP is currently the standard mail protocol for the Internet. It allows hosts on the Internet to route mail from the sender to the destination. All Internet messages must be sent using SMTP; older proprietary mail systems must convert their internal mail formats to SMTP in order to communicate effectively over the Internet. Post Office Protocol (POP) With POP, mail is delivered to a shared mail server; users periodically connect to the server and download all pending mail to their machines. Thereafter, all mail processing is local to the client machine. POP provides only the store-and-forward service, moving mail on demand from a mail server to a single destination machine, usually a PC, Macintosh or UNIX workstation, and then typically deleting the messages from the POP server. Web-based Email Web-based email, also known as HTML (Hyper Text Markup Language) email, allows users to access their mail from any computer with Web browser and Internet access. This eliminates the need to maintain a separate program for accessing email. 43 Internet Message Access Protocol (IMAP) IMAP is more sophisticated than the POP3 protocol and provides greater flexibility at the server level. This enhanced service allows users to sort mail by sender and subject, search for specific text, and manipulate folders and mailboxes while the files remain on the server, rather than downloading them to their local desktop. This flexibility is particularly valuable for users who travel frequently and access their mail from a variety of different computers and email clients. Account Provisioning We have created a proprietary Account Provisioning Protocol ("APP") for account creation and maintenance. The APP enables accounts transitioning from other services or legacy systems to be bulk-loaded, tested, replicated and deployed on our service automatically. This addresses a critical time to market issue by enabling organizations to quickly transition to the new standards- based email service with minimal down-time and degradation to their existing internal systems. In addition, the APP can be used by customers and partners to facilitate automatic account sign-ups from websites, typically in less than three minutes. Data Centers and Network Access We maintain data centers in San Francisco and Palo Alto, California and Laurel, Maryland. The data centers have private peering with all major backbones to allow high-bandwidth access to the Internet. With multiple high- speed connections to different backbone providers, we have reduced the likelihood that our customers will suffer downtime as a result of network outages. Our backbone architecture and interconnection strategy consists of clear channel DS-3 and OC-3 connections and direct 100 MB/sec Ethernet connections. We currently have bilateral peering arrangements in place with the following organizations: AboveNet Communications Inc. Exodus Communications Nuri Net Compaq/Digital Equipment Corporation Frontier GlobalCenter Pilot Network Services Concentric Networks GTE Internetworking/Genuity Skybytes Dacom, Inc. @Home Verio DataResearch Associates Hurricane Electric Web Professionals Electric Lightwave, Inc. MAXIM XMISSION
In addition to our peering connections, we currently purchase additional Internet access from MCI WorldCom and Sprint, through their relationships with AboveNet Communications Inc. Our data centers feature redundant systems for power, fire protection, seismic reinforcement, and security surveillance 24 hours a day, seven days a week by both personnel and video monitors. If we experience service interruptions on either the East Coast or the West Coast due to a natural disaster, all Critical Path-hosted messages will be automatically rerouted to the data center that is not affected. We intend to open data centers in Europe and Asia. These data centers will add further redundancy and create a local connectivity in those markets. Network Security We have created a custom firewall solution to reduce the incidence of network security breaches, utilizing Cisco Systems, Inc. routers for firewall hardware. To enhance security for the network, our staff members monitor the network and hardware 24 hours a day, seven days a week. Any suspicious activity is reported and investigated immediately. 44 Our operations and engineering staffs include many active participants in open Internet security groups. Newsgroups and industry consortium postings are actively monitored for information regarding reported security flaws. Suspected flaws in software and hardware products that could compromise security are investigated thoroughly and fixes are implemented, often within a matter of hours. The goals of our security efforts are to prevent intruders from gaining access to our customers' email messages, passwords or financial information, to protect our server software and design information from being accessed by intruders, and to prevent malicious individuals from causing service failure or slowdown. We accomplish these goals by ensuring that our server clusters are entirely isolated from the Internet at large except for the specific services we provide, continuously monitoring the network to detect intrusion attempts, staying up to date on current security issues, and tracking abuse incidents, such as "spamming," blocking as necessary, and reporting incidents to the appropriate originating ISPs. Spam Blocking Our basic email and web-based email services include comprehensive spam prevention at no additional charge. This spam prevention is currently being used to screen messages for all of our service partners and customers. Our engineers have written proprietary "learning" software that automatically screens incoming messages for telltale items in message headers and subject lines. We have also developed a comprehensive database of commonly forged addresses and frequently abused domain names. Most additions to the "black list" have been reported by our end-users, who are encouraged to notify us of suspected abuse. The black list is actively reviewed to ensure that no legitimate domains or individual users are blocked from accessing the system or sending messages. In addition to filtering technology at the server level, our personnel monitor incoming messages 24 hours a day, seven days a week. We are part of a group of key network operators and ISPs working to develop technologies and other measures aimed at protecting users from junk email. We have representatives serving on the Coalition Against Unsolicited Commercial Email, the leading national organization lobbying for anti-spam legislation. Our Acceptable Use Policy explicitly states that partners and customers may not use our service to send unsolicited bulk email. Customer Support We provide customer support 24 hours a day, seven days a week by contractual agreement. Our customer support service consists of two tiers. Tier 1 includes technical support in response to end-user inquiries. Although our customers typically provide Tier 1 support directly to their end-users, they can outsource this function to us and we can provide Tier 1 support to their end- users via email or web-based support. We also provide support information on our website. Tier 2 support includes technical support, provided to our ISP, web hosting, web portal and corporate customers, via toll-free access and email correspondence managed by our team of trained technical support representatives. Our technical support representatives include pooled and dedicated representatives. Pooled representatives are trained to resolve the majority of inquiries and, where necessary, to escalate and manage inquiries through to resolution. Dedicated representatives must meet stringent technical criteria, are assigned to strategic accounts and assist in identifying and qualifying new features and functionality in addition to advanced problem solving. 45 In an effort to further improve customer satisfaction, we are deploying new tools designed to allow customers to track the status of their open tickets and access standard reported metrics through a secure web interface. These tools will also facilitate our ability to track recurring customer issues that will identify opportunities for service improvements. Our staff of trained technical representatives, coupled with leading edge monitoring and tracking tools allows us to successfully serve the needs of our clients. Competition The market for Internet-based email service is characterized by companies that elect to develop and maintain in-house solutions and companies that seek outsourcing arrangements for their email service. For customers seeking outsourcing arrangements, we compete with email service providers, such as USA.NET, and iName, as well as product-based companies, such as Software.com and Lotus Development Corporation. In addition, companies such as Software.com, Microsoft, Netscape, Lotus and Sun Microsystems are currently offering email products directly to ISPs, web hosting companies, web portals and corporations. These companies could potentially leverage their existing capabilities and relationships to enter the email service industry by redesigning their system architecture, pricing and marketing strategies to sell through to the entire market. In the future, ISPs, web hosting companies and outsourced application companies may broaden their service offerings to include outsourced email solutions. The level of competition is likely to increase as current competitors increase the sophistication of their offerings and as new participants enter the market. In the future, as we expand our service offerings, we expect to encounter increased competition in the development and delivery of these services. 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 well- financed companies. Certain of our competitors may be able to enter into such strategic or commercial relationships on more favorable terms. Further, certain of our competitors may offer services at or below cost. In addition, new technologies and the expansion of existing technologies may increase competitive pressures on us. Increased competition may result in reduced operating margins and loss of market share. We believe that our service solution competes favorably with that of other providers with respect to the following: . providing cost savings over in-house solutions by relieving customers of expenses associated with acquiring and maintaining hardware and software and the associated administrative burden; . providing greater functionality and access to leading technologies and protocols, which in turn enables customers to choose the protocol that best suits their end-users' needs; . enabling customers to maintain brand control, thereby enhancing their brand identity; and . facilitating scalability through an infrastructure designed to support hundreds of millions of mailboxes across millions of domains. However, despite our competitive positioning, we may not be able to compete successfully against current and future competitors, and competitive pressures we face could have a material adverse effect on our business, operating results and financial condition. 46 Intellectual Property We regard our copyrights, service marks, trademarks, trade secrets and similar intellectual property as critical to our success, and rely on trademark and copyright law, trade secret protection and confidentiality and/or license agreements with our employees, customers, partners and others to protect our proprietary rights. We have no registered trademarks or service marks to date. It may be possible for unauthorized third parties to copy certain portions of our products or reverse engineer or obtain and use information that we regard as proprietary. Certain end-user license provisions protecting against unauthorized use, copying transfer and disclosure of the licensed program may be unenforceable under the laws of certain jurisdictions and foreign countries. We have one patent pending in the United States. We do not know whether this patent will be granted or, that if granted, that the patent will not be challenged or invalidated. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States. There can be no assurance that our means of protecting our proprietary rights in the United States or abroad will be adequate or that competing companies will not independently develop similar technology. Other parties may assert infringement claims against us. We may also be subject to legal proceedings and claims from time to time in the ordinary course of our business, including claims of alleged infringement of the trademarks and other intellectual property rights of third parties by us and our licensees. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources. We also intend to continue to strategically license certain technology from third parties, including our web server and SSL encryption technology. In the future, if we add certificate technology to our systems, we may license additional technology from third-party vendors. We cannot be certain that these third-party content licenses will be available to us on commercially reasonable terms or that we will be able to successfully integrate the technology into our products and services. These third-party in-licenses may expose us to increased risks, including risks associated with the assimilation of new technology, the diversion of resources from the development of our own proprietary technology and our inability to generate revenues from new technology sufficient to offset associated acquisition and maintenance costs. The inability to obtain any of these licenses could result in delays in product and service development until equivalent technology can be identified, licensed and integrated. Any such delays in services could cause our business, financial condition and operating results to suffer. See "Risk Factors--We Have Limited Protection of Our Intellectual Property and Proprietary Rights." Government Regulation Although there are currently few laws and regulations directly applicable to the Internet and commercial email services, it is possible that a number of laws and regulations may be adopted with respect to the Internet or commercial email services covering issues such as user privacy, pricing, content, copyrights, distribution, antitrust and characteristics and quality of products and services. Further, the growth and development of the market for online email may prompt calls for more stringent consumer protection laws that may impose additional burdens on those companies conducting business online. The adoption of any additional laws or regulations may impair the growth of the Internet or commercial online services, which could, in turn, decrease the demand for our products and services and increase our cost of doing business, or otherwise have a material adverse effect on our business, operating results and financial condition. Moreover, the applicability to the Internet of existing laws in various jurisdictions governing issues such as property ownership, 47 sales and other taxes, libel and personal privacy is uncertain and may take years to resolve. Any such new legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to our business or the application of existing laws and regulations to the Internet could have a material adverse effect on our business, operating results and financial condition. See "Risk Factors--We Face Risks Associated with Government Regulation and Legal Uncertainties." Employees As of February 28, 1999, we had 133 full-time employees. None of our employees is covered by collective bargaining agreements. We believe that our relations with our employees are good. Facilities Our principal executive offices are located in San Francisco, California, in a 31,500 square foot facility under a lease expiring on June 30, 2002, with a five-year renewal option and a sublease expiring on March 31, 2002. We believe that our facilities will be adequate for the next 12 months. However, we may not be able to lease additional space on commercially reasonable terms or at all. 48 MANAGEMENT Directors and Executive Officers The executive officers, directors and key employees of Critical Path and their ages as of December 31, 1998 are as follows:
Name Age Position ---- --- -------- Douglas T. Hickey....... 43 President, Chief Executive Officer and Director David C. Hayden......... 43 Chairman of the Board of Directors David A. Thatcher....... 43 Executive Vice President and Chief Financial Officer Wayne D. Correia........ 32 Chief Technology Officer Joseph Duncan........... 50 Vice President and Chief Information Officer Judie A. Hayes.......... 51 Vice President of Corporate Communications Carolyn J. Patterson.... 34 Vice President of Operations William H. Rinehart..... 34 Vice President of Sales Marcy Swenson........... 34 Vice President of Software Engineering Mari E. Tangredi........ 33 Vice President of Marketing and Strategic Planning Christos M. Cotsakos.... 50 Director Lisa Gansky(1).......... 40 Director Kevin R. Harvey(1)...... 34 Director James A. Smith(2)....... 46 Director George Zachary(2)....... 33 Director
- -------- (1) Member of Compensation Committee of the Board of Directors. (2) Member of Audit Committee of the Board of Directors. Douglas T. Hickey has served as the President and Chief Executive Officer and a director of Critical Path since October 1998. From February 1998 to October 1998, Mr. Hickey served as Executive Vice President of Frontier Communications Corporation, a telecommunications company, and as President of Frontier GlobalCenter. From July 1996 to February 1998, Mr. Hickey served as President and CEO of GlobalCenter, Inc., a web hosting company. In February 1998, GlobalCenter was acquired by Frontier. From December 1994 to July 1996, Mr. Hickey was President of Internet services at MFS Communications, a provider of high-speed fiber-optic services. From September 1990 to November 1994, Mr. Hickey was general manager of North American sales and field operations at Ardis, a Motorola company. Mr. Hickey received a B.S. in economics from Siena College. David C. Hayden founded Critical Path and served as the Chairman, President and Chief Executive Officer and Secretary from its inception in February 1997 to October 1998. Mr. Hayden has served as Chairman of the Board of Directors of Critical Path since October 1998. From February 1993 to August 1996, Mr. Hayden served as Chairman, Chief Executive Officer, and co-founder of The McKinley Group, Inc., creators of Magellan, an Internet search engine. Mr. Hayden received a B.A. in political science from Stanford University. David A. Thatcher has served as Executive Vice President, Chief Financial Officer and Secretary of Critical Path since December 1998, and served as a director of Critical Path from May 1997 to March 1998 and from May 1998 to November 1998. From June 1998 to December 1998, Mr. Thatcher served as President and Chief Executive Officer of Geoworks Corporation, a provider of software solutions for the wireless market. Mr. Thatcher joined Geoworks Corporation in March 1997 as Vice President of Finance and Administration and Chief Financial Officer and was appointed President and Director in January 1998. From May 1996 to January 1997, Mr. Thatcher served as 49 Vice President and Chief Financial Officer of Diba, Inc., an Internet software company, which was later acquired by Sun Microsystems, Inc. From January 1996 to May 1996, Mr. Thatcher served as Vice President and Chief Financial Officer of The McKinley Group. From March 1993 to November 1995, Mr. Thatcher served as Vice President and Chief Financial Officer of Peregrine Systems, Inc., a provider of customer support software. Mr. Thatcher received a B.S. in accounting from San Diego State University and is a CPA in California. Wayne D. Correia has served as the Chief Technology Officer since April 1997 and as a director of Critical Path from May 1997 to January 1999. From November 1994 to February 1997, Mr. Correia was President and founder of domainNET, an Internet strategy, engineering and services company, providing application hosting and on-demand high-speed wireless Internet connections for mediacasts and other events. In January 1992, Mr. Correia founded Collaboration Technologies, a developer of leading-edge computer telephony hardware and software and was Chief Executive Officer until May 1995. From July 1988 to October 1993, he worked in the Macintosh Software Architecture Division and Apple Developer Group at Apple Computer, Inc., a computer manufacturer. Joseph Duncan has served as Vice President and Chief Information Officer of Critical Path since December 1998. From December 1997 to December 1998, Mr. Duncan was founder and Chief Executive Officer of Charybdis Software, a software company. From June 1993 to November 1997, Mr. Duncan held various positions at Oracle Corporation, most recently as Senior Vice President for Groupware Systems and Object-Oriented Tools. Mr. Duncan received a B.A. in philosophy from the University of Minnesota. Judie A. Hayes joined Critical Path as Vice President of Corporate Communications in December 1998. From January 1997 to December 1998, Ms. Hayes served as Vice President Corporate Marketing and Communications for Frontier GlobalCenter. From March 1995 to January 1997, Ms. Hayes served as Senior Director of Corporate Communications for NETCOM On-Line Communication Services, Inc., an Internet service provider. Ms. Hayes has served as Director of Marketing Communications for MCI Data Services Division, a telecommunications company, and Director of Corporate Communications for British Telecom North America, a telecommunications company. Ms. Hayes received her bachelor's degree from University of Wisconsin-Whitewater. Carolyn J. Patterson has served as Vice President of Operations of Critical Path since January 1999 and as Director of Operations of Critical Path from August 1998 to January 1999. From January 1998 to July 1998, Ms. Patterson served as Manager, Strategic Alliances for Sybase Inc. From February 1997 to January 1998, Ms. Patterson served as General Manager, Data Services Operations for AT&T Corp. From June 1986 to February 1997, Ms. Patterson worked as a programmer and later in various AT&T Corp. divisions including sales, product management, customer care, finance and sales. Ms. Patterson holds a B.S.C. in decision science from Rider University and an M.B.A. from Monmouth University. William H. Rinehart joined Critical Path as Vice President, Sales in November 1998. From May 1997 to November 1998, Mr. Rinehart served as Senior Vice President, General Manager at Frontier GlobalCenter. From July 1996 to June 1997, Mr. Rinehart held a range of positions including Vice President, Product Development and Vice President, Sales for Genuity, a Bechtel company. He has also served as Vice President, General Manager at MFS Communications, Internet Division, from January 1995 to July 1996. From April 1993 to January 1995, Mr. Rhinehart was a Senior Account Executive at Ardis, a wireless data communications company. Mr. Rinehart received a B.S. in business administration from Ball State University. 50 Marcy Swenson has served as the Vice President of Software Engineering of Critical Path since June 1997. From May 1995 to June 1997, Ms. Swenson served as Vice President of Software Development at Providence Systems. In June 1987, Ms. Swenson co-founded After Hours Software, Inc., which provides custom software solutions to Fortune 500 customers, and served as Vice President of Software and Consulting Services until May 1994. Ms. Swenson has completed advanced studies in Artificial Intelligence at Stanford University, and received a B.S. in math/computer science from UCLA. Mari E. Tangredi has served as Vice President, Marketing and Strategic Planning for Critical Path since February 1998. From June 1995 to November 1997, Ms. Tangredi served as the General Manager/Vice President of Electronic Commerce of Pacific Bell. From July 1986 to May 1995, Ms. Tangredi worked at AT&T Corp. as a programmer and later in various positions in sales, emerging product development and customer care, providing network products and services to Fortune 500 customers. Ms. Tangredi received a B.S. in M.I.S. from Clarkson University and an M.B.A in high technology from Northeastern University. Christos M. Cotsakos has served as a director of Critical Path since May 1998. Mr. Cotsakos has served as President, Chief Executive Officer and a director of E*TRADE, an on-line brokerage services company, since March 1996. From March 1995 to January 1996, Mr. Cotsakos served as President, Co-Chief Executive Officer, Chief Operating Officer and a director of A.C. Nielsen, Inc. From September 1993 to March 1995, he served as President and Chief Executive Officer of Nielsen International. From March 1992 to September 1993, he served as President and Chief Operating Officer of Nielsen Europe, Middle East and Africa. Mr. Cotsakos serves as a director of National Processing Company, Forte Software, Inc. and The Fourth Network Communications Network, Inc. Mr. Cotsakos received a B.A. from William Patterson College and an M.B.A. from Pepperdine University and is currently pursuing a Ph.D. in economics at the Management School, University of London. Lisa Gansky has served as a director of Critical Path since May 1998. Ms. Gansky has been a Principal at Trading Fours, a venture development company, since January 1997. From June 1995 to January 1997, Ms. Gansky served as Vice President of AOL, Inc., an online and Internet services company. From June 1994 to January 1995, Ms. Gansky founded and served as Chief Executive Officer of Global Network Navigator, Inc. ("GNN"), an Internet solutions company. Kevin R. Harvey has served as a director of Critical Path since April 1998. Mr. Harvey has been a General Partner of Benchmark Capital, a venture capital firm, since January 1995. From July 1993 to January 1995, he served as General Manager for Lotus Development Corporation. In August 1990, Mr. Harvey founded Approach Software Corporation ("Approach"), a software company, where he served as the President and Chief Executive Officer until July 1993 when Approach was sold to Lotus Development Corporation. Prior to founding Approach, Mr. Harvey founded Styleware, a software company, which was subsequently sold to Claris Corporation. Mr. Harvey is also a director of Silicon Gaming, Inc., an entertainment and gaming technology company, and a director of several privately held companies. Mr. Harvey received a B.S.E.E. degree from Rice University, 1987. James A. Smith has served as a director of Critical Path since January 1999. Mr. Smith has served as the President and Chief Executive Officer of US West Dex, a provider of Internet directory and database marketing services, since October 1997. From March 1996 to October 1997, Mr. Smith served as Vice President of Local Markets for US West. From July 1992 to March 1996, Mr. Smith served as Vice President and General Manager of Mass Markets for US West. Mr. Smith received a B.A. from Willamette University and a J.D. from the University of Washington. 51 George Zachary has served as a director of Critical Path since April 1998. Mr. Zachary has been a partner at Mohr, Davidow Ventures II, a venture capital firm, since January 1996. From March 1993 to December 1997, Mr. Zachary ran the consumer products business at Silicon Graphics, Inc., a computer workstation company. Since September 1986 until March 1993, Mr. Zachary has held various engineering and marketing management positions at Silicon Graphics, Inc., VPL Research, Inc., Apple Computer, Inc., Texas Instruments Incorporated and C-ATS Software Inc. Mr. Zachary received a B.S. degree from Massachusetts Institute of Technology and Massachusetts Institute of Technology Sloan School of Management. We have authorized seven (7) directors. All directors are elected to hold office until our next annual meeting of shareholders and until their successors have been elected. Officers are elected at the first board of directors meeting following the shareholders' meeting at which the directors are elected and serve at the discretion of the board of directors. There are no family relationships among any of our directors or executive officers. Compensation Committee Interlocks and Insider Participation The Compensation Committee is responsible for determining salaries, incentives and other forms of compensation for our directors, officers and other employees and administering various incentive compensation and benefit plans. The Compensation Committee consists of two outside directors. Lisa Gansky and Kevin Harvey are currently the two outside directors on our Compensation Committee. Director Compensation We reimburse each member of our board of directors for out-of-pocket expenses incurred in connection with attending board meetings. No member of our board of directors currently receives any additional cash compensation. In connection with their joining the board of directors in May 1998, directors Christos Cotsakos and Lisa Gansky each received an option to purchase 136,363 shares of common stock vesting monthly over two years at an exercise price of $0.22 per share. 52 Executive Compensation The following table summarizes all compensation earned by or paid to Critical Path's Chief Executive Officer and to each of Critical Path's four most highly compensated executive officers other than the Chief Executive Officer whose total annual salary and bonus exceeded $100,000 (collectively, the "Named Executive Officers"), for services rendered in all capacities to Critical Path during the fiscal year ended December 31, 1998. Summary Compensation Table for Last Fiscal Year
Long-Term Annual Compensation Compensation(1) Awards ----------------- ------------ Security Underlying Name and Principal Position Salary Bonus Options (#) - --------------------------- -------- -------- ------------ Douglas Hickey(2) President and Chief Executive Officer.......... $ 51,136 $ -- 2,549,374(4) David Hayden(3) Chairman of the Board of Directors............. 170,833 135,000 1,363,636(5) Wayne Correia Chief Technology Officer....................... 140,417 25,000 -- Marcy Swenson Vice President of Software Engineering......... 127,500 40,000 -- Mari E. Tangredi Vice President of Marketing and Strategic Planning............................ 108,056 65,000 431,816(6)
- -------- (1) Other than the salary and bonus described herein, Critical Path did not pay any executive officer named in the Summary Compensation Table any fringe benefits, perquisites or other compensation in excess of 10% of such executive officer's salary and bonus during fiscal 1998. (2) Mr. Hickey became President and Chief Executive Officer in October 1998. (3) Prior to October 1998, Mr. Hayden served as Critical Path's Chief Executive Officer and President as well as its Chairman. (4)In October 1998, Mr. Hickey received two options to purchase shares of common stock (an option to purchase 478,468 and 2,070,906 shares at an exercise price of $0.84, each of which vest in equal installments over 48 months. (5) Option to purchase 1,363,636 shares of common stock at an exercise price of $.02 per share vests as to 25% of the shares on the first anniversary of Mr. Hayden's employment with Critical Path and 1/48th each full month thereafter. (6) Includes options to purchase 68,181, 45,454, 227,272 and 90,909 shares at exercise prices of $0.02, $0.22, $0.84 and $2.20 per share, respectively. All options vest as to 25% of the shares on the first anniversary of Ms. Tangredi's employment with Critical Path and 1/48th each full month thereafter. 53 Option Grants in Last Fiscal Year
Potential Realizable Value at Assumed Percentage of Annual Rates of Stock Total Options Price Appreciation Granted to Exercise or for Option Term(3) Options Employees in Base Price Expiration --------------------- Name Granted Fiscal Year(1) ($/Share)(2) Date 5% 10% - ---- --------- -------------- ------------ ---------- ---------- ---------- Douglas Hickey.......... 478,468(4) 4.50% $0.84 10/18/08 7,387,546 12,004,762 2,070,906(5) 19.5 0.84 10/18/08 31,974,788 51,959,031 David Hayden............ 1,363,636(6) 12.9 0.02 3/2/03 17,376,562 21,927,267 Wayne Correia........... -- -- -- -- -- -- Marcy Swenson........... -- -- -- -- -- -- Mari Tangredi........... 68,181(7) 0.64 0.02 3/2/03 868,625 1,096,350 45,454(7) 0.43 0.22 6/15/03 569,993 721,809 227,272(7) 2.14 0.84 9/29/03 2,709,082 3,468,170 90,909(4) 0.86 2.20 12/14/08 1,279,998 2,157,270
- -------- (1) Based on options to purchase an aggregate of 10,595,453 shares of common stock granted during fiscal 1998. Under the terms of Critical Path's 1998 Stock Plan, the committee designated by the board of directors to administer the 1998 Stock Plan retains the discretion, subject to certain limitations within the 1998 Stock Plan, to modify, extend or renew outstanding options and to reprice outstanding options. Options may be repriced by canceling outstanding options and reissuing new options with an exercise price equal to the fair market value on the date of reissue, which may be lower than the original exercise price of such canceled options. See "Stock Plans." (2) The exercise price on the date of grant was equal to 100% of the fair market value on the date of grant as determined by the board of directors. (3) The 5% and 10% assumed rates of appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent Critical Path's estimate or projection of the future common stock price. There can be no assurance that any of the values reflected in the table will be achieved. (4) This incentive stock option has a 10-year term, subject to earlier termination in certain events related to termination of employment, and vests as to 1/48th of the shares per month over a four-year period. This option provides for partial acceleration of vesting upon change of control of Critical Path, and an early exercise provision. (5) This non-statutory stock option has a 10-year term, subject to earlier termination in certain events related to termination of employment, and vests as to 1/48th of the shares per month over a four-year period. This option provides for partial acceleration of vesting upon change of control of Critical Path, and an early exercise provision. In November 1998 this option was exercised as to 1,274,687 shares. (6) This incentive stock option has a five-year term, subject to earlier termination in certain events related to termination of employment, and vests as to 25% of the shares on the first anniversary of the vest start date, and vests ratably on a monthly basis thereafter, becoming fully vested on the fourth anniversary of the vest start date. (7) These incentive stock options have a five-year term, subject to earlier termination in certain events related to termination of employment, and vest as to 25% of the shares on the first anniversary of the vest start date, and vest ratably on a monthly basis thereafter, becoming fully vested on the fourth anniversary of the vest start date. 54 Aggregated Option Exercises in Last Fiscal Year And Fiscal Year-End Option Values
Value of Unexercised Number of Unexercised In-the-Money Shares Options at Options at Acquired Fiscal Year-End Fiscal Year-End(3) on Value ------------------------- ------------------------- Name Exercise Realized Exercisable/Unexercisable Exercisable/Unexercisable ---- --------- -------- ------------------------- ------------------------- Douglas Hickey(1)....... 1,274,687(2) $116,846 1,274,687/0 $11,676,132/-- David Hayden............ -- -- 653,409/710,227 6,517,908/7,088,065 Wayne Correia........... -- -- -- -- Marcy Swenson........... -- -- -- -- Mari Tangredi........... -- -- 0/431,816 0/3,915,888
- -------- (1) Mr. Hickey's option agreements allow for early exercise subject to repurchase by Critical Path over the vesting period. A portion of the shares acquired by Mr. Hickey upon exercise of his option remain subject to vesting. (2) Includes 9,090 shares which are held in trust for benefit of minor children. (3) Assumes a per share fair market value equal to $10.00, the mid-point of the estimated per share price of the common stock offered hereby. 1998 Stock Plan Our 1998 Stock Plan was adopted by the board of directors on January 21, 1998, amended on December 15, 1998 and will be amended and restated effective upon completion of this offering. Our 1998 Stock Plan provides for awards or sales of shares and options (including incentive stock options ("ISOs") and nonstatutory stock options ("NSOs")). Employees, consultants and advisors of Critical Path are eligible for all awards except ISOs. Only employees are eligible for the grant of ISOs. A total of 12,288,741 shares of common stock has been reserved for issuance under our 1998 Stock Plan and this amount is increased by 5% each January 1, commencing January 1, 2000. Our 1998 Stock Plan is administered by our compensation committee and our non-insider option committee. Our compensation committee consists of at least two directors who are "non-employee directors," as defined in Rule 16b-3. The board of directors may amend our 1998 Stock Plan as desired without further action by Critical Path's shareholders except as required by applicable law. Our 1998 Stock Plan will continue in effect until terminated by the board or for a term of 10 years from its original adoption date, whichever is earlier. The consideration for each award under our 1998 Stock Plan will be established by the compensation committee, but in no event will the option price for ISOs be less than 100% of the fair market value of the stock on the date of grant. Awards will have such terms and be exercisable in such manner and at such times as the compensation committee may determine. However, each ISO must expire within a period of not more than 10 years from the date of grant. Our 1998 Stock Plan provides that, in the event of a merger or reorganization of Critical Path, outstanding options and restricted shares shall be subject to the agreement of merger or reorganization. As of February 28, 1999, 11,498,862 awards had been granted under our 1998 Stock Plan. Such options have exercise prices ranging from $0.02 to $3.39 per share and a weighted average per share exercise price of $0.95, and were held by 157 persons. Options to purchase 2,230,401 shares have been exercised. 55 Employee Stock Purchase Plan The board of directors adopted our Employee Stock Purchase Plan in January 1999, to be effective upon completion of this offering. A total of 600,000 shares of common stock have been reserved for issuance under our Employee Stock Purchase Plan and this amount will be increased by 5% each January 1 commencing January 1, 2000, up to a maximum of 500,000 shares per year. Our Employee Stock Purchase Plan, which is intended to qualify under Section 423 of the Internal Revenue Code of 1986, as amended, is administered by the board of directors or by a committee appointed by the board. Employees (including officers and employee directors of Critical Path but excluding 5% or greater shareholders) are eligible to participate if they are customarily employed for at least 20 hours per week and for more than five months in any calendar year. Our Employee Stock Purchase Plan permits eligible employees to purchase common stock through payroll deductions, which may not exceed 15% of an employee's compensation. Our Employee Stock Purchase Plan will be implemented in a series of overlapping 24 month participation periods. The initial participation period commences on the effectiveness of this offering and ends on April 30, 2001. Subsequent 24 month participation periods will commence on November 1, 1999 and each May 1 and November 1 thereafter. Purchases will occur on each April 30 and October 31 (the "purchase dates") during each participation period, excluding April 30, 1999. If on any purchase date during a participation period the fair market value of a share of common stock is less than the fair market value on the commencement of the participation period, the participation period shall be terminated immediately following such purchase date. The employees who had enrolled in the terminated participation period shall automatically be enrolled in the participation period commencing on the day after the purchase date. The purchase price of the common stock under our Employee Stock Purchase Plan will be equal to 85% of the fair market value per share of common stock on either the start date of the offering period or on the purchase date, whichever is less. Employees may end their participation in an offering period at any time during that period, and participation ends automatically on termination of employment with Critical Path. In the event of a proposed dissolution or liquidation of Critical Path, the offering periods terminate immediately prior to the consummation of the proposed action, unless otherwise provided by the board. If there is a proposed sale of all or substantially all of Critical Path's assets or the merger of Critical Path with or into another corporation, then the offering period in progress will be shortened and a new exercise date will be set that is before the sale or merger. The offering period in progress shall end on the new exercise date. Each participant shall be notified at least ten business days prior to the new exercise date, and unless such participant ends his or her participation, the option will be exercised automatically on the new exercise date. Our Employee Stock Purchase Plan will terminate in 2009, unless sooner terminated by the board of directors. 401(k) Plan Critical Path has established a tax-qualified employee savings and retirement plan (the "401(k) Plan") for which all of Critical Path's employees are eligible except for employees subject to a collective bargaining agreement and nonresident aliens with no U.S. source income. Pursuant to the 401(k) Plan, employees may elect to reduce their current compensation by up to the lower of 16% or the statutorily prescribed limit and have the amount of such reduction contributed to the 401(k) Plan. The 401(k) Plan permits additional discretionary matching contributions by Critical Path. To date, Critical Path has made no such matching contributions. The 401(k) Plan is intended to qualify under 56 Section 401 of the Internal Revenue Code of 1986, as amended, so that contributions by employees or by Critical Path to the 401(k) Plan, and income earned on plan contributions, are not taxable to employees until withdrawn from the 401(k) Plan, and so that contributions by Critical Path, if any, will be deductible by Critical Path when made. Employment Agreement and Change in Control Arrangements Critical Path does not currently have any employment contracts in effect with any of the Named Executive Officers other than Douglas T. Hickey, its President, Chief Executive Officer and director. Critical Path and Mr. Hickey are parties to a letter agreement dated October 1, 1998 governing his employment with Critical Path. The agreement sets forth Mr. Hickey's compensation level and eligibility for salary increases, bonuses, benefits and option grants under the 1998 Stock Plan. In the event of a change of control, Mr. Hickey is entitled to receive, for each of his shares of common stock and each vested option, a bonus equal to the difference between the value of the consideration per share to be received by Critical Path's Series B Preferred shareholders and the value of the consideration per share to be received by Critical Path's common shareholders, up to a maximum amount equal to $8 million less the consideration payable in the transaction with respect to Mr. Hickey's shares. Mr. Hickey's right to receive this bonus will terminate upon the closing of this offering. The agreement also provides for accelerated vesting of a portion of Mr. Hickey's options in the event of a change of control. Mr. Hickey also received a loan in the amount of $500,000, bearing interest at the applicable federal rate. The loan will be due on the earlier of five years or 30 days following termination of his employment and is non- recourse unless Mr. Hickey terminates his employment voluntarily. Mr. Hickey's employment under the letter agreement is at-will and may be terminated by Critical Path or Mr. Hickey at any time, with or without cause and with or without notice. Limitation of Liability and Indemnification Matters Critical Path's articles of incorporation limit the liability of directors to the maximum extent permitted by California law. This limitation of liability is subject to exceptions including intentional misconduct, obtaining an improper personal benefit and abdication or reckless disregard of director duties. Critical Path's articles of incorporation and bylaws provide that Critical Path may indemnify its directors, officers, employees and other agents to the fullest extent permitted by law. Critical Path's bylaws also permit it to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in such capacity, regardless of whether the bylaws would permit indemnification. Critical Path has entered into agreements to indemnify its directors and executive officers, in addition to indemnification provided for in Critical Path's bylaws. These agreements, among other things, provide for indemnification of Critical Path's directors and executive officers for certain expenses (including attorneys' fees), judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by or in the right of Critical Path, arising out of such person's services as a director or executive officer of Critical Path, any subsidiary of Critical Path or any other company or enterprise to which the person provides services at the request of Critical Path. Critical Path believes that these provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. 57 CERTAIN TRANSACTIONS Between April 1998 and February 1999, Critical Path sold and issued 19,603,712 shares of its preferred stock for an aggregate consideration of $38,433,214. Critical Path sold 12,716,861 shares of Series A Preferred Stock in April 1998 at a sale price of $0.72 per share. In addition, 22,860 shares of Series A Preferred Stock were purchased at a sale price of $0.72 per share pursuant to the exercise of warrants. Critical Path sold an aggregate of 6,863,991 shares of Series B Preferred Stock in September 1998 and January 1999 at a sale price of $4.26 per share. Each share of Series A Preferred Stock and Series B Preferred Stock converts into one share of common stock. The following table summarizes purchases, valued in excess of $60,000, of shares of preferred stock and of common stock by directors, executive officers and 5% shareholders of Critical Path:
Shares ----------------------------- Common Series A Series B --------- --------- --------- 5% Shareholders E*TRADE Group, Inc................................ -- 346,452 3,519,424 US West Data Investments, Inc..................... 1,090,909 -- 1,313,918 Mohr, Davidow Ventures V, L.P..................... -- 4,330,654 234,628 Benchmark Capital Partners II, L.P................ -- 4,330,654 234,628 CMG@Ventures II, L.L.C............................ -- 1,385,809 351,942 Directors and Executive Officers Douglas Hickey.................................... 1,256,504 -- -- The Cotsakos Revocable Trust, UAD 9/3/87.......... 136,363 -- 39,885 David Hayden...................................... 2,272,727 151,104 -- Lisa Gansky....................................... 159,090 83,146 --
In April 1998, Critical Path entered into an agreement with E*TRADE pursuant to which each party will include the other party in certain advertising campaigns, including E*TRADE's international and strategic partner relationships. Critical Path will also provide email services to users of E*TRADE's Internet access services. In addition, under the terms of the agreement, Critical Path agreed to develop certain features for its email services which Critical Path may make available to other customers in addition to E*TRADE. E*TRADE accounted for approximately 62% of our revenues in 1998. Christos Cotsakos, the Chief Executive Officer of E*TRADE is a director of Critical Path. Mr. Cotsakos is the trustee of The Cotsakos Revocable Trust, UAD 9/3/87. In December 1998, Critical Path entered into an agreement with US West pursuant to which Critical Path agreed to provide email services and certain related development services to US West. In exchange for such services, US West, through the use of its sales channels, will provide Critical Path assistance in selling advertising for the email sites of certain customers of Critical Path. The agreement also provides for the joint development of certain services and features from time to time. The shares held by Mohr, Davidow Ventures V, L.P. include 4,245,713 shares held by it and 319,570 shares held by Mohr, Davidow Ventures V, L.P. as nominee for MDV Entrepreneurs' Network Fund II (A), L.P. and MDV Entrepreneurs' Network Fund II (B), L.P. George Zachary, a member of Mohr, Davidow Ventures V, L.P., is a director of Critical Path. The shares held by Benchmark Capital Partners II, L.P. are held by it as nominee for Benchmark Capital Partners II, L.P., Benchmark Founders' Fund II, L.P., Benchmark Founders Fund II-A, L.P. and Benchmark Members' Fund II, L.P. Kevin Harvey, a managing member of Benchmark Capital Partners II, L.P., is a director of Critical Path. 58 In November 1998, Critical Path loaned Douglas Hickey, the Chief Executive Officer of Critical Path, $500,000 pursuant to a five-year promissory note bearing interest at the rate of 4.51% (the applicable federal rate) per annum. In November 1998, Mr. Hickey exercised an option to purchase 1,274,687 shares of common stock by execution of a five-year promissory note in the principal amount of $1,065,638.94 bearing interest of 4.51% annually. In January 1999, Critical Path loaned William Rinehart $65,000 pursuant to a promissory note bearing interest at the rate of 4.64% per annum. Mr. Rinehart is an executive officer of Critical Path. In 1997, Critical Path sold 2,272,727 shares of common stock to David Hayden, the founder and Chairman of the Board of Critical Path at a purchase price of $0.01 per share. Critical Path has also entered into a stock option agreement with Mr. Hayden pursuant to which it granted options to purchase 1,363,636 shares of common stock to Mr. Hayden at a purchase price of $0.02. These options vest over a four-year period, with a portion vesting in the event of a merger, reorganization or similar change in the voting control of Critical Path. Critical Path believes that the foregoing transactions were in its best interests. It is Critical Path's current policy that all transactions by Critical Path with officers, directors, 5 percent shareholders and their affiliates will be entered into only if such transactions are approved by a majority of the disinterested independent directors, are on terms no less favorable to Critical Path than could be obtained from unaffiliated parties and are reasonably expected to benefit Critical Path. For information concerning indemnification of directors and officers, see "Management--Limitation of Liability and Indemnification Matters." 59 PRINCIPAL SHAREHOLDERS The following table sets forth certain information regarding beneficial ownership of common stock as of February 28, 1999, on a pro forma basis to reflect the automatic conversion upon completion of this offering of the outstanding shares of Series A Preferred Stock and Series B Preferred Stock into common stock and the conversion of outstanding warrants into common stock for a total of 29,575,388 shares of common stock, by: . each person or entity known to Critical Path to own beneficially more than 5% of Critical Path's common stock; . each of Critical Path's directors; . each of Critical Path's Named Executive Officers; and . all executive officers and directors as a group.
Percentage of Common Stock(2) ----------------- Name and Address of Total Shares Before After Beneficial Owner(1) Beneficially Owned(2) Offering Offering - ------------------- --------------------- -------- -------- Benchmark Capital Partners II, L.P.(3) 2480 Sand Hill Road Menlo Park, CA 94025... 4,565,283 15.4% 13.4% Mohr, Davidow Ventures V, L.P.(4) 2775 Sand Hill Road, Suite 240 Menlo Park, CA 94025... 4,565,283 15.4 13.4 CMG@Ventures II, L.L.C. 2420 Sand Hill Road Menlo Park, CA 94025... 1,737,752 5.9 5.1 E*TRADE Group, Inc. Four Embarcadero 2400 Geng Road Palo Alto, CA 94306.... 3,865,877 13.1 11.3 US West Data Investments, Inc. 1999 Broadway, Suite 500 Denver, CO 80202....... 2,404,827 8.1 7.1 Douglas T. Hickey(5).... 1,316,315 4.4 3.9 David Hayden(6)......... 3,219,283 10.6 9.2 Wayne Correia........... 2,500,000 8.5 7.3 Marcy Swenson........... 1,113,636 3.8 3.3 Mari Tangredi(7)........ 99,427 * * Christos M. Cotsakos(8)............ 176,248 * * Lisa Gansky(9).......... 242,236 * * Kevin R. Harvey(10)..... 4,565,283 15.4 13.4 James A. Smith.......... 0 * * George Zachary(11)...... 4,565,283 15.4 13.4 All directors and executive officers as a group (15 persons)(12)........... 18,147,303 59.2% 51.6%
- -------- *Less than 1%. (1) Unless otherwise indicated, the address for the following shareholders is c/o Critical Path, Inc., 320 1st Street, San Francisco, California 94105. 60 (2) Assumes no exercise of the underwriters' over-allotment option. Applicable percentage ownership is based on 29,575,388 shares of common stock outstanding as of February 28, 1999 and 34,075,388 shares outstanding immediately following completion of this offering. Beneficial ownership is determined in accordance with the rules and regulations of the Securities and Exchange Commission. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock subject to options held by that person that are currently exercisable or exercisable within 60 days of the date of this prospectus are deemed outstanding. These shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of any other person. Except as indicated in the footnotes to this table and pursuant to applicable community property laws, each shareholder named in the table has sole voting and investment power with respect to the shares set forth opposite such shareholder's name. (3) These shares are held by Benchmark Capital Partners II, L.P. as nominee for Benchmark Capital Partners II, L.P., Benchmark Founders Fund II, L.P., Benchmark Founders Fund II-A, L.P. and Benchmark Members' Fund II, L.P. (4) Includes 4,245,713 shares held by Mohr, Davidow Ventures V, L.P. and 319,570 shares held by Mohr, Davidow Ventures V, L.P. as nominee from MDV Entrepreneurs' Network Fund II (A), L.P. and MDV Entrepreneurs' Network Fund II (B), L.P. (5) Includes 1,034,009 shares of common stock subject to Critical Path's right of repurchase as of April 29, 1999. Also includes 18,181 shares held in the name of Mr. Hickey's minor children's name. (6) Includes 767,043 shares subject to options exercisable within 60 days after February 28, 1999. (7) Includes 99,427 shares subject to options exercisable within 60 days after February 28, 1999. (8) Represents shares held by The Cotsakos Revocable Trust, UAD 9/3/87 of which Mr. Cotsakos is the trustee and includes 73,872 shares of common stock subject to Critical Path's right of repurchase as of April 29, 1999. (9) Includes 73,872 shares of common stock subject to Critical Path's right of repurchase as of April 29, 1999. (10) Represents shares held by Benchmark Capital Partners II, L.P., of which Mr. Harvey is a managing partner. Mr. Harvey disclaims beneficial ownership of all such shares except to the extent of his pecuniary interest therein. (11) Represents shares held by Mohr, Davidow Ventures V, L.P., of which Mr. Zachary is a member. Mr. Zachary disclaims beneficial ownership of all such shares except to the extent of his pecuniary interest therein. (12) Includes 1,087,916 shares subject to options exercisable within 60 days after February 28, 1999, of which 1,255,625 shares of common stock is subject to Critical Path's right of repurchase as of April 29, 1999. 61 DESCRIPTION OF CAPITAL STOCK Upon the closing of this offering, our authorized capital stock, after giving effect to the conversion of all outstanding preferred stock into common stock, conversion of outstanding warrants and the amendment of our articles of incorporation, will consist of 150,000,000 shares of common stock, par value $0.001 and 5,000,000 shares of preferred stock, par value $0.001. The following summary of certain provisions of our common stock, preferred stock, amended and restated articles of incorporation and bylaws, as in effect upon completion of this offering, assumes that our shareholders will approve of the amended and restated articles of incorporation and bylaws. Common Stock As of February 28, 1999, there were 29,575,388 shares of common stock outstanding, held by approximately 102 shareholders of record. Holders of our common stock are entitled to one vote for each share held of record on all matters submitted to a vote of the shareholders, including the election of directors, and will not have cumulative voting rights when Critical Path becomes a "listed company" as defined under Section 301.5(d) of the California Corporations Code. Subject to preferences that may be applicable to any then outstanding preferred stock, holders of common stock are entitled to receive ratably such dividends, if any, as may be declared by the board of directors out of funds legally available therefor. See "Dividend Policy." Upon a liquidation, dissolution or winding up of Critical Path, the holders of common stock will be entitled to share ratably in the net assets legally available for distribution to shareholders after the payment of all debts and other liabilities of Critical Path, subject to the prior rights of any preferred stock then outstanding. Holders of common stock have no preemptive or conversion rights or other subscription rights and there are no redemption or sinking funds provisions applicable to the common stock. All outstanding shares of common stock are, and the common stock to be outstanding upon completion of this offering will be, fully paid and nonassessable. Preferred Stock Upon the closing of this offering, there are no shares of preferred stock outstanding. Our board of directors has the authority, without further action by the shareholders, to issue from time to time the preferred stock in one or more series and to fix the number of shares, designations, preferences, powers and relative, participating, optional or other special rights and the qualifications or restrictions thereof. The preferences, powers, rights and restrictions of different series of preferred stock may differ with respect to dividend rates, amounts payable on liquidation, voting rights, conversion rights, redemption provisions, sinking fund provisions and purchase funds and other matters. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to holders of common stock or affect adversely the rights and powers, including voting rights, of the holders of common stock, and may have the effect of delaying, deferring or preventing a change in control of Critical Path. We currently do not plan to issue any shares of preferred stock. Registration Rights The holders of the Series A Preferred Stock and B Preferred Stock, who own 19,603,712 shares of Series A Preferred Stock and Series B Preferred Stock, and holders of 6,037,468 shares of common stock have the right to cause us to register the shares of common stock issuable upon 62 conversion of the Series A Preferred Stock and Series B Preferred Stock and the common stock under the Securities Act of 1933, as amended (the "Securities Act"), as follows: . Demand Registration Rights: Six months after this offering, the holders can send a written request to Critical Path to register their shares with respect to all or a part of their registrable securities having an aggregate offering price exceeding $12,500,000 and an initial offering price of at least $1.312 per share (as adjusted for splits or the like). . Piggyback Registration Rights: The holders can request to have their shares registered anytime Critical Path is filing a registration statement to register any of our securities for our own account. Such registration opportunities are unlimited but the number of shares that can be registered may be eliminated entirely or cut back in certain situations by the underwriters. . S-3 Registration Rights: The holders of at least 20% of the registrable securities can request Critical Path to register their shares if Critical Path is eligible to use Form S-3 and if the aggregate price of the shares to the public is at least $1,000,000. The Form S-3 registration opportunities are not limited. All of the holders of registrable securities may sell their shares pursuant to Rule 144 after the 180 day lockup period ends following the effectiveness of this registration statement, with the exception of 3,227,252 shares held by Series B holders, which shares will be eligible for resale under Rule 144 after January 2000 . The registration rights terminate the earlier of 5 years following the closing of this offering or at such time as Rule 144 is available for the sale of all such holders' shares during any 90 day period. Antitakeover Effects of Provisions of Articles of Incorporation and Bylaws Our articles of incorporation and bylaws authorize us to indemnify our current and former directors, officers, employees or agents to the fullest extent permitted by law. Our articles of incorporation eliminate a director's liability for monetary damages to the fullest extent permitted by the California Corporations Code. We believe that these provisions will assist us in attracting or retaining qualified individuals to serve as directors and officers. Articles of Incorporation Under our articles of incorporation, the board of directors has the power to authorize the issuance of up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without further vote or action by the shareholders. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, may have the effect of delaying, deferring or preventing a change in control of Critical Path, may discourage bids for the common stock at a premium over the market price of the common stock and may adversely affect the market price of and the voting and other rights of the holders of the common stock. These provisions of our articles of incorporation could discourage potential acquisition proposals and could delay or prevent a change in control of Critical Path. These provisions are intended to: . enhance the likelihood of continuity and stability in the composition of the board of directors and in the policies formulated by the board of directors, . discourage certain types of transactions that may involve an actual or threatened change of control of Critical Path 63 . reduce the vulnerability of Critical Path to an unsolicited acquisition proposal and . discourage certain tactics that may be used in proxy fights. Such provisions, however, could have the effect of discouraging others from making tender offers for our shares and, as a consequence, they also may inhibit fluctuations in the market price of our shares that could result from actual or rumored takeover attempts. Such provisions also may have the effect of preventing changes in our management. Our articles of incorporation provide that our bylaws may be repealed or amended only by a two-thirds vote of the board of directors or a two-thirds shareholder vote. Further, our articles of incorporation require that all shareholder action be taken at a shareholders' meeting. In addition, those provisions of the articles of incorporation may only be amended or repealed by the holders of at least two-thirds of the voting power of all the then- outstanding shares of stock entitled to vote generally for the election of directors voting together as a single class. Bylaws Our bylaws provide for a board that consists of a range of authorized directors from four to seven, which exact number can be set and amended from time to time by our Board. The directors will be elected at the annual meeting of shareholders or any special meeting of shareholders and each director so elected will hold office until the next annual meeting or until his successor is duly elected and qualified or until his earlier resignation or removal. The shareholders may not cumulate their votes in the election of directors. Unless otherwise restricted by statute, our Articles of Incorporation or Bylaws, any director or the entire board may be removed, with or without cause, by the holders of at least two-thirds of the shares entitled to vote at an election of directors. Vacancies may be filled by a majority of the directors then in office or by a sole remaining director. Special meetings of shareholders may be called by the board of directors, the chairman of the Board, the chief executive officer and president, or by the holders of shares entitled to cast no less than 10% of the votes at the meeting. The notice of any special meeting must specify the general nature of the business to be transacted, and not other business may be transacted at such meeting. The bylaws may be amended or repealed by the affirmative vote of two-thirds of the outstanding shares entitled to vote or by the board of directors. The provisions described above, together with the ability of the board of directors to issue preferred stock as described under "--Preferred Stock," may have the effect of deterring a hostile takeover or delaying a change in control or management of Critical Path. See "Risk Factors--Antitakeover Effects of Our Articles of Incorporation and Bylaws." Transactions Involving Interested Parties Under California Law Section 1203 of the California Corporations Code requires delivery of a report of an independent appraiser to shareholders in certain reorganizations, tender offers and cash-for-asset sales proposed by an interested party. The report must include an opinion as to the fairness of the consideration. An interested party is a person who indirectly or directly controls the subject corporation, is directly or indirectly controlled by an officer or director of the subject corporation or is an entity in which a material financial interest is held by any director or executive officer of the corporation. Transfer Agent and Registrar The transfer agent and registrar for our common stock is American Securities Transfer & Trust. 64 SHARES ELIGIBLE FOR FUTURE SALE Prior to this offering there has been no public market for our common stock, and no predictions can be made regarding the effect, if any, that market sales of shares or the availability of shares for sale will have on the market price prevailing from time to time. As described below, only a limited number of shares will be available for sale shortly after this offering due to certain contractual and legal restrictions on resale. Nevertheless, sales of substantial amounts of our common stock in the public market after the restrictions lapse could adversely affect the prevailing market price. Upon completion of this offering, we will have 34,075,388 shares of common stock outstanding based on 29,575,388 shares outstanding at February 28, 1999 and assuming no exercise of the underwriters' over-allotment option. The 4,500,000 shares of common stock being sold hereby will be freely tradable, other than by our "affiliates" as such term is defined in the Securities Act, without restriction or registration under the Securities Act. The 29,575,388 remaining shares were issued and sold by us in private transactions are restricted shares and are eligible for public sale if registered under the Securities Act or sold in accordance with Rule 701 under the Securities Act. All restricted shares are subject to lock-up agreements with the Underwriters under which the holders of the restricted shares have agreed they will not sell any common stock owned by them without the prior written consent of the representatives of the underwriters for a period of 180 days from the effective date of the Registration Statement of which this prospectus is a part. The following table indicates approximately when the shares of our common stock that are not being sold in the offering but which will be outstanding after the offering is completed will be eligible for sale into the public market. Eligibility for Resale into Public Market of Restricted Shares
Time Number of Shares ---- ---------------- Effective Date 0 180 days after Effective Date 26,348,136
The remaining shares of our common stock, including 3,227,252 shares of Series B Preferred Stock issued in January 1999, will be eligible for sale into the public market at various times after the expiration of one-year holding periods. Most of the restricted shares that will be available for public resale after 180 days after the effective date will be subject to volume and other resale restrictions pursuant to Rule 144 because the holders are affiliates of Critical Path. Subject to limitations on the aggregate offering price of a transaction and other conditions, Rule 701 may be relied upon with respect to the resale of securities originally purchased from us by our employees, directors, officers, consultants or advisers prior to the closing of this offering, pursuant to written compensatory benefit plans or written contracts relating to the compensation of such persons. In addition, the Securities and Exchange Commission has indicated that Rule 701 will apply to stock options granted by us before this offering, along with the shares acquired upon exercise of such options. Securities issued in reliance on Rule 701 are deemed to be restricted shares and, beginning 90 days after the date of this prospectus (unless subject to the contractual restrictions described above), may be sold by persons other than affiliates subject only to the manner of sale provisions of Rule 144 and by affiliates under Rule 144 without compliance with its two-year minimum holding period requirements. 65 In general, under Rule 144 as currently in effect, beginning 90 days after the date of this prospectus, a person deemed to be our affiliate, or a person holding restricted shares who beneficially owns shares that were not acquired from us or our affiliate within the previous two years, would be entitled to sell within any three-month period a number of shares that does not exceed the greater of: . 1% of the then outstanding shares of common stock, approximately 340,754 shares immediately after this offering, or . the average weekly trading volume of the common stock during the four calendar weeks preceding the date on which notice of the sale is filed with the Securities and Exchange Commission. Sales under Rule 144 are subject to certain requirements relating to manner of sale, notice and availability of current public information about us. However, a person (or persons whose shares are aggregated) who is not deemed to have been our affiliate at any time during the 90 days immediately preceding the sale and who beneficially owns restricted shares is entitled to sell these shares under Rule 144(k) without regard to the limitations described above; if at least three years have elapsed since the later of the date the shares were acquired from us or from our affiliate. The foregoing is a summary of Rule 144 and is not intended to be a complete description of it. We intend to file a registration statement under the Securities Act covering approximately 12,288,741 shares of common stock reserved for issuance under the 1998 Stock Plan. This registration statement is expected to be filed soon after the date of this prospectus and will automatically become effective upon filing. Accordingly, shares registered under this registration statement will be available for sale in the open market, unless the shares are subject to vesting restrictions with us or the contractual restrictions described above. We also intend to register an aggregate of 600,000 shares of common stock received for issuance under our 1999 Employee Stock Purchase Plan. However, no shares will be issuable under the 1999 Employee Stock Purchase Plan. 66 UNDERWRITING The underwriters named below, acting through their representatives, BancBoston Robertson Stephens Inc., Hambrecht & Quist LLC, Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, and FAC/Equities, a division of First Albany Corporation, have severally agreed with Critical Path, subject to the terms and conditions set forth in the underwriting agreement, to purchase from Critical Path the number of shares of common stock set forth opposite their names below. The underwriters are committed to purchase and pay for all such shares if any are purchased.
Number Underwriter of Shares ----------- --------- BancBoston Robertson Stephens Inc............................... Hambrecht & Quist LLC........................................... Dain Rauscher Wessels........................................... First Albany Corporation........................................ Total......................................................... ====
Critical Path has been advised by the representatives of the underwriters that the underwriters propose to offer the shares of common stock to the public at the initial public offering price set forth on the cover page of this prospectus and to certain dealers at such price less a concession of not in excess of $ per share, of which $ may be reallowed to other dealers. After the initial public offering, the public offering price, concession and reallowance to dealers may be reduced by the representatives. No such reduction shall change the amount of proceeds to be received by Critical Path as set forth on the cover page of this prospectus. The common stock is offered by the underwriters as stated herein, subject to receipt and acceptance by them and subject to their right to reject any order in whole or in part. The underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority. Over-allotment Option Critical Path has granted to the underwriters an option, exercisable during the 30-day period after the date of this prospectus, to purchase up to 675,000 additional shares of common stock at the same price per share as Critical Path will receive for the 4,500,000 shares that the underwriters have agreed to purchase. To the extent that the underwriters exercise this option, each of the underwriters will have a firm commitment to purchase approximately the same percentage of such additional shares that the number of shares of common stock to be purchased by it shown in the above table represents as a percentage of the shares offered hereby. If purchased, such additional shares will be sold by the underwriters on the same terms as those on which the 4,500,000 shares are being sold. Critical Path will be obligated, pursuant to the option, to sell shares to the extent the option is exercised. The underwriters may exercise such option only to cover over-allotments made in connection with the sale of the shares of common stock offered hereby. If such option is exercised in full, the total public offering price, underwriting discounts and commissions and proceeds to Critical Path will be $ , $ and $ , respectively. Indemnity The underwriting agreement contains covenants of indemnity among the underwriters and Critical Path against certain civil liabilities, including liabilities under the Securities Act and 67 liabilities arising from breaches of representations and warranties contained in the underwriting agreement. Lock-up Agreements Each of Critical Path's executive officers, directors, director-nominees, shareholders of record, optionholders, warrantholders and holders of convertible notes has agreed with the representatives of the underwriters, for a period of 180 days after the date of this prospectus, subject to certain exceptions, not to offer to sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant any rights with respect to any shares of common stock, any options or warrants to purchase any shares of common stock, or any securities convertible into or exchangeable for shares of common stock owned as of the date of this prospectus or thereafter acquired directly by such holders or with respect to which they have or hereafter acquire the power of disposition, without the prior written consent of BancBoston Robertson Stephens Inc. However, BancBoston Robertson Stephens Inc. may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to the lock-up agreements. There are no agreements between the representatives and any of Critical Path's shareholders providing consent by the representatives to the sale of shares prior to the expiration of the lock- up period. Future Sales In addition, Critical Path has agreed that during the lock-up period Critical Path will not, without the prior written consent of BancBoston Robertson Stephens Inc., subject to certain exceptions, . consent to the disposition of any shares held by shareholders subject to lock-up agreements prior to the expiration of the lock-up period or . issue, sell, contract to sell, or otherwise dispose of, any shares of common stock, any options to purchase any shares of common stock or any securities convertible into, exercisable for or exchangeable for shares of common stock other than Critical Path's sale of shares in this offering, the issuance of common stock upon the exercise of outstanding options, and the issuance of options under existing stock option and incentive plans provided such options do not vest prior to the expiration of the lock-up period. See "Shares Eligible for Future Sale." Listing Application has been made to have the common stock approved for quotation on the Nasdaq National Market under the symbol "CPTH." No Prior Public Market Prior to this offering, there has been no public market for the common stock of Critical Path. Consequently, the initial public offering price for the common stock offered hereby will be determined through negotiations between Critical Path and the representatives of the underwriters. Among the factors to be considered in such negotiations are prevailing market conditions, certain financial information of Critical Path, market valuations of other companies that Critical Path and the representatives believe to be comparable to Critical Path, estimates of the business potential of Critical Path, the present state of Critical Path's development and other factors deemed relevant. Stabilization The representatives of the underwriters have advised Critical Path that, pursuant to Regulation M under the Securities Act, certain persons participating in this offering may engage in 68 transactions, including stabilizing bids, syndicate covering transactions or the imposition of penalty bids, that may have the effect of stabilizing or maintaining the market price of the common stock at a level above that which might otherwise prevail in the open market. A "stabilizing bid" is a bid for or the purchase of the common stock on behalf of the underwriters for the purpose of fixing or maintaining the price of the common stock. A "syndicate covering transaction" is the bid for or the purchase of the common stock on behalf of the underwriters to reduce a short position incurred by the underwriters in connection with this offering. A "penalty bid" is an arrangement permitting the representatives to reclaim the selling concession otherwise accruing to an underwriter or syndicate member in connection with this offering if the common stock originally sold by such underwriter or syndicate member is purchased by the representatives in a syndicate covering transaction and has therefore not been effectively placed by such underwriter or syndicate member. The representatives have advised Critical Path that such transactions may be effected on the Nasdaq National Market or otherwise and, if commenced, may be discontinued at any time. Directed Share Program At the request of Critical Path, the underwriters have reserved up to five percent of the shares of common stock to be issued by Critical Path and offered hereby for sale, at the initial public offering price, to directors, officers, employees, business associates and related persons of Critical Path. The number of shares of common stock available for sale to the general public will be reduced to the extent such individuals purchase such reserved shares. Any reserved shares which are not so purchased will be offered by the underwriters to the general public on the same basis as the other shares offered hereby. Prior Transactions Hambrecht & Quist LLC acted as the placement agent for the sale of shares of Critical Path's Series B Preferred Stock in September 1998 and January 1999. In compensation for its services, Hambrecht & Quist LLC received a fee and a warrant. In addition, certain funds affiliated with Hambrecht & Quist LLC purchased shares of Series B Preferred Stock on the same terms as other purchasers of the Series B Preferred Stock. In February 1999, BancBoston Robertson Stephens made a $2,000,000 loan to David C. Hayden, our Chairman, pursuant to a promissory note bearing interest at prime plus .25% per annum. LEGAL MATTERS Certain legal matters with respect to the validity of the common stock offered hereby are being passed upon for Critical Path by Pillsbury Madison & Sutro LLP, Palo Alto, California. Certain legal matters in connection with this offering will be passed upon for the underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. Certain partners of Pillsbury Madison & Sutro LLP beneficially own an aggregate of 138,747 shares of common stock. EXPERTS The consolidated financial statements of Critical Path, Inc. as of December 31, 1997 and 1998 and for the period from February 19, 1997 (Inception) through December 31, 1997 and for the year ended December 31, 1998 included in this Prospectus have been so included in reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. 69 WHERE YOU CAN FIND MORE INFORMATION We have filed with the SEC a registration statement on Form S-1 with respect to the common stock offered hereby. This prospectus, which constitutes a part of the registration statement, does not contain all of the information set forth in the registration statement or the exhibits and schedules which are part of the registration statement. For further information with respect to Critical Path and the common stock, reference is made to the registration statement and the exhibits and schedules thereto. You may read and copy any document we file at the SEC's public reference room in Washington, DC. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. Our SEC filings are also available to the public from the SEC's website at http://www.sec.gov. Upon completion of this offering, Critical Path will become subject to the information and periodic reporting requirements of the Securities Exchange Act and, in accordance therewith, will file periodic reports, proxy statements and other information with the SEC. Such periodic reports, proxy statements and other information will be available for inspection and copying at the SEC's public reference rooms, Critical Path's website and the website of the SEC referred to above. Information on our website does not constitute a part of this prospectus. 70 CRITICAL PATH, INC. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- Report of Independent Accountants.......................................... F-2 Consolidated Balance Sheet................................................. F-3 Consolidated Statement of Operations....................................... F-4 Consolidated Statement of Shareholders' Equity (Deficit)................... F-5 Consolidated Statement of Cash Flows....................................... F-6 Notes to Consolidated Financial Statements................................. F-7
F-1 Report of Independent Accountants To the Board of Directors and Shareholdersof Critical Path, Inc. The Reverse Stock Split described in Note 9 to the consolidated financial statements has not been consummated at March 2, 1999. When it has been consummated, we will be in a position to furnish the following report. "In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of shareholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Critical Path, Inc. and its subsidiary at December 31, 1997 and 1998, and the results of their operations and their cash flows for the period from February 19, 1997 (Inception) to December 31, 1997 and the year ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above." PricewaterhouseCoopers LLP San Jose, California January 28, 1999, except for Note 9, which is as of March 2, 1999 F-2 CRITICAL PATH, INC. CONSOLIDATED BALANCE SHEET (in thousands, except per share amounts)
Pro Forma Shareholders' December 31, Equity at ----------------- December 31, 1997 1998 1998 ------- -------- ------------- (Unaudited) ASSETS Current assets: Cash and cash equivalents................... $ 1 $ 14,791 Restricted cash............................. -- 325 Accounts receivable, net.................... -- 121 Other current assets........................ 4 138 ------- -------- Total current assets...................... 5 15,375 Note receivable from officer.................. -- 500 Property and equipment, net................... 501 4,687 Other assets.................................. 44 101 ------- -------- $ 550 $ 20,663 ======= ======== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current liabilities: Accounts payable............................ $ 593 $ 423 Accrued expenses............................ 34 426 Deferred revenue............................ -- 500 Convertible promissory notes payable........ 420 -- Convertible promissory notes payable-- related party.............................. 427 -- Capital lease obligations, current.......... 55 1,502 ------- -------- Total current liabilities................. 1,529 2,851 Capital lease obligations, long-term.......... 42 2,454 ------- -------- 1,571 5,305 ------- -------- Commitments (Note 6) Shareholders' equity (deficit): Series A Convertible Preferred Stock, $0.001 par value; 13,288 shares authorized, 12,725 shares issued and outstanding, no shares pro forma (unaudited)...................... -- 13 $ -- Series B Convertible Preferred Stock, $0.001 par value; 10,000 shares authorized, 3,637 shares issued and outstanding, no shares pro forma (unaudited)...................... -- 4 -- Common Stock, $0.001 par value, 38,636 shares authorized; 2,394 and 8,294 shares issued and outstanding, 24,921 (unaudited) shares issued and outstanding pro forma.... 2 8 25 Additional paid-in capital.................. 51 41,901 41,901 Notes receivable from shareholders.......... -- (1,151) (1,151) Unearned compensation....................... -- (12,882) (12,882) Accumulated deficit......................... (1,074) (12,535) (12,535) ------- -------- -------- Total shareholders' equity (deficit)...... (1,021) 15,358 $ 15,358 ------- -------- ======== $ 550 $ 20,663 ======= ========
The accompanying notes are an integral part of these consolidated financial statements. F-3 CRITICAL PATH, INC. CONSOLIDATED STATEMENT OF OPERATIONS (in thousands, except per share amounts)
Period from February 19, 1997 (Inception) to Year Ended December 31, December 31, 1997 1998 -------------- ------------ Net revenues........................................ $ -- $ 897 Cost of net revenues................................ -- (2,346) ------- -------- Gross profit (loss)............................... -- (1,449) ------- -------- Operating expenses: Research and development.......................... 454 2,246 Sales and marketing............................... 244 2,318 General and administrative........................ 358 5,435 ------- -------- Total operating expenses........................ 1,056 9,999 ------- -------- Loss from operations................................ (1,056) (11,448) Interest and other income........................... -- 375 Interest expense.................................... (18) (388) ------- -------- Net loss............................................ $(1,074) $(11,461) ======= ======== Net loss per share--basic and diluted .............. $ (0.54) $ (2.94) ======= ======== Weighted average shares--basic and diluted.......... 1,994 3,899 ======= ======== Pro forma net loss per share (unaudited): Net loss per share basic and diluted ............. $ (0.81) ======== Weighted average shares--basic and diluted........ 14,194 ========
The accompanying notes are an integral part of these consolidated financial statements. F-4 CRITICAL PATH, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT) (in thousands)
Convertible Preferred Notes Total Stock Common Stock Additional Receivable Shareholders' ------------- ------------- Paid-in from Unearned Accumulated Equity Shares Amount Shares Amount Capital Shareholders Compensation Deficit (Deficit) ------ ------ ------ ------ ---------- ------------ ------------ ----------- ------------- Inception, February 19, 1997 Issuance of Common Stock.................. -- $-- 2,394 $ 2 $ 51 $ -- $ -- $ -- $ 53 Net loss................ -- -- -- -- -- -- -- (1,074) (1,074) ------ --- ----- --- ------- ------- -------- -------- -------- Balance at December 31, 1997................... -- -- 2,394 2 51 -- -- (1,074) (1,021) Issuance of Common Stock.................. -- -- 3,975 4 82 (85) -- -- 1 Exercise of stock options................ -- -- 1,925 2 1,104 (1,066) -- -- 40 Issuance of Series A Preferred Stock, net... 12,725 13 -- -- 9,111 -- -- -- 9,124 Issuance of Series B Preferred Stock, net... 3,637 4 -- -- 15,437 -- -- -- 15,441 Issuance of warrants and stock purchase rights.. -- -- -- -- 723 -- -- -- 723 Unearned compensation... -- -- -- -- 15,393 -- (15,393) -- -- Amortization of unearned compensation........... -- -- -- -- -- -- 2,511 -- 2,511 Net loss................ -- -- -- -- -- -- -- (11,461) (11,461) ------ --- ----- --- ------- ------- -------- -------- -------- Balance at December 31, 1998................... 16,362 $17 8,294 $ 8 $41,901 $(1,151) $(12,882) $(12,535) $ 15,358 ====== === ===== === ======= ======= ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. F-5 CRITICAL PATH, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)
Period from February 19, 1997 (Inception) to Year Ended December 31, December 31, 1997 1998 -------------- ------------ Cash flows from operating activities: Net loss......................................... $(1,074) $(11,461) Adjustments to reconcile net loss to net cash used in operating activities: Provision for doubtful accounts................ -- 50 Depreciation and amortization.................. 26 1,019 Common stock issued for services............... 3 -- Amortization of warrants and stock purchase rights........................................ -- 473 Amortization of unearned compensation.......... -- 2,511 Changes in assets and liabilities: Accounts receivable.......................... -- (171) Other assets................................. (48) (86) Accounts payable............................. 593 (170) Accrued expenses............................. 34 392 Deferred revenue............................. -- 500 ------- -------- Net cash used in operating activities...... (466) (6,943) ------- -------- Cash flows from investing activities: Notes receivable from officer.................... -- (500) Property and equipment purchases................. (409) (491) Restricted cash.................................. -- (325) ------- -------- Net cash used in investing activities...... (409) (1,316) ------- -------- Cash flows from financing activities: Proceeds from issuance of Convertible Preferred Stock, net...................................... -- 23,445 Proceeds from equipment lease line............... -- 198 Proceeds from issuance of Common Stock........... 50 41 Proceeds from convertible promissory notes payable......................................... 847 500 Repayment of convertible promissory notes payable......................................... -- (227) Principal payments on lease obligations.......... (21) (908) ------- -------- Net cash provided by financing activities.. 876 23,049 ------- -------- Net increase in cash and cash equivalents.......... 1 14,790 Cash and cash equivalents at beginning of period... -- 1 ------- -------- Cash and cash equivalents at end of period......... $ 1 $ 14,791 ======= ======== Supplemental cash flow disclosure: Cash paid for interest........................... $ 1 $ 244 Non-cash investing and financing activities Property and equipment leases.................... $ 118 $ 4,714 Common Stock issued for notes receivable......... $ -- $ 1,151 Conversion of notes payable into Convertible Preferred Stock................................. $ -- $ 1,120
The accompanying notes are an integral part of these consolidated financial statements F-6 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: The Company Critical Path, Inc. (the "Company") was incorporated in California on February 19, 1997 to deliver advanced email hosting services. Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Basis of presentation The financial statements include the accounts of the Company and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation. Cash equivalents and restricted cash The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Cash equivalents consist primarily of deposits in money market funds. Restricted cash comprises amounts held on deposit which is required as collateral for Company provided credit cards. Concentration of credit risk Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents, restricted cash and accounts receivable. Cash and cash equivalents and restricted cash are deposited with financial institutions that management believes are creditworthy. The Company's accounts receivable are derived from transactions with companies throughout the United States. The Company maintains an allowance for doubtful accounts receivable based upon the expected collectibility of accounts receivable. During the year ended December 31, 1998, approximately 62% and 30% of revenues before charges related to amortization of the fair value of warrants issued to customers were derived from the delivery of email services to two customers. Fair value of financial instruments The Company's financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable and capital lease obligations, are carried at cost, which approximates fair value due to the short maturity of these instruments. F-7 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Property and equipment Property and equipment are stated at cost. Depreciation and amortization is computed using the straight-line method over the shorter of the estimated useful lives of the assets, generally three to five years, or the lease term, if applicable. The Company periodically assesses the recoverability of the carrying amount of property and equipment and provides for any possible impairment loss based upon the difference between the carrying amount and the fair value of such assets. Since February 19, 1997 (Inception) through December 31, 1998, no impairment losses have been identified. Revenue recognition The Company derives revenue through the sale of email hosting services. Payments for such services are based either on contractual rates per active mailbox per month, non-refundable fixed payments or as a percentage of customer generated email advertising revenues. Revenues from contracts specifying a contractual rate per active mailbox per month are recognized monthly for each active mailbox covered by the respective contract. Revenues from contracts that provide non-refundable fixed payments are not dependent upon the active number of mailboxes and are therefore recognized ratably over the contract term. Revenues based upon a percentage of customer generated email advertising revenues are recognized when such revenues are earned and reported by the customer. Amounts billed or received in advance of service delivery are recorded as deferred revenue. In connection with certain customer contracts, the Company granted warrants or options to purchase Series B Convertible Preferred Stock to such customers. The fair value of such warrants or options, determined using the Black-Scholes option pricing model, is being recognized ratably as a sales discount over the terms of the respective agreements. See Note 7--Shareholders' Equity. Research and development Research and development costs include expenses incurred by the Company to develop and enhance its email service offerings and to develop new electronic messaging services. Research and development costs are expensed as incurred. Advertising expense Advertising costs are expensed as incurred and totaled $0 and $135,000 during the period from February 19, 1997 (Inception) through December 31, 1997 and the year ended December 31, 1998, respectively. Stock-based compensation The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" and complies with the disclosure provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the Company's stock and the exercise price of the option. The Company accounts for equity instruments issued to nonemployees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force ("EITF") 96-18. F-8 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Income taxes Income taxes are accounted for using an asset and liability approach, which requires the recognition of taxes payable or refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. The measurement of current and deferred tax assets and liabilities are based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized. Net loss per share Net loss per share is calculated in accordance with SFAS No. 128, "Earnings per Share" and Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 98 ("SAB 98"). Under the provisions of SFAS No. 128 and SAB 98, basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of common and potential common shares outstanding during the period if their effect is dilutive. Potential common shares comprise restricted Common Stock and incremental common and preferred shares issuable upon the exercise of stock options and warrants and upon conversion of Series A and Series B Convertible Preferred Stock. At December 31, 1998, approximately 28,456,331 potential common shares are excluded from the determination of diluted net loss per share as the effect of such shares on a weighted average basis is anti-dilutive. Pro forma net loss per share (unaudited) Pro forma net loss per share for the year ended December 31, 1998 is computed using the weighted average number of common shares outstanding, including the pro forma effects of the automatic conversion of the Company's Series A and Series B Convertible Preferred Stock into shares of the Company's Common Stock as if such conversion occurred on January 1, 1998, or at date of original issuance, if later. The resulting pro forma adjustment includes an increase in the weighted average shares used to compute basic and diluted net loss per share of approximately 10,295,000 shares for the year ended December 31, 1998. The pro forma effects of these transactions are unaudited and have been reflected in the accompanying pro forma consolidated statement of operations. Pro forma shareholders' equity (unaudited) Effective upon the closing of the Company's planned initial public offering ("Offering"), the outstanding shares of Series A and Series B Convertible Preferred Stock will automatically convert into 12,725,864 and 3,636,739 shares, respectively, of Common Stock. In addition, warrants relating to 223,762 shares of Series A Preferred and 40,346 shares of Series B Preferred Stock are expected to be exercised on a net basis immediately prior to the close of the Offering. The pro forma effects of these transactions are unaudited and have been reflected in the accompanying pro forma consolidated balance sheet at December 31, 1998. Comprehensive income Effective January 1, 1998, the Company adopted the provisions of SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting comprehensive income F-9 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) and its components in financial statements. Comprehensive income, as defined, includes all changes in equity (net assets) during a period from non-owner sources. To date, the Company has not had any transactions that are required to be reported in comprehensive income other than its net loss. Segment information In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for the way companies report information about operating segments in annual financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. In accordance with the provisions of SFAS No. 131, the Company has determined that it does not have separately reportable operating segments. Recent accounting pronouncements In March 1998, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") No. 98-1, "Software for Internal Use," which provides guidance on accounting for the cost of computer software developed or obtained for internal use. SOP No. 98-1 is effective for financial statements for fiscal years beginning after December 15, 1998. The Company does not expect that the adoption of SOP No. 98-1 will have a material impact on its consolidated financial statements. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". The Company is required to adopt SFAS 133 in fiscal 2000. SFAS 133 established methods of accounting for derivative financial instruments and hedging activities related to those instruments as well as other hedging activities. To date, the Company has not entered into any derivative financial instruments or hedging activities. NOTE 2--BALANCE SHEET COMPONENTS:
December 31, ------------- 1997 1998 ---- ------- (in thousands) Accounts receivable, net: Accounts receivable......................................... $ -- $ 171 Less: Allowance for doubtful accounts..................... -- (50) ---- ------- $ -- $ 121 ==== ======= Property and equipment, net: Computer equipment and software............................. $440 $ 5,247 Furniture and fixtures...................................... 34 74 Leasehold improvements...................................... 53 411 ---- ------- 527 5,732 Less: Accumulated depreciation and amortization........... (26) (1,045) ---- ------- $501 $ 4,687 ==== =======
F-10 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Property and equipment includes $118,000 and $4,832,000 of assets under capital leases at December 31, 1997 and 1998, respectively. Accumulated depreciation of assets under capital leases totaled $3,000 and $765,000 at December 31, 1997 and 1998, respectively.
December 31, --------------- 1997 1998 ------- ------- (in thousands) Accrued liabilities: Compensation related....................................... $ 18 $ 89 Other...................................................... 16 337 ------ ------- $ 34 $ 426 ====== =======
NOTE 3--RELATED PARTY TRANSACTIONS: Notes receivables from shareholders At December 31, 1998, the Company had notes receivable from shareholders and officers of the Company related to purchases of Common Stock in the amount of $85,000 and $1,066,000 which accrue interest at 5.69% and 4.51% per annum, respectively. The notes are full recourse and secured by Common Stock. The notes are due and payable in February 2003 or, for the $1,066,000 note, 90 days following termination of the officer. At December 31, 1998, the Company held a note receivable from an officer totaling $500,000. The note accrues interest at the rate of 4.51% per annum, is secured by all shares of the Company's Common Stock held by this individual, and is due and payable in November 2003 or 30 days following termination. Revenues In April 1998, the Company entered into an email services agreement with a significant customer, who is also a holder of the Company's Series B Preferred Stock. Net revenues from this shareholder approximated $605,000 in 1998. NOTE 4--INCOME TAXES: No provision for income taxes was recorded due to the net losses for the periods from February 19, 1997 (Inception) to December 31, 1998. At December 31, 1998, the Company had deferred tax assets of approximately $4,001,000. Management believes that, based on a number of factors, it is more likely than not that the deferred tax assets will not be realized, such that a full valuation allowance has been recorded. Deferred tax assets relate primarily to net operating loss carryforwards. At December 31, 1998, the Company had approximately $8,803,000 of federal and state net operating loss carryforwards available to offset future taxable income which expire in varying amounts beginning in 2012 and 2005, respectively. Under the Tax Reform Act of 1986, the amounts F-11 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) of and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that the Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over a three year period. NOTE 5--BORROWINGS: Line of credit At December 31, 1998, the Company maintained a revolving line of credit with a bank that provides for borrowings of up to $1,000,000. The line of credit expires in November 1999 and accrues interest on outstanding borrowings at a rate equal to the bank's prime rate plus 2.0% (9.75% at December 31, 1998). The line of credit requires the Company to meet certain financial tests and to comply with certain other covenants. Borrowings are secured by substantially all of the assets of the Company. At December 31, 1998, there were no borrowings outstanding and the Company was in compliance with all restrictive covenants. Convertible promissory notes At December 31, 1997, the Company had obligations totaling $420,000 under 7% convertible promissory notes payable to individual investors. In April 1998, the principal amount of the notes was converted into 582,040 shares of Series A Convertible Preferred Stock at $0.72 per share. In January and February 1998, the Company issued an additional $430,000 of 7% convertible promissory notes to individual investors. In April 1998, the principal amount of the notes was converted into 595,897 shares of Series A Convertible Preferred Stock at $0.72 per share. Convertible promissory notes--related parties At December 31, 1997, the Company had obligations totaling $427,000 under 7%- 10% convertible promissory notes payable to the Company's founder and an individual associated with the founder. In April 1998, $200,000 of the principal amount of the notes was converted into 277,162 shares of Series A Convertible Preferred Stock at $0.72 per share and the remaining balance of $227,000 was repaid in cash. In January and February 1998, the Company issued an additional $70,000 of 7% convertible promissory notes to a member of the Board of Directors and an individual associated with the Company's founder. In April 1998, the principal amount of the notes was converted into 97,006 shares of Series A Convertible Preferred Stock at $0.72 per share. NOTE 6--COMMITMENTS: Leases The Company leases office space and equipment under noncancelable operating and capital leases with various expiration dates through 2002. Rent expense for the period from February 19, F-12 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 1997 (inception) to December 31, 1997 and the year ended December 31, 1998, totaled $33,000 and $220,000, respectively. Future minimum lease payments under noncancelable operating and capital leases, including operating lease commitments entered into subsequent to December 31, 1998, are as follows:
Capital Operating Leases Leases Year Ending December 31, ------- --------- (in thousands) 1999...................................................... $1,792 $358 2000...................................................... 1,779 222 2001...................................................... 979 213 2002...................................................... 3 103 ------ ---- Total minimum lease payments.............................. 4,553 $896 ==== Less: Amount representing interest........................ (453) Unamortized discount.................................... (144) ------ Present value of capital lease obligations................ 3,956 Less: Current portion..................................... (1,502) ------ Long-term portion of capital lease obligations............ $2,454 ======
Equipment lease lines In April 1998, the Company entered into a financing agreement that provides for the acquisition of equipment up to $1,000,000. Amounts available under this agreement are limited to specific acquisitions through March 2001 and are collateralized by the related equipment. Such amounts are payable over a three- year period in monthly installments of principal and interest, with interest accruing at a rate of 6.3% per annum. In April 1998, the Company entered into another financing agreement which provides for the acquisition of equipment up to $2,000,000. Amounts available under this agreement are limited to specific acquisitions between May 1, 1998 and April 30, 1999. Such amounts are payable over a three-year period in monthly installments of principal and interest, with interest accruing at the rate of 7.0% per annum. As part of this agreement, the Company issued warrants to purchase 97,006 shares of Series A Preferred Stock at a purchase price of $0.72 per share. The Company estimated the fair value of these warrants at date of issuance was approximately $53,000 which is being amortized as interest expense over the term of the lease obligation. In May 1998, the Company entered into a financing agreement which provides for the acquisition of equipment up to $3,500,000 and software and tenant improvements up to $1,500,000. Amounts available under this agreement are limited to specific acquisitions between March 1, 1998 and May 1, 1999. Such amounts are payable over a three-year period in monthly installments of principal and interest, with interest accruing at the rate of 7.0% per annum. As part of this agreement, the Company issued warrants to purchase 242,516 shares of Series A Preferred Stock at a purchase price of $0.72 per share. The Company estimated the fair value associated with these warrants at date of issuance was approximately $133,000 which is being amortized as interest expense over the term of the lease obligation. F-13 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Email service commitments Net revenues are derived from contractual relationships which typically have one to two year terms. Certain agreements require minimum performance standards regarding the availability and response time of email services. If these standards are not met, such contracts are subject to termination and the Company could be subject to monetary penalties. NOTE 7--SHAREHOLDERS' EQUITY: As of December 31, 1998, the Company's Articles of Incorporation authorized the Company to issue 38,636,363 shares of Common Stock at $0.001 par value, and 13,288,519 and 10,000,000 shares of Series A and Series B Convertible Preferred Stock ("Preferred Stock"), respectively, at $0.001 par value. Preferred Stock On April 1, 1998, the Company completed its Series A Convertible Preferred Stock ("Series A") financing through the issuance of 12,707,869 shares at a price per share of $0.72 for net cash proceeds of $7,991,000, and the conversion of convertible promissory notes payable totaling $1,120,000. The Company issued an additional 18,013 shares of Series A Preferred Stock to the convertible promissory note holders upon the exercise of their warrants for proceeds of $13,000. In September 1998, the Company issued 3,636,738 shares of its Series B Convertible Preferred Stock ("Series B") at $4.26 per share for net proceeds of approximately $15,441,000. The holders of Preferred Stock have various rights and preferences as follows: Voting Each share of Preferred Stock has voting rights equal to an equivalent number of shares of Common Stock into which it is convertible and votes together as one class with Common Stock. As long as at least 2,954,545 shares of Preferred Stock remain outstanding, the Company must obtain approval from a majority of the holders of Preferred Stock to declare or pay any dividend on Common Stock; redeem, purchase or otherwise acquire any Common Stock other than shares subject to right of repurchase by the Company; cause the acquisition, reorganization, merger or consolidation of the Company that results in a transfer of 50% or more of the voting control of the Company; authorize or issue another equity security having a preference over, or being on parity with, the Series A and Series B; or increase the number of directors of the Company. As long as at least 681,818 shares of Preferred Stock remain outstanding, the Company must obtain approval from a majority of the holders of Preferred Stock to alter the Articles of Incorporation as it relates to the Preferred Stock or change the authorized number of shares of Preferred Stock. F-14 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Dividends Holders of Series A and Series B are entitled to receive noncumulative dividends at the per annum rate of $0.0577 and $0.34 per share, respectively, when and if declared by the Board of Directors. The holders of Preferred Stock will also be entitled to participate in dividends on Common Stock, when and if declared by the Board of Directors, based on the number of shares of Common Stock held on an as-if converted basis. No dividends on Preferred Stock or Common Stock have been declared by the Board of Directors. Liquidation In the event of any liquidation, dissolution or winding up of the Company, including a merger, acquisition or sale of assets where the beneficial owners of the Company's Common Stock and Preferred Stock own less than 51% of the resulting voting power of the surviving entity, the holders of Series A and Series B are entitled to receive an amount of $0.72 and $4.26 per share, respectively, plus any declared but unpaid dividends prior to and in preference to any distribution to the holders of Common Stock. The remaining assets, if any, shall be distributed ratably among the holders of Common Stock. Should the Company's legally available assets be insufficient to satisfy the liquidation preferences, the funds will be distributed ratably among the holders of Preferred Stock Conversion Each share of Preferred Stock is convertible, at the option of the holder, according to a conversion ratio, subject to adjustment for dilution. Each share of Preferred Stock automatically converts into the number of shares of Common Stock into which such shares are convertible at the then effective conversion ratio upon: (1) the closing of a public offering of Common Stock at a per share price of at least $15.50 per share with gross proceeds of at least $30,000,000, or (2) the consent of the holders of the majority of Convertible Preferred Stock. The initial conversion ratio of Preferred Stock for Common Stock is 1 to 1. Warrants and Stock Purchase Rights In May 1998, the Company issued a right to purchase 454,544 shares of Common Stock or Preferred Stock in a subsequent financing to a customer as part of an email services agreement. Under the agreement, the price shall be 80% of the price at which the stock is sold in the subsequent financing for the initial 227,272 shares and 100% of such price for the remaining 227,272 shares. In September 1998, the Company completed its Series B financing at a per share price of $4.26. The Company has estimated the fair value of the purchase right to be $194,000, which will be recognized as a sales discount over the term of the services agreement. Approximately $136,000 was recognized in 1998. No warrants were exercised as of December 31, 1998. In May 1998, the Company issued to a different customer, a warrant to purchase up to $250,000 of Preferred Stock in the Company's next financing round. The warrant is exercisable until December 31, 2001 and the exercise price per share will equal the price per share at which the Preferred Stock is sold by the Company. In September 1998, the warrants were exercised in F-15 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) connection with the Series B financing at a per share price of $4.26. The Company has estimated the fair value of the warrants approximated $143,000, which will be recognized as a sales discount over the term of the services agreement. Approximately $95,000 was recognized in 1998. In connection with various financing agreements described in Note 6, the Company issued warrants to purchase 339,522 share of Series A at $0.72 per share. The warrants are exercisable for seven years from May 1, 1998, or five years from the effective date of the Company's initial public offering, whichever is shorter. As of December 31, 1998, no warrants were exercised. In connection with the issuance of certain convertible promissory notes described in Note 5, the Company issued warrants to purchase 113,636 shares of Common Stock at $0.02 per share and 241,123 shares of Series A at $0.72 per share. These warrants are exercisable for one and three years, respectively. The warrants to purchase Common Stock were exercised in September 1998. At December 31, 1998, warrants to purchase 18,013 shares of Series A had been exercised. The Company estimated the fair value of the warrants issued at approximately $119,000 which is being amortized as interest expense. In connection with the Series B financing, the Company issued warrants to purchase 70,290 shares of Series B at $4.26 per share to the placement agent. As of December 31, 1998, no warrants were exercised. Common Stock purchase agreements In February 1998, the Company entered into stock purchase agreements with three founders and sold 3,863,635 shares of the Company's Common Stock at $0.02 per share. Under the terms of the stock purchase agreements, the Company has the right to purchase the shares of Common Stock at the original issue price in the event any one of the founders ceases to be an employee of the Company. The repurchase rights lapse 25% on the first anniversary of the vesting start date and ratably each month thereafter for 36 months. In the event of a change in control of the Company or the closing date of an Initial Public Offering, as defined, repurchase rights with respect to 50% of the then unvested shares of Common Stock will lapse. At December 31, 1998, 2,130,680 of theses shares of Common Stock were subject to repurchase rights. In connection with the issuance of these shares, the Company recorded unearned compensation of $765,000 which is being recognized over the periods in which the Company's repurchase rights lapse. In November 1998, the Company entered into stock purchase agreement with an officer who exercised stock options to purchase 1,274,687 shares of the Company's Common Stock at a price of $0.84 per share. Under the terms of the stock purchase agreement, the Company has the right to purchase the shares of Common Stock at the original issue price in the event the officer ceases to be an employee of the Company. The repurchase rights lapse 25% on the first anniversary of the vesting start date and ratably each month thereafter for 36 months. In the event of a change in control of the Company or the closing date of an Initial Public Offering, as defined, repurchase rights with respect to 50% of the then unvested shares of Common Stock will lapse. At December 31, 1998, 1,274,687 of these shares of Common Stock were subject to repurchase rights. In connection with the option grant preceding this transaction, the Company recognized unearned compensation totaling $3.25 million which is included in the aggregate unearned compensation charges disclosed in Notes 8 and 9 to these consolidated financial statements. F-16 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 8--STOCK OPTIONS: In January 1998, the Company's Board of Directors adopted the 1998 Stock Option Plan. The Plan provides for the granting of up to 12,288,741 stock options to employees and consultants of the Company. Options granted under the Plan may be either incentive stock options ("ISO") or nonqualified stock options ("NSO"). ISOs may be granted only to Company employees (including officers and directors who are also employees). NSOs may be granted to Company employees and consultants. Options under the Plan may be granted for periods of up to ten years and at prices no less than 85% of the estimated fair value of the shares on the date of grant as determined by the Board of Directors, provided, however, that (i) the exercise price of an ISO may not be less than 100% of the estimated fair value of the shares on the date of grant, and (ii) the exercise price of an ISO granted to a 10% shareholder may not be less than 110% of the estimated fair value of the shares on the date of grant. Options generally vest 25% per year and are exercisable for a maximum period of ten years from the date of grant. The following table summarizes activity under the Plan for the year ended December 31, 1998:
Year Ended December 31, 1998 ---------------------------- Weighted Average Exercise Shares Price ---------------- --------------- Granted..................................... 10,595,453 $0.74 Exercised................................... (1,924,723) 0.58 Canceled.................................... (918,174) 0.16 ---------------- Outstanding at end of period................ 7,752,556 0.86 ================ Options exercisable at period end........... 939,522 0.02 ================ Weighted average minimum value of options granted during period...................... 1.56
The following table summarizes information about stock options outstanding at December 31, 1998:
Options Exercisable Options Outstanding at December 31, 1998 at December 31, 1998 ------------------------------------------- -------------------- Weighted Average Weighted Weighted Number of Remaining Average Number of Average Shares Contractual Exercise Shares Exercise Range of Exercise Price Outstanding Life Price Exercisable Price ----------------------- -------------- -------------- ----------- ----------- -------- $0.02- $0.55 2,850,201 9.2 years $ 0.08 939,522 $0.02 $0.84- $2.20 4,902,355 9.8 years 1.30 -- -- -------------- ------- 7,752,556 9.5 years 0.89 939,522 0.02 ============== =======
F-17 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Fair value disclosures The Company calculated the minimum value of each options grant on the date of grants using the Black-Scholes option pricing model as prescribed by SFAS No. 123 using the following assumptions:
Year Ended December 31, ------------------------- 1997 1998 ----------- ----------- Risk-free interest rates......................... 6.0% 5.9% Expected lives (in years)........................ 4.0 4.0 Dividend yield................................... 0.0% 0.0% Expected volatility.............................. 0.0% 0.0%
The compensation cost associated with the Company's stock-based compensation plans, determined using the minimum value method prescribed by SFAS No. 123, did not result in a material difference from the reported net loss for the year ended December 31, 1998. Unearned stock-based compensation In connection with certain stock option grants and common stock issuances during the year ended December 31, 1998, the Company recognized unearned compensation totaling $15,393,000 which is being amortized over the vesting periods of the related options. Amortization expense recognized during the year ended December 31, 1998 totaled approximately $2,511,000. NOTE 9--SUBSEQUENT EVENTS: Reverse Stock Split On February 26, 1999, the Company's Board of Directors approved a 1:2.2 reverse stock split of the Company's outstanding shares to be effected prior to the close of the Offering. All share and per share information included in these consolidated financial statements have been retroactively adjusted to reflect this reverse stock split. Series B Convertible Preferred Stock Financing In January 1999, the Company completed the second round of the Series B financing through the issuance of 3,227,246 shares at $4.26 per share for gross proceeds of approximately $13,561,000. In connection with this financing, the Company issued warrants to purchase 51,364 shares of Series B at $4.26 per share to the placement agent. Exercise of Stock Purchase Rights In January 1999, a customer exercised stock purchase rights granted in May 1998 to purchase 454,544 shares of Series B for cash proceeds of approximately $1,744,000. Employee Stock Purchase Plan In January 1999, the Board of Directors adopted the 1999 Employee Stock Purchase Plan (the "Purchase Plan") effective on the date of the Offering. The Purchase Plan reserves 600,000 shares F-18 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) for issuance thereunder. Employees generally will be eligible to participate in the Purchase Plan if they are customarily employed by the Company for more than 20 hours per week and more than five months in a calendar year and are not 5% or greater shareholders. Under the Purchase Plan, eligible employees may select a rate of payroll deduction up to 15% of their compensation subject to certain maximum purchase limitations. The Purchase Plan will be implemented in a series of overlapping twenty-four month offering periods and beginning on the effective date of the Offering and subsequent offering periods will begin on the first trading day on or after May 1 and November 1 of each year. Purchases will occur on each April 30 and October 31 (the "purchase dates") during each participation period. Under the Purchase Plan, eligible employees will be granted an option to purchase shares of Common Stock at a purchase price equal to 85% of the fair market value per share of Common Stock on either the start date of the offering period or the date on which the option is exercised, whichever is less. If the fair market value of the Common Stock on any purchase date (other than the final purchase date) is lower than the fair market value on the start date of that offering period, then all participants in that offering period will be automatically withdrawn from such offering period and re-enrolled in the offering period immediately following. Stock Option Grants In January 1999, the Company granted incentive stock options to employees to purchase 903,409 shares of Common Stock at an exercise price of $3.39 per share. In connection with such option grants, the Company recognized record unearned compensation totaling $3.4 million which is being amortized over the vesting period of the related options. Sale of Common Stock In January 1999, the Company sold 1,090,909 shares of Common Stock at a price of $2.20 per share to a customer that also agreed to provide marketing related services. In connection with the transactions, the Company recognized a $1.3 million charge that will be attributed to sales and marketing expense over the one year term of the agreement. Common Stock Warrant Issued for Services In January 1999, the Company entered into an agreement with ICQ, Inc., a subsidiary of America Online, Inc., pursuant to which it will provide email hosting services that will be integrated with ICQ's instant messaging service provided to ICQ's customers. The ICQ instant messaging service is designed to allow users to communicate in real time over the Internet. As part of the agreement, ICQ agreed to provide sub-branded advertising for the Company in exchange for a warrant to purchase 2,442,766 shares of Series B, issuable upon attainment of each of five milestones. The following table summarizes the shares underlying each milestone and the related exercise price:
Shares Underlying Exercise Warrant Price ---------- -------- Milestone 1............................................. 814,254 $ 4.26 Milestone 2............................................. 407,128 5.50 Milestone 3............................................. 407,128 6.60 Milestone 4............................................. 407,128 8.80 Milestone 5............................................. 407,128 11.00 --------- Totals................................................ 2,442,766 =========
F-19 CRITICAL PATH, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The shares underlying the first milestone were immediately vested on the effective date of the agreement. The shares underlying the remaining milestones vest on the dates that ICQ completes registration of the specified number of sub-branded ICQ mailboxes applicable to each milestone. Using the Black-Scholes option pricing model and assuming a term of seven years and expected volatility of 90%, the initial fair value of the warrant on the effective date of the agreement approximated $14.473 million, which is being amortized to advertising expense using the straight-line method over four years. The shares underlying the second through fifth milestones will be remeasured at each subsequent reporting date until each sub-branded ICQ mailbox registration threshold is achieved. In the event such remeasurement results in increases or decreases from the initial fair value, which could be substantial, such increases or decreases will be recognized immediately, in the event the fair value of the shares underlying the milestone has been previously recognized, or over the remaining term. F-20 INSIDE BACK COVER the brand behind the brand [pictures of Critical Path customer branded web mail interfaces appears here] PART II INFORMATION NOT REQUIRED IN PROSPECTUS Item 13. Other Expenses of Issuance and Distribution The following table sets forth the various expenses expected to be incurred by the Registrant in connection with the sale and distribution of the securities being registered hereby, other than underwriting discounts and commissions. All amounts are estimated except the Securities and Exchange Commission registration fee and the National Association of Securities Dealers, Inc. filing fee.
Payable by Registrant ---------- SEC registration fee.............................................. $ 14,387 National Association of Securities Dealers, Inc. filing fee....... 5,675 Nasdaq National Market Listing Fee................................ 95,000 Accounting fees and expenses...................................... 200,000 Legal fees and expenses........................................... 250,000 Printing and engraving expenses................................... 200,000 Blue Sky fees and expenses........................................ 1,000 Registrar and Transfer Agent's fees............................... 15,000 Miscellaneous fees and expenses................................... 18,938 -------- Total............................................................. $800,000 ========
-------- * To be filed by amendment. Item 14. Indemnification of Directors and Officers Section 317 of the California Corporations Code provides for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons under certain circumstances for liabilities (including reimbursement for expenses incurred) arising under the Securities Act of 1933, as amended (the "Act"). Article V, Section B of our articles of incorporation (Exhibit 3.1 hereto) provides for indemnification of our directors, officers, employees and other agents to the extent and under the circumstances permitted by the California Corporations Code. We have also entered into agreements with our directors and officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers to the fullest extent permitted by law. The Underwriting Agreement (Exhibit 1.1) provides for indemnification by ourself, our underwriters and our directors and officers of the underwriters, for certain liabilities, including liabilities arising under the Act, and affords certain rights of contribution with respect thereto. Item 15. Recent Sales of Unregistered Securities 1. From February 1997 to February 26, 1999, the Registrant issued and sold 8,486,398 shares of common stock to employees, directors and consultants at prices ranging from $0.02 to $2.20 per share. 2. On April 1, 1998, the Registrant issued and sold 12,707,869 shares of Series A Preferred Stock to a total of 29 investors for an aggregate purchase price of $9,170,002. II-1 3. On September 11, 1998 and January 13, 1999, the Registrant issued and sold 6,863,991 shares of Series B Preferred Stock to a total of 19 investors for an aggregate purchase price of $29,061,014. 4. On January 13, 1999, the Registrant issued and sold 1,090,909 shares of common stock to one investor for an aggregate purchase price of $2,400,000. 5. From February 1997 to February, 1998, the Registrant issued and sold 6,258,251 shares of common stock to 5 investors at a purchase price of $0.02 per share. 6. On January 1999 the Registrant issued a warrant to purchase up to 2,442,766 shares of Series B Preferred Stock to one investor in connection with the Registrant's entering into a commercial agreement with a subsidiary of such investor. The sales of the above securities were deemed to be exempt from registration under the Securities Act in reliance on Section 4(2) of the Securities Act, or Regulation D promulgated thereunder, or Rule 701 promulgated under Section 3(b) of the Securities Act, as transactions by an issuer not involving a public offering or transactions pursuant to compensatory benefit plans and contracts relating to compensation as provided under Rule 701. The recipients of securities in each of these transactions represented their intention to acquire the securities for investment only and not with view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the share certificates and instruments issued in such transactions. All recipients had adequate access, through their relationship with the Registrant, to information about the Registrant. Item 16. Exhibits and Financial Statement Schedules (a) Exhibits See exhibits listed on the Exhibit Index following the signature page of the Form S-1, which is incorporated herein by reference. (b) Financial Statement Schedules Schedules other than those referred to above have been omitted because they are not applicable or not required or because the information is included elsewhere in the Financial Statements or the notes thereto. Item 17. Undertakings Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended (the "Act"), may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. II-2 The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, as amended, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, as amended, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) The Registrant will provide to the underwriters at the closing(s) specified in the underwriting agreement certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Amendment No. 2 to the Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Francisco, State of California, on the 3rd day of March, 1999. Critical Path, Inc. /s/ Douglas T. Hickey By: _________________________________ Douglas T. Hickey President, Chief Executive Officer and Director Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities and on the dates indicated.
Name Title Date ---- ----- ---- /s/ Douglas T. Hickey President, Chief Executive March 3, 1999 ____________________________________ Officer and Director Douglas T. Hickey /s/ David A. Thatcher Executive Vice President, March 3, 1999 ____________________________________ Chief Financial Officer David A. Thatcher (Principal Financial Officer) and Accounting Officer /s/ David C. Hayden Chairman of the Board March 3, 1999 ____________________________________ David C. Hayden * Director March 3, 1999 ____________________________________ Christos M. Cotsakos * Director March 3, 1999 ____________________________________ Lisa Gansky * Director March 3, 1999 ____________________________________ Kevin R. Harvey * Director March 3, 1999 ____________________________________ James A. Smith * Director March 3, 1999 ____________________________________ George Zachary
*By: /s/ David A. Thatcher ---------------------------- David A. Thatcher (Attorney-in-Fact) II-4 EXHIBIT INDEX
Exhibit Number Description of Document ------- ----------------------- 1.1 Form of Underwriting Agreement. 3(i)(a)** Amended and Restated Articles of Incorporation and amendments thereto. 3(i)(b)** Form of Amended and Restated Articles of Incorporation to be filed prior to completion of this offering. 3(ii)(a)** Bylaws of the Registrant, as amended. 3(ii)(b)** Form of Amended and Restated Bylaws. 4.1** Form of Common Stock Certificate. 4.2** Warrant to Purchase Preferred Stock dated September 11, 1998 issued by the Registrant to Hambrecht & Quist LLC. 4.3** Warrant to Purchase Preferred Stock dated January 13, 1999 issued by the Registrant to Hambrecht & Quist LLC. 4.4** Warrant to Purchase Common Stock dated January 29, 1999 issued by the Registrant to America Online, Inc. 5.1 Opinion of Pillsbury Madison & Sutro LLP. 10.1** Form of Indemnification Agreement between the Registrant and each of its directors and officers. 10.2** Employee Stock Purchase Plan. 10.3** 1998 Stock Plan and forms of stock option agreements thereunder. 10.4** Series B Preferred Stock Purchase Agreement dated September 11, 1998. 10.5** Amendment to Series B Preferred Stock Purchase Agreement dated January 13, 1999. 10.6** Amended and Restated Investors' Rights Agreement dated September 11, 1998. 10.7** Amendment to the Amended and Restated Investors' Rights Agreement dated January 13, 1999. 10.8** Master Equipment Lease Agreement dated April 28, 1998, and Lease Line Schedule thereto, by and between the Registrant and Lighthouse Capital Partners II, L.P. 10.9** Master Lease Agreement dated May 1, 1998, and addendum thereto, by and between the Registrant and Comdisco, Inc. 10.10** Standard Industrial/Multitenant Lease-Gross dated June 20, 1997 by and between the Registrant and 501 Folsom Street Building. 10.11** Letter Agreement dated October 1, 1998 by and between the Registrant and Douglas Hickey. 10.12** Promissory Note and Security Agreement dated November 2, 1998 by and between the Registrant and Douglas Hickey. 10.13** Warrant Agreement dated April 28, 1998 by and between the Registrant and Lighthouse Capital Partners II, L.P. 10.14** Warrant Agreement dated May 1, 1998 by and between the Registrant and Comdisco, Inc. 10.15+** Master Services Agreement dated December 10, 1998 by and between the Registrant and US West Communications Services, Inc. 10.16+** Email Services Agreement dated May 27, 1998 by and between the Registrant and Network Solutions, Inc. 10.17+** Email Services Agreement dated July 6, 1998 by and between the Registrant and StarMedia Network, Inc. 10.18+** Amendment to Email Services Agreement September 30, 1998 by and between the Registrant and E*TRADE Group, Inc. 10.19+** Email Services Agreement dated September 14, 1998 by and between the Registrant and Sprint Communications Company L.P. 10.20+** Email Services Agreement dated March 19, 1998 by and between the Registrant and NTX, Inc. dba TABNet, Inc.
Exhibit Number Description of Document ------- ----------------------- 10.21** QuickStart Loan and Security Agreement dated May 12, 1998 by and between the Registrant and Silicon Valley Bank. 10.22**+ Email Services Agreement dated January 29, 1999 by and between the Registrant and ICQ, Inc. 10.23 Sublease dated February 8, 1999 by and between Times Direct Marketing, Inc. and Critical Path. 10.24 Promissory Note and Security Agreement dated January 26, 1999 by and between the Registrant and Bill Rinehart. 23.1 Consent of PricewaterhouseCoopers LLP. 23.2 Consent of Pillsbury Madison & Sutro LLP (included in Exhibit 5.1). 24.1** Power of Attorney. 27.1 Financial Data Schedule.
- -------- *To be filed by amendment. **Previously Filed. + Confidential treatment has been requested with respect to certain portions of these agreements. EX-5.1 2 OPINION OF PILLSBURY MADISON & SUTRO LLP Exhibit 5.1 PILLSBURY MADISON & SUTRO LLP 2550 Hanover Street Palo Alto, CA 94304-1115 Tel: (650) 233-4500 Fax: (650) 233-4545 March 3, 1999 Critical Path, Inc. 320 First Street San Francisco, CA 94105 Re: Registration Statement on Form S-1 Ladies and Gentlemen: We are acting as counsel for Critical Path, Inc., a California corporation (the "Company"), in connection with the registration under the Securities Act of 1933, as amended, of 5,175,000 shares of Common Stock, par value $.001 per share (the "Common Stock"), of the Company (including 675,000 shares subject to the underwriters' over-allotment option) to be offered and sold by the Company. In this regard we have participated in the preparation of a Registration Statement on Form S-1 relating to such 5,175,000 shares of Common Stock. (Such Registration Statement, as amended, and including any registration statement related thereto and filed pursuant to Rule 462(b) under the Securities Act (a "Rule 462(b) registration statement") is herein referred to as the "Registration Statement.") We are of the opinion that the shares of Common Stock to be offered and sold by the Company have been duly authorized and, when issued and sold by the Company in the manner described in the Registration Statement and in accordance with the resolutions adopted by the Board of Directors of the Company, will be legally issued, fully paid and nonassessable. We hereby consent to the filing of this opinion as Exhibit 5.1 to the Registration Statement and to the use of our name under the caption "Legal Matters" in the Registration Statement and in the Prospectus included therein. Very truly yours, /s/ Pillsbury Madison & Sutro LLP E-12984 EX-10.23 3 SUBLEASE DATED 2/8/99 WITH TIMES DIRECT MARKETING EXHIBIT 10.23 SUBLEASE 1. Parties. This Sublease, dated February 8, 1999, is made between TIMES ------- ----- DIRECT MARKETING, INC., a California corporation ("Sublandlord"), and Critical - ---------------------- -------- Path, a California corporation ("Subtenant"). - ---- 2. Master Lease. Sublandlord is the tenant under a lease dated December ------------ 23, 1996, as amended April 15, 1998, wherein 501 Folsom Street Building ("Master Landlord") leased to Sublandlord certain premises located on the 3rd Floor ("3rd Floor Premises") and 4th Floor ("4th Floor Premises") in that certain building (the "Building") commonly known as 501 Folsom Street, San Francisco, California (the 3rd Floor Premises and the 4th Floor Premises are collectively referred to as the "Premises"). A copy of the "Master Lease" is attached hereto as Exhibit ------- A. Each capitalized term used herein without definition shall have the meaning - - ascribed to such term in the Master Lease. 3. Subleased Premises. Sublandlord hereby subleases to Subtenant on the ------------------ terms and conditions set forth in this Sublease the entirety of the Premises. 4. Sublease Term. ------------- 4.1 Sublease Term. The term ("Sublease Term") of this Sublease shall ------------- commence (the "Commencement Date") on the later of (a) the date hereof or (b) when Master Landlord consents in writing to this Sublease, and end on March 31, 2002 ("Sublease Expiration Date"), unless otherwise sooner terminated in accordance with the provisions of this Sublease. In the event the Sublease Term commences on a date other than the date set forth in clause (a), Sublandlord and Subtenant shall execute a memorandum setting forth the actual date of commencement of the Sublease Term. Subtenant shall have no right or option to extend the Sublease Term under any circumstances. Delivery of the Premises shall take place in accordance with Section 5 hereof. 4.2 Termination Right. This Sublease shall be of no force or effect ----------------- unless consented to in writing by Master Landlord. If for any reason Sublandlord does not obtain Master Landlord's consent to this Sublease on or before April 1, 1999, then, unless and until such consent is obtained, either Subtenant or Sublandlord may terminate this Sublease and all of the obligations of the parties hereunder upon written notice thereof to the other party. In the event of such termination, the Security Deposit shall be promptly returned to Subtenant. 5. Delivery. Possession of the 3rd Floor Premises shall be delivered to -------- Subtenant on the Commencement Date; possession of the 4th Floor Premises shall be delivered to Subtenant on the later of the Commencement Date or the date Sublandlord vacates the 4th Floor Premises, which is currently estimated (without warranty thereof by Sublandlord) to be May 1, 1999. If the Sublandlord has not vacated the 4th Floor Premises and tendered possession thereof by May 1, 1999, then Subtenant's payment to Sublandlord of prepaid rent pursuant to the third sentence of Section 6.2 below shall be reduced by $185 per day for each day of delay. -1- 6. Rent. ---- 6.1 Monthly Rent. Commencing upon the later of the Commencement Date or ------------ the delivery of the 3rd Floor Premises, Subtenant shall pay to Sublandlord during the Sublease Term as monthly base rent for the 3rd Floor Premises the sum of $13,825.89 in respect of the leasing of the 3rd Floor Premises and commencing upon the later of the Commencement Date or the delivery of the 4th Floor Premises Subtenant shall pay to Sublandlord during the Sublease Term as monthly base rent for the 4th Floor Premises the sum of $11,300.00 in respect of the leasing of the 4th Floor Premises. Rent for any period during the term hereof which is for less than one (1) month shall be a pro rata portion of the monthly installment, based upon a thirty (30) day month. 6.2 Prepaid Rent. Upon delivery of the 3rd Floor Premises, Subtenant ------------ shall prepay to Sublandlord the sum of $143,659.38 which shall be deemed additional prepaid rent in respect of the leasing of the 3rd Floor Premises. Said additional prepaid rent shall be amortized evenly over the same period Monthly Rent is due in respect of the 3rd Floor Premises pursuant to Section 6.1. Upon delivery of the 4th Floor Premises, Subtenant shall prepay to Sublandlord the sum of $143,659.38 which shall be deemed additional prepaid rent in respect of the leasing of the 4th Floor Premises. Said additional prepaid rent shall be amortized evenly over the same period Monthly Rent is due in respect of the 4th Floor Premises pursuant to Section 6.1. The rent due under this Section 6.2 shall be in addition to the rent due under Section 6.1. All rent due under Section 6.1 and this Section 6.2 shall collectively be referred to hereinafter as the "Sublease Base Rent." All Sublease Base Rent shall be paid without deduction, setoff, notice or demand, at the address set forth in Section 10, or at such other place as Sublandlord shall designate from time to time by notice to Subtenant, and, in the case of the Sublease Base Rent due pursuant to Section 6.1, in advance, on the first day of each month, 6.3 Additional Rent. All amounts over and above, or in addition to, --------------- Sublease Base Rent which are payable by Subtenant to Sublandlord under the terms of this Sublease, shall be deemed additional rent hereunder and Sublandlord shall have all the rights and remedies in the event of the nonpayment thereof as it would have had in the event of the nonpayment of any installment of Sublease Base Rent. 7. Security Deposit. Subtenant shall deposit with Sublandlord upon ---------------- execution of this Sublease the sum of $33,125.00 as security for Subtenant's faithful performance of Subtenant's obligations hereunder (the "Security Deposit"). If Subtenant fails to pay rent or other charges within any applicable cure period under this Sublease, or fails to perform any of its other obligations hereunder, Sublandlord may use or apply all or any portion of the Security Deposit for the payment of any rent or other amount then due hereunder and unpaid, for the payment of any other sum for which Sublandlord may become obligated by reason of Subtenant's default or breach, or for any loss or damage sustained by Sublandlord as a result of Subtenant's default or breach beyond any applicable cure period. If Sublandlord so uses any portion of the Security Deposit, Subtenant shall, within seven (7) days after written demand by Sublandlord, restore the Security Deposit to the full amount originally deposited, and Subtenant's failure to do so shall constitute a default under this Sublease. Sublandlord shall not be required to keep the Security Deposit separate from its general accounts, and shall have no obligation or liability for payment of interest on the Security Deposit. In the event Sublandlord assigns its interest in this Sublease, Sublandlord shall deliver to its assignee so much of the Security Deposit as is then held by Sub- -2- landlord. Within thirty (30) days after the Sublease Term has expired, or Subtenant has vacated the Premises, whichever shall last occur, and provided Subtenant is not then in default of any of its obligations hereunder, the Security Deposit, or so much thereof which has not previously been applied by Sublandlord, shall be returned to Subtenant or to the last assignee, if any, of Subtenant's interest hereunder. In the event Sublandlord has not delivered the 4th floor Premises to Subtenant on or prior to June 1, 1999, then Sublandlord shall return to Subtenant a portion of the security deposit equal to $19,375.00; said portion shall be redeposited with Sublandlord at such later date, if at all, as such delivery occurs. 8. Condition of Subleased Premises. In entering into this Sublease ------------------------------- Subtenant has not relied upon or been induced by any statements or representations of any persons with respect to the physical condition of the Building or the Premises or with respect to any other matter affecting the Premises, that might be pertinent in considering the leasing of the Premises or the execution of this Sublease. Sublessee has, on the contrary, relied solely on such investigations, examinations and inspections as Subtenant has chosen to make or have made on its behalf. Subtenant acknowledges that Sublandlord has afforded Subtenant the opportunity for full and complete investigations, examinations and inspections. Upon taking possession of the Premises, Subtenant shall be deemed to have accepted the Subtenant Premises in an "as-is" condition. Notwithstanding the foregoing to the contrary, Sublandlord shall deliver the Premises clean and in broom-swept condition, with all building systems which Sublandlord is responsible to maintain under the provisions of the Master Lease in good, working order as of the Commencement Date. 9. Incorporation of Master Lease. ----------------------------- (a) Subject to the following provisions of this Section 9, all terms and conditions of the Master Lease, including, without limitation, all default provisions, are incorporated into and made a part of this Sublease, except the following provisions, and all references thereto, shall be deemed deleted from the Master Lease for the purpose of incorporation herein: 1.3; 1.5; 1.6(a); 1.7; 1.10(a) and (b), 2.1; 2.2; 2.3; 2.4; 2.5; 3; 4.1; 5; 8.2(b); 8.3(a); 8.3(d); the final sentence of 12.3(a); 15; 25; 39; 50; 51; 52; 53; 54 and 55. All references in such incorporated provisions to Lease, Lessor, Lessee, Term, Expiration Date and Base Rent shall mean, respectively, Sublease, Sublandlord, Subtenant, Sublease Term, Sublease Expiration Date and Sublease Base Rent. Subtenant assumes and agrees to perform for the benefit of Sublandlord the tenant's conditions, covenants and obligations under the Master Lease to the extent the same are incorporated in this Sublease. Subtenant shall not commit or suffer any act or omission that will violate any of the provisions of the Master Lease. The foregoing incorporated provisions are modified in the following respects: (b) The time limits contained in the Master Lease for the giving of notices, making of demands or performing of any act, condition or covenant on the part of tenant under the Master Lease, or for the exercise by the tenant thereunder of any right, remedy or option incorporated herein are changed for the purpose of incorporation herein by reference by shortening the same, in each instance, by three (3) days, so that, in each instance, Subtenant shall have three (3) days less time to observe or perform hereunder than Sublandlord has as tenant under the Master Lease. If the Master Lease, as incorporated herein, only allows six (6) days or less for Subtenant -3- to perform any act or to correct any failure relating to the Premises or this Sublease, then, except in the event of an emergency, Subtenant shall nevertheless be allowed three (3) days to perform any such act or correct any such failure. (c) In determining whether to grant or withhold any consent or response, Sublandlord may expressly condition the same upon the consent or approval of Master Landlord. (d) Sublandlord shall not be required to perform any of the covenants and obligations of Master Landlord under the Master Lease and, insofar as any of the obligations of the Sublandlord hereunder are required to be performed under the Master Lease by Master Landlord, Subtenant shall rely on and look solely to Master Landlord for the performance thereof. Sublandlord shall not be responsible for any representations or warranties of Master Landlord in any incorporated text. (e) Any reference to Paragraph 8 within the Master Lease shall mean Paragraph 8 as modified by Section 11 of the Sublease. (f) In the event of any conflict between any provision of the Master Lease which is incorporated herein as described above and any provision in any other Section of this Sublease, the later shall control. 10. Notices. All notices and demands which may be or are required or ------- permitted to be given by either party to the other party hereunder shall be sent to the address hereinbelow: To Sublandlord: 355 Fremont Street San Francisco, California Attn: Stuart McClain To Subtenant: 501 Folsom Street San Francisco, California Attn: David Thatcher 11. Insurance. Subtenant shall comply with all of the insurance --------- requirements and obligations of Sublandlord, as tenant under the Master Lease, except that the amount of coverage of liability insurance to be maintained as of the Commencement Date by Subtenant under Section 8.2(a) of the Master Lease incorporated herein shall be increased to $2,000,000 per occurrence; thereafter, if Master Landlord requires Sublandlord to increase its coverage pursuant to the Master Lease to an amount greater than $2,000,000, then Subtenant shall also increase its coverage to such greater amount. Notwithstanding anything to the contrary in the Master Lease or Sublease, Subtenant shall be obligated to maintain the casualty insurance required of the tenant under Section 8.4 of the Master Lease with respect to any and all personal property, Trade Fixtures and Lessee-Owned Alterations and Utility Installations whether placed or installed in the Premises by Sublandlord prior to the Commencement Date or by Subtenant thereafter. Subtenant shall, whether required by the Master Lease or not, name Master Landlord and Sublandlord as additional insureds, as their interests may appear, on all policies of insurance required to be carried by Subtenant hereunder or thereunder. -4- 12. Subordination to the Master Lease. This Sublease is expressly --------------------------------- subject and subordinate to the Master Lease, and, if the Master Lease terminates (including, without limitation, upon the occurrence of any casualty or condemnation pertaining to the Premises or the Building), this Sublease shall terminate. Subtenant acknowledges that it has received a copy, and has reviewed the terms, of the Master Lease. Subtenant shall indemnify and hold Sublandlord harmless from and against any and all claims, suits, liabilities, costs and expenses, including reasonable attorneys' fees and costs, asserted against or sustained by Sublandlord resulting from a breach or default under or termination of the Master Lease caused by Subtenant. Subtenant shall not do, omit to do, or permit to be done or omitted any act in or related to the Premises which could or does constitute a breach or default under the terms of the Master Lease. If any of the express provisions of this Sublease shall conflict with any of the provisions of the Master Lease as incorporated herein, such conflict shall be resolved in favor of the express provisions of this Sublease. Sublandlord, to the best of its knowledge, represents to Subtenant that the Master Lease is in full force and effect and that no default exists on the part of any party to the Master Lease and that Sublandlord has received no written notice from any governmental authority that the Premises are in violation of any applicable law. Sublandlord shall not default under the Master Lease in respect of any required rental payment thereunder provided Subtenant shall have previously paid to Sublandlord the full amount thereof and Sublandlord shall have failed to pay the same to Master Landlord. 13. Representations and Covenants of Master Landlord. Master Landlord ------------------------------------------------ represents that, to the best of Master Landlord's knowledge, (a) no default presently exists under the Master Lease with respect to obligations to be performed by Sublandlord, (b) the Master Lease is in full force and effect, (c) there is no event which with the giving of notice and/or the passage of time would constitute a default as of the commencement of the term of the Sublease (d) the Master Lease attached hereto as Exhibit A is a true and complete copy of the lease, and (e) there are no other agreements of any kind affecting Sublandlord's lease and occupancy of the Premises. In the event that Sublandlord is in Breach (as such term is defined in the Master Lease) with respect to any obligation under the Master Lease, Master Landlord agrees to deliver to Subtenant a notice thereof. Master Landlord agrees that Subtenant shall have the right to cure such Breach within ten (10) days after such notice. In the event the Master Lease between Master Landlord and Sublandlord is canceled or terminated for any reason, or involuntarily surrendered by operation of law before the Sublease Expiration Date, Subtenant agrees at the sole option of Master Landlord, to attorn to the Master Landlord for the balance of the term of this Sublease and on the then-executory terms of this Sublease. Such a recognition and attornment will be evidenced by an agreement in form and substance reasonably satisfactory to the Master Landlord and Subtenant. Subtenant agrees to execute and deliver such an agreement at any time within ten (10) business days after request by the Master Landlord. 14. Right to Cure Subtenant's Defaults. If Subtenant shall at any time ---------------------------------- fail to make any payment or perform any other obligation of Subtenant hereunder, then Sublandlord shall have the right, but not the obligation, after the lesser of five (5) days notice to Subtenant or the time within which Master Landlord may act on Sublandlord's behalf under the Master Lease, or without notice to Subtenant in the case of any emergency, and without waiving or releasing Subtenant from any obligations of Subtenant hereunder, to make such payment or perform such other obligation of Subtenant in such manner and to such extent as Sublandlord shall deem necessary, and in exercising any such right, to pay any reasonable incidental costs and expenses, -5- employ attorneys and other professionals, and incur and pay reasonable attorneys' fees and other costs reasonably required in connection therewith. Subtenant shall pay to Sublandlord upon demand, as additional rent, all sums so paid by Sublandlord and all incidental costs and expenses of Sublandlord in connection therewith, together with interest thereon at the maximum legal rate and late fees as provided in the Master Lease. 15. Bonus Rent. In the event that Subtenant shall assign, sublease or ---------- otherwise transfer the Sublease to a party for consideration in excess of the Sublease Base Rent, Sublandlord and Subtenant shall evenly divide such excess consideration after first deducting the portion of any such bonus rent payable to Master Landlord by either Sublandlord or Subtenant. 16. Survival. Except as otherwise set forth in this Sublease, any -------- obligations of Subtenant (including, without limitation, rental and other monetary obligations, repair obligations and obligations to indemnify Sublandlord), shall survive the expiration or sooner termination of this Sublease, and Subtenant shall immediately reimburse Sublandlord for any expense incurred by Sublandlord in curing Subtenant's failure to satisfy any such obligation (notwithstanding the fact that such cure might be effected by Sublandlord following the expiration or earlier termination of this Sublease). This Sublease has been executed on the day and year first written above.
SUBLANDLORD SUBTENANT - ----------- --------- TIMES DIRECT MARKETING, a California CRITICAL PATH, a California corporation corporation By /s/ Chris Peterson By /s/ David Thatcher ------------------------------------- --------------------------------------------- Name Chris Peterson Name David Thatcher ----------------------------------- ------------------------------------------- Title President Title EVP/CFO ---------------------------------- ------------------------------------------
-6- Subject to the provisions of the Consent to Sublease, a copy of which is attached hereto as Exhibit B, Master Landlord, by its signature below, hereby consents to the foregoing Sublease: 501 FOLSOM STREET BUILDING By /s/ David Bruck ----------------------------------- Name David Bruck --------------------------------- Title Partner --------------------------------- -7- EXHIBIT A (MASTER LEASE) A-1 EX-10.24 4 PROMISSORY NOTE AND SECURITY AGREEMENT DATED 1/26 Exhibit 10.24 PROMISSORY NOTE -------------------- $65,000.00 January 26, 1999 San Francisco, California 1. Principal and Interest. ---------------------- (a) For value received, the undersigned, BILL RINEHART ("Maker"), promises ------------- to pay to the order of CRITICAL PATH, INC., a California corporation (the ------------------- "Company"), the principal sum of sixty-five thousand dollars ($65,000.00), with interest from the date hereof on the unpaid principal at the applicable federal rate of 4.64%, compounded annually. (b) In the event that Maker shall cease, for any reason, to be a Service Provider to the Company (which term shall refer to a capacity in which Maker provides to the Company periodic service, either as an employee or consultant), the entire unpaid balance of principal and interest shall be due within thirty (30) days of the date that Maker ceased to be a Service Provider. (c) If Maker continues to serve as a Service Provider to the Company, this Note shall be due and payable on January 15, 2004. (d) The undersigned shall have the right to prepay all or any part of the unpaid principal amount of this Note, without premium or penalty, at any time. 2. Attorneys' Fees. If payment is not made when due, and if action is --------------- instituted on this note, the undersigned agrees to pay, in addition to the principal and interest payable hereunder, the Company reasonable attorneys' fees and costs of suit, as fixed by court. 3. Security. This Note is secured by a pledge of all shares of, and -------- options to purchase shares of, the Company's Common Stock now and hereafter held by Maker, including any shares for which such shares and options may be converted or exercised and all proceeds of such shares and options (collectively, the "Securities"), pursuant to a Security Agreement of even date herewith, which is on file with the Secretary of the Company. This Note shall be non-recourse; provided, however, that if at any time prior to January 15, 2004, Maker voluntarily ceases to be a Service Provider to the Company for any reason, other than "Good Reason" as defined in Maker's letter agreement with the Company dated November 17, 1998, this Note shall become a full-recourse note. 4. Subordination. The indebtedness evidenced by this Note is expressly ------------- subordinated in priority and payment to any and all future indebtedness that Maker may incur to the Company as a result of Maker's purchase of shares of the Company's Common Stock by promissory note pursuant to Maker's stock option agreement with the Company dated November 12, 1998. 5. Assignment. The rights and obligations of the Company and Maker shall be binding upon and benefit the successor, assigns, heirs, administrators and transferees of the parties. 6. Waiver and Amendment. Any provision of this Note may be amended, -------------------- waived or modified upon the written consent of the Company and Maker. -1- 7. Waiver by Maker. Maker hereby waives demand, notice, presentment, --------------- protest and notice of dishonor. 8. Delays. No delay by the Company in exercising any power or right ------ hereunder shall operate as a waiver of any power or right. 9. Severability. If one or more provisions of this note are held to be ------------ unenforceable under applicable law, such provision shall be excluded from the note and the balance of the Note shall be interpreted as if such provision were so excluded and shall be enforceable in accordance with its terms. 10. No Impairment. Maker will not, by any voluntary action, avoid or seek ---- ------------- to avoid the observance or performance of any of the terms to be observed or performed hereunder by the Company, but will at all times in good faith assist in the carrying out of all the provisions of this Note and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the holders of this Note against impairment. 11. Governing Law. This Note shall be governed by and construed in ------------- accordance with the laws of the State of California. IN WITNESS WHEREOF, the undersigned has signed, dated and delivered this Note as of the date and year first above written. CRITICAL PATH, INC. By David Thatcher -------------------------------------- Title EVP/CFO -------------------------------------- MAKER /s/ William H. Rinehart -------------------------------------- Bill Rinehart -2- SECURITY AGREEMENT ------------------ THIS SECURITY AGREEMENT (the "Agreement") is entered into as of January 15, 1999, by and between CRITICAL PATH, INC., a California corporation (the ------------------- "Company"), and BILL RINEHART (the "Purchaser"). ------------- W I T N E S S E T H: WHEREAS, in connection with the Company's offer of employment to Purchaser and Purchaser's acceptance of such offer, the Company has loaned to Purchaser the amount of sixty-five thousand dollars ($65,000); and WHEREAS, Purchaser has executed and delivered to the Company a promissory note evidencing such loan (the "Note") and has agreed to pledge all of Purchaser's shares and options to purchase shares of the Company's Common Stock now and hereafter held by Purchaser, including any shares for which such shares and options may be converted or exercised, and all proceeds of such shares and options (collectively, the "Securities"), as security for the payment of the Note: NOW, THEREFORE, it is agreed as follows: 1. Purchaser hereby pledges and grants a security interest in all of the Securities as security for the timely payment of all of Purchaser's obligations under the Note and for Purchaser's performance of all of its obligations under this Agreement. In the event of a default in payment of the Note, Purchaser hereby appoints the Company as Purchaser's true and lawful attorney to take such action as may be necessary or appropriate to cause the Securities to be transferred into the name of the Company or any assignee of the Company and to take any other action on behalf of Purchaser permitted hereunder or under applicable law. 2. Purchaser agrees to deliver to the Company immediately upon receipt one or more certificates representing the Securities, together with an Assignment Separate From Certificate signed by Purchaser. 3. The Company agrees to hold the Securities as security for the timely payment of all of Purchaser's obligations under the Note and for Purchaser's performance of all of its obligations under this Agreement, as provided herein. At no time shall the Company dispose of or encumber the Securities, except as otherwise provided in this Agreement. 4. The Company and Purchaser acknowledge that pursuant to an option agreement dated as of November 12, 1998 Purchaser may elect to purchase shares of the Company's Common Stock by execution of a full recourse promissory note secured by the shares being purchased. In such event, Purchaser's obligations to the Company under the Note and this Security Agreement shall be subordinated in priority and payment to Purchaser's obligations to the Company under such other promissory note(s) for the purchase of the Company stock. 5. At all times while the Company is holding the Securities as security under this Agreement, the Company shall: -1- (a) Collect any dividends that may be declared on the Securities and credit such dividends against any accrued interest or unpaid principal under the Note, as part payment; (b) Collect and hold any shares that may be issued upon conversion of the Securities; and (c) Collect and hold any other securities or other property that may be distributed with respect to the Securities. Such shares and other securities or property shall be subject to the security interest granted in Section 1 of this Agreement and shall be held by the Company under this Agreement. 6. While the Company holds the Securities as security under this Agreement, Purchaser shall have the right to vote the Securities at all meetings of the Company's stockholders; provided that Purchaser is not in default in the performance of any term of this Agreement or in any payment due under the Note. In the event of such a default, the Company shall have the right to the extent permitted by law to vote and to give consents, ratifications and waivers and take any other action with respect to the Securities with the same force and effect as if the Company were the absolute and sole owner of the Securities. 7. Upon payment of the outstanding principal balance of the Note and any interest and other charges due under the Note, the Company shall release the Securities from pledge and, subject to any other pledge and any continuing vesting or other restrictions on such Securities, redeliver to Purchaser (i) the certificate(s) representing the Securities for which payment has been received and (ii) the Assignment Separate From Certificate forms. 8. In the event that Purchaser fails to perform any term of this Agreement or fails to make any payment when due under the Note, the Company shall have all of the rights and remedies of a creditor and secured party at law and in equity, including (without limitation) the rights and remedies provided under the California Uniform Commercial Code. Without limiting the foregoing, the Company may, after giving ten (10) days' prior written notice to Purchaser by certified mail at Purchaser's residence or business address, sell any or all of the Securities in such manner and for such price as the Company may determine, including (without limitation) through a public or private sale or at any broker's board or on any securities exchange, for cash, upon credit or for future delivery. The Company is authorized at any such sale, if it deems it advisable to do so, to restrict the prospective bidders or purchasers of any of the Securities to persons who will represent and agree that they are purchasing for their own account for investment, and not with a view to the distribution or sale of any of the Securities to restrict the prospective bidders or purchasers and the use any purchaser may make of the Securities and impose any other restriction or condition that the Company deems necessary or advisable under the federal and state securities laws. Upon any such sale the Company shall have the right to deliver, assign and transfer to Purchaser thereof the Securities so sold. Each purchaser at any such sale shall hold the Securities so sold absolute, free from any claim or right of any kind. In case of any sale of any or all of the Securities on credit or for future delivery, the Securities so sold may be retained by the Company until the selling price is paid by Purchaser thereof, but the Company shall not incur any liability in case of the failure of such purchaser to take up and pay for the Securities so sold and, in case of any such failure, such Securities may again be sold under the terms of this section. Purchaser hereby agrees that any disposition of any or all of the Securities by way of a private placement or other method which in the opinion of the Company -2- is required or advisable under Federal and state securities laws is commercially reasonable. At any public sale, the Company may (if it is the highest bidder) purchase all or any part of the Securities at such price as the Company deems proper. Out of the proceeds of any sale, the Company may retain an amount sufficient to pay all amounts then due under the Note, together with the expenses of the sale and reasonable attorneys' fees. The Company shall pay the balance of such proceeds, if any, to Purchaser. Purchaser shall be liable for any deficiency that remains after the Company has exercised its rights under this Agreement. 9. This Agreement shall be governed by and construed in accordance with the laws of the State of California. This Agreement shall inure to the benefit of, and be binding upon, the Company and its successors and assigns and be binding upon Purchaser and Purchaser's legal representative, heirs, legatees, distributees, assigns and transferees by operation of law. This Agreement contains the entire security agreement between the Company and Purchaser. Purchaser will execute any additional agreements, assignments or documents or take any other actions reasonably required by the Company to preserve and perfect the security interest in the Securities granted to the Company herein and otherwise to effectuate this Agreement. IN WITNESS WHEREOF, the Company has caused this Security Agreement to be executed on its behalf by its duly authorized officer, and Purchaser has personally executed this Security Agreement. CRITICAL PATH, INC. By David Thatcher ------------------------------------ Title EVP/CFO -------------------------------- PURCHASER /s/ William H. Rinehart -------------------------------------- Bill Rinehart -3- ASSIGNMENT SEPARATE FROM CERTIFICATE ------------------------------------ FOR VALUE RECEIVED and pursuant to that certain Security Agreement dated as of January 15, 1999, the undersigned hereby sells, assigns and transfers unto CRITICAL PATH, INC., a California corporation, ___________________ shares of the - ------------------ Common Stock of the Company, standing in the undersigned's name on the books of the Company represented by certificate No. __ herewith, and does hereby irrevocably constitute and appoint attorney-in-fact to transfer the said stock on the books of the Company with full power of substitution in the premises. Dated: __________, ____. ------------------------------------ Bill Rinehart -4- EX-23.1 5 CONSENT OF PRICEWATERHOUSECOOPERS LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in the Prospectus constituting part of this Registration Statement on Form S-1 of our report dated January 28, 1999, except for Note 9, which is as of March 2, 1999, relating to the consolidated financial statements of Critical Path, Inc., which appears in such Prospectus. We also consent to the reference to us under the heading "Experts" in such Prospectus. /s/ PricewaterhouseCoopers LLP San Jose, California March 2, 1999 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS 9-MOS DEC-31-1998 DEC-31-1997 JAN-01-1998 FEB-19-1997 DEC-31-1998 DEC-31-1997 14,791 1 0 0 121 0 0 0 0 0 15,375 5 4,687 501 1,019 26 20,663 550 2,851 1,529 0 0 0 0 36 0 18 5 15,304 (1,026) 20,663 550 897 0 897 0 2,346 0 0 0 9,999 0 0 0 388 18 (11,461) (1,074) 0 0 (11,461) (1,074) 0 0 0 0 0 0 (11,461) (1,074) (2.94) (0.54) (2.94) (0.54)
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