10-Q 1 0001.txt 3RD QUARTER REPORT FOR PERIOD ENDING 09/30/2000 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2000 ------------------------------------------- or [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________________ to _________________ Commission file number: ______________________________________________________ Stamps.com Inc. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 77-0454966 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 3420 Ocean Park Boulevard, Suite 1040, Santa Monica, California 90405 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (310) 581-7200 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [_] No The number of shares of the registrant's common stock, $0.001 par value, issued and outstanding as of November 8, 2000 was 49,359,729. -------------------------------------------------------------------------------- 1 STAMPS.COM INC. QUARTERLY REPORT ON FORM 10-Q THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 INDEX Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements Unaudited Consolidated Balance Sheets at September 30, 2000 and December 31, 1999 Unaudited Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2000 and 1999 Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2000 and 1999 Notes to Unaudited Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk 26 PART II OTHER INFORMATION 27 Item 1. Legal Proceedings 27 Item 2. Change in Securities and Use of Proceeds 28 Item 3. Defaults Upon Senior Securities 28 Item 4. Submission of Matters to a Vote of Security Holders 28 Item 5. Other Information 28 Item 6. Exhibits and Reports on Form 8-K 28 Signatures 29 2 PART I FINANCIAL INFORMATION Item 1. Financial Statements. STAMPS.COM INC. CONSOLIDATED BALANCE SHEETS
September 30, December 31, 2000 1999 ----------------------------- (unaudited) ASSETS (In thousands) Current assets: Cash and short-term investments........................ $ 290,090 $ 374,746 Accounts receivable.................................... 1,879 134 Prepaid expenses....................................... 13,535 23,883 ------------ ----------- Total current assets........................................ 305,504 398,763 Property and equipment, net................................. 49,184 9,702 Goodwill and other intangible assets, net................... 188,461 -- Other assets................................................ 6,063 1,977 ------------ ----------- Total assets................................................ $ 549,212 $ 410,442 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Line of credit......................................... $ 1,917 $ 1,000 Accounts payable....................................... 6,509 2,707 Accrued expenses....................................... 7,196 4,004 Deferred revenue....................................... 2,546 182 Current portion of long-term debt and capital leases... 3,833 513 ------------ ----------- Total current liabilities................................... 22,001 8,406 Long-term debt and capital leases, less current portion..... 4,109 438 Commitments and contingencies Minority interest in consolidated subsidiary .......... 34,784 -- Stockholders' equity: Common stock........................................... 49 42 Additional paid-in capital............................. 718,658 472,714 Notes receivable from stock sales...................... (101) (101) Deferred compensation.................................. (25,075) (9,435) Accumulated deficit.................................... (205,213) (60,683) Treasury stock at cost................................. -- (939) ------------ ----------- Total stockholders' equity.................................. 488,318 401,598 ------------ ----------- Total liabilities and stockholders' equity.................. $ 549,212 $ 410,442 ============ ===========
The accompanying notes are an integral part of these financial statements. 3 STAMPS.COM INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended Nine Months Ended September 30, September 30, ------------- ------------- 2000 1999 2000 1999 ---- ---- ---- ---- (In thousands, except per share data) Revenues ................................................... $ 4,201 $ -- $ 9,911 $ -- Cost of revenues ........................................... 5,644 -- 19,131 -- ----------- --------- ------------ ---------- Gross profit...................................... (1,443) -- (9,220) -- Operating expenses: Sales and marketing.................................... 20,573 7,640 59,537 10,856 Research and development............................... 10,269 2,371 21,689 5,049 General and administrative............................. 11,436 3,363 25,817 5,766 Amortization of goodwill and other intangibles......... 13,772 -- 32,175 -- Acquired in-process research and development........... -- -- 2,000 -- Deferred compensation amortization..................... 3,123 1,050 9,022 2,510 ----------- --------- ------------ ---------- 59,173 14,424 150,240 24,181 ----------- --------- ------------ ---------- Loss from operations ....................................... (60,616) (14,424) (159,460) (24,181) Other income (expense): Interest expense....................................... (213) (40) (377) (122) Interest income........................................ 5,482 766 15,307 1,200 ----------- --------- ------------ ---------- Net loss.................................................... $ (55,347) $ (13,698) $ (144,530) $ (23,103) =========== ========= ============ ========== Basic and diluted net loss per share........................ $ (1.15) $ (0.40) $ (3.11) $ (1.59) =========== ======== ============ ========== Weighted average shares outstanding used in basic and diluted per-share calculation ...................................... 48,259 34,102 46,418 14,496 =========== ======== =========== =========
The accompanying notes are an integral part of these financial statements. 4 STAMPS.COM INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30, ------------- 2000 1999 ----------- --------- (In thousands) Operating activities: Net loss............................................................. $ (144,530) $ (23,103) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization............................. 37,952 555 Amortization of deferred compensation..................... 9,022 2,510 Charge for acquired in-process research and development... 2,000 -- Changes in operating assets and liabilities, net of effects of acquisition: Accounts receivable................................. (1,738) -- Prepaid expenses.................................... 10,825 (7,167) Accounts payable.................................... 1,422 1,939 Accrued expenses.................................... 2,944 2,696 Deferred revenue.................................... 2,363 -- ---------- --------- Net cash used in operating activities................................. (79,740) (22,570) Investing activities: Purchase of short-term investments, net......................... (119,576) (19,640) Acquisition of property and equipment........................... (33,296) (4,562) Acquisition of iShip.com, net of cash acquired.................. (2,111) -- Other........................................................... (5,495) (198) ---------- --------- Net cash used in investing activities................................ (160,478) (24,400) Financing activities: Repayment of long-term debt and capital leases ................. 12 (150) Repayment of line of credit .................................... (949) -- Issuance of redeemable preferred stock of subsidiary, net....... 34,784 -- Issuance of redeemable preferred stock, net..................... -- 28,299 Issuance of common stock........................................ 1,200 57,842 Repurchase of common stock...................................... 939 (939) Proceeds from exercise of stock options......................... -- 6 ---------- --------- Net cash provided by financing activities............................. 35,986 85,058 Net (decrease) increase in cash and cash equivalents.................. (204,232) 38,088 Cash and cash equivalents at beginning of period...................... 326,820 1,966 ---------- --------- Cash and cash equivalents at end of period............................ 122,588 40,054 Short-term investments................................................ 167,502 21,144 ---------- --------- Cash and short-term investments....................................... $ 290,090 $ 61,198 ========== =========
The accompanying notes are an integral part of these financial statements. 5 STAMPS.COM INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (ALL INFORMATION WITH RESPECT TO SEPTEMBER 30, 2000 AND 1999 IS UNAUDITED) 1. Summary of Significant Accounting Policies Basis of Presentation The financial statements are unaudited, other than the balance sheet at December 31, 1999, and, in the opinion of management, reflect all adjustments that are necessary for a fair presentation of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year or for any future period. These financial statements should be read in conjunction with the financial statements as of December 31, 1999 and related notes included in the Company's Annual Report on Form 10-K/A filed with the Securities and Exchange Commission (the "SEC") on April 28, 2000. The Company formerly reported as a development stage company. Principles of Consolidation The consolidated financial statements include the accounts of Stamps.com Inc. (the "Company") and its wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. 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 amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates and such differences may be material to the financial statements. Cash and Short-term Investments The Company considers all highly liquid investments with an original or remaining maturity of three months or less at the date of purchase to be cash equivalents. The Company's short-term investments are comprised of U.S. government obligations and public corporate debt securities with maturities of less than one year at the date of purchase. All short-term investments are classified as available for sale and are recorded at market using the specific identification method. Realized gains and losses are reflected in other income and expense while unrealized gains and losses, which to date have not been material, are included as a separate component of stockholders' equity. Reclassifications Certain prior period balances have been reclassified to conform to current period presentation. 2. Acquisition of iShip.com On March 7, 2000, the Company completed the acquisition of iShip.com, Inc. ("iShip"), a development stage enterprise developing Internet-based shipping technology. In connection with the acquisition, approximately 5.6 million shares of Stamps.com common stock were issued in exchange for all outstanding iShip stock. An additional 1.6 million shares of Stamps.com common stock have been reserved for issuance upon exercise of options and warrants assumed in the transaction. Finally, 800,000 shares of Stamps.com common stock have been deposited 6 into an escrow account. The escrow amount is intended to compensate the Company for any inaccuracy or breach of any representation, warranty, covenant or agreement of iShip as contained in the merger agreement. The shares must remain in the escrow fund for a period of one year from the close of the acquisition. The parties are currently not aware of any inaccuracy or breach of any representation, warranty, covenant or agreement of iShip as contained in the merger agreement. The acquisition was accounted for as a purchase in accordance with the provisions of Accounting Principles Board Opinion ("APB") No. 16. Under the purchase method of accounting, the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. The Company recorded intangible assets of $220.4 million and deferred compensation of $24.7 million, which will be amortized over periods ranging from three to four years. Results of operations for iShip have been included with those of the Company for periods subsequent to the acquisition date. The purchase price was allocated as follows (in thousands): Goodwill $209,188 Deferred compensation 24,662 Purchased technology 11,200 In-process research and development 2,000 Tangible assets acquired 8,931 Liabilities assumed (7,232) -------- Purchase price $248,749 ======== Presented below is unaudited selected pro forma financial information, presenting the results of operations of the Company as if the acquisition had taken place on January 1 (in thousands, except per share amounts):
Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 2000 1999 2000 1999 ---- ---- ---- ---- Revenues $4,201 $-- $9,911 $-- Net loss $(55,347) $(13,698) $(157,541) $(29,294) Basic and diluted net loss per share $(1.15) $(0.40) $(3.03) $(1.31) Shares used in per share calculation - basic 48,259 34,102 51,990 22,412 and diluted
The unaudited pro forma information is not necessarily indicative of the actual results of operations had the acquisition occurred at the beginning of the periods indicated, nor should it be indicative of operations for any future date or period. 3. Change in Subsidiary Ownership During the first half of this year, the Company sold approximately 42% of EncrypTix, Inc., until then a wholly owned subsidiary, in a private financing of approximately $35.8 million. The financing was completed in April 2000. The Company includes EncrypTix's balances and results in its consolidated financial statements. The minority interest reflected in the attached consolidated balance sheet represents the investment received in the private financing. 4. Segment Information The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" in the second quarter of fiscal year 2000. SFAS 131 establishes standards of reporting information regarding operating segments in annual financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. 7 As of the beginning of the second quarter, the Company operates in three specialized strategic business units (SBUs) focused on the enterprise, e- commerce and small business market segments of mailing and shipping services. The Small Business SBU provides small businesses and consumers with Internet Postage and shipping services. The Enterprise SBU will offer companies with more than 100 employees an Internet-based, multi-carrier mailing and shipping service. The E-commerce SBU addresses the shipping needs of e-tailers and other online businesses, including auctioneers. There are no intersegment revenues between the three reportable segments. Shared support service functions such as human resources, facilities management and other infrastructure support groups are consolidated in general & administrative and allocated to the three operating segments based on usage or headcount, where practical. The information available to the chief operating decision makers of the Company does not include allocations of assets and liabilities to the Company's segments. As of September 30, 2000, revenues and operating losses by reportable segment were as follows (in thousands):
Three Months Ended September 30, 2000 Nine Months Ended September 30, 2000 ------------------------------------------------------------------------------------------------------- Small Small ----- ----- Business Enterprise E-Commerce Business Enterprise E-Commerce -------- ---------- ---------- -------- ---------- ---------- Revenues $ 3,701 $ 500 $ -- $ 7,411 $ 2,500 $ -- Operating (32,947) (7,701) (2,281) (94,724) (18,106) (4,866) expenses
A reconciliation of combined operating losses for the reportable segments to consolidated net loss is as follows:
Three Months Ended Nine Months Ended September 30 September 30 --------------------------------------------------------------------------- 2000 1999 2000 1999 ---- ---- ---- ---- Operating Revenues $4,201 $ --- $9,911 $ --- Total operating expenses for (42,929) $(13,374) (117,696) $(21,671) reportable segments Other losses /1/ (21,888) (1,050) (51,675) (2,510) --------- -------- ---------- -------- Operating loss $ (60,616) $(14,424) $ (159,460) $(24,181) ========= ======== ========== ========
1. For the three months ended September 30, 2000, Other Losses include EncrypTix operating losses of $5.0 million, deferred compensation of $3.1 million and amortization of goodwill of $13.8 million. For the nine months ended September 30, 2000, Other Losses include EncrypTix operating losses of $8.5 million, deferred compensation amortization of $9.0 million, amortization of goodwill of $32.2 million and in- process research and development charges of $2 million. Other Losses also includes $1.1 million and $2.5 million of deferred compensation for the three and nine month periods ended September 30, 1999, respectively. 5. Legal Proceedings Please refer to "Part II--Other Information--Item 1" of this report for a discussion of legal proceedings. 6. Computation Of Historical Net Loss Per Share Basic earnings per share is computed by dividing the net earnings available to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per share 8 is computed by dividing the net earnings for the period by the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares, consisting of unvested restricted common stock and incremental common shares issuable upon the exercise of stock options and warrants and upon conversion of convertible preferred stock, are excluded from the diluted earnings per share calculation if their effect is anti-dilutive. 7. Related Party Transactions In February 2000, Mr. Payne (former Chairman of the Board and Chief Executive Officer, and current director) purchased 187,000 shares of the Company's common stock on the open market for an aggregate purchase price of approximately $6.0 million. The shares were purchased on margin by Mr. Payne and the margin account was secured by a pledge of 1,467,500 shares of the Company's common stock held by Mr. Payne, of which approximately 593,750 shares are subject to repurchase by the Company. As of October 31, 2000, Mr. Payne's total indebtedness under the margin account was approximately $6.7 million, which amount consists of the purchase price of the 187,000 shares, accrued interest on the purchase price and other fees and indebtedness incurred by Mr. Payne, less the proceeds from his sale of the Company's common stock during the third quarter. In April 2000, the Company agreed to guarantee Mr. Payne's margin account in the event the value of the shares pledged is insufficient collateral to secure the indebtedness outstanding under the margin account. The guarantee is in the form of a single-purpose line of credit extended to Mr. Payne which will have a balance due to the Company to the extent the value of the pledged shares is insufficient collateral to secure indebtedness outstanding under the margin account. This line of credit is secured by all of Mr. Payne's assets. In addition, the Company has entered into a loan repayment agreement with Mr. Payne and the brokerage firm where he maintains his margin account. Under the terms of that agreement, the Company agrees to guarantee Mr. Payne's margin account. The agreement further provides that, without previous notice to or consent from Mr. Payne, the Company may require the sale of any or all shares of Stamps.com stock held by Mr. Payne in order to satisfy any balances due under the terms of Mr. Payne's margin account. More specifically, the Company may require such sales in the event the closing price of Stamps.com on Nasdaq is below $6 per share for three consecutive trading days or if the closing price of Stamps.com on Nasdaq is greater than $30 per share on any trading day. The loan repayment agreement also provides that the brokerage firm may not extend Mr. Payne any additional credit, except to allow for the accrual of interest against the outstanding balance of the margin account. Mr. Payne agreed to sell a minimum of 100,000 shares of common stock during each fiscal quarter (beginning the third fiscal quarter of 2000) in order to pay down the indebtedness outstanding under the margin account. Pursuant to this agreement, on August 29, 2000, Mr. Payne sold 7,500 shares at a price of $4.50 per share and 92,500 shares at a price of $4.3125 per share, which resulted in aggregate repayment of indebtedness in the amount of approximately $430,000. 8. Subsequent Event In October 2000, the Company experienced significant personnel changes at the senior management level including the resignation of its Chief Executive Officer and Chairman of the Board, its President and Chief Operating Officer, its Chief Financial Officer and its Controller. Additionally, the Company's Chief Marketing Officer departed in connection with the Company's recent restructuring. Although the Board has appointed Bruce Coleman as interim Chief Executive Officer and Kenneth McBride, the Company's previous Senior Director of Finance, as the Company's acting Chief Financial Officer, permanent replacements have not been appointed and the position of Controller remains open. The Company does not currently anticipate that it will hire a new Chief Marketing Officer. In October 2000, the Company implemented a new business strategy in an effort to more rapidly decrease its operating losses and enhance its ability to achieve profitability. This strategy involved a restructuring that reduced the Company's total headcount by approximately 40%, which included full time, part time and contract employees. The Company also announced that it would implement other cost-cutting programs, including a significant reduction in and redeployment of its sales and marketing expenses to those programs that have demonstrated higher returns on investment. Finally, the Company is combining its Enterprise and E-Commerce Business Units to reduce duplication of costs and effort. The Company expects to take a one-time charge in the fourth quarter of 2000 relating to this restructuring. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Cautionary Statement This report on Form 10-Q contains forward-looking statements based on our current expectations, estimates and projections about our industry, management's beliefs and certain assumptions made by us. Words such as "anticipates," "expects," "intends," "plans," "believes," "may," "will" or similar expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward- looking statements. Such statements include, but are not limited to, statements concerning the uncertainty of the Internet mailing and shipping markets; our ability to make our services widely available and the uncertainty of the commercial adoption of our services; our ability to implement our new business strategy; our ability to achieve profitability; pending litigation regarding intellectual property infringement allegations; recent changes in our business strategy and executive management; regulation of our business; projected operating losses; strategic relationships, direct sales and distribution arrangements; the security of our mailing and shipping services; competition; the need for additional capital; and the commercial acceptance of our services. Such statements are not guarantees of future performance and are subject to certain risks, 9 uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. The section entitled "Risk Factors" set forth in this Form 10-Q and similar discussions in our Annual Report on Form 10-K/A filed with the Securities and Exchange Commission ("SEC") on April 28, 2000, discuss some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the other information in this report and in our other filings with the SEC, before deciding to invest in our company or to maintain or increase your investment. We undertake no obligation to revise or update publicly any forward-looking statements for any reason. The information contained in this Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC, including our 10-K/A filed with the SEC on April 28, 2000, that discuss our business in greater detail and advise interested parties of certain risks, uncertainties and other factors that may affect our business, results of operations or financial condition. Overview Stamps.com provides easy, convenient and cost-effective Internet-based services for mailing or shipping letters, packages or parcels anywhere and at anytime. Our core mailing and shipping services are designed to allow individual consumers or employees of small businesses or larger enterprises to select a carrier, print US postage or shipping labels from multiple carriers, schedule a pick-up, track a package and apply enterprise-wide business rules to manage and account for mailing and shipping costs. With all of our services, no additional hardware is required; a customer can access our services through an existing Internet connection and print postage or shipping labels with ordinary laser or inkjet printers. In October 2000, we experienced significant personnel changes at the senior management level including the resignation of our Chief Executive Officer and Chairman of the Board, our President and Chief Operating Officer, our Chief Financial Officer and our Controller. Additionally, our Chief Marketing Officer departed in connection with our recent restructuring. Although the Board has appointed Bruce Coleman as interim Chief Executive Officer and Kenneth McBride, our previous Senior Director of Finance, as our acting Chief Financial Officer, permanent replacements have not been appointed and the position of Controller remains open. We do not currently anticipate that we will hire a new Chief Marketing Officer. We cannot predict how these changes in management will affect our business. However, if we fail to attract and retain qualified individuals for these senior management positions, our business, financial condition and results of operations will be seriously harmed. In October 2000, we implemented a new business strategy in an effort to more rapidly decrease our operating losses and enhance our ability to achieve profitability. This strategy involved a restructuring that reduced our total headcount by approximately 40%, which included full time, part time and contract employees. We also announced that we would implement other cost-cutting programs, including a significant reduction in and redeployment of our sales and marketing to those programs that have demonstrated higher returns on investment. Finally, we are combining our Enterprise and E-Commerce Business Units to reduce duplication of costs and effort. We expect to take a one-time charge in the fourth quarter of 2000 relating to this restructuring. If our new business strategy is not successful, we will not achieve profitability as currently planned, if at all. Our majority-owned subsidiary, EncrypTix, Inc., will leverage many of the proprietary, Internet-based technologies developed by Stamps.com in the events, travel and financial services industries. EncrypTix will enable sellers and distributors of tickets and financial instruments to deliver value-bearing instruments such as tickets, vouchers, boarding passes and gift certificates over the Internet. Small Business Services: Our small business services include our traditional business of serving small businesses and consumers with our easy, convenient and cost-effective Internet Postage service as well as offering multi-carrier document and package shipping to companies with less than 100 employees. The revenues from our small business services consist primarily of fees for our Internet Postage Service and commission fees from our online store operated by a third-party. Service fee revenues are generated from the two service plans that we are currently offering to our users: Simple Plan and Power Plan. Under the Simple Plan, a user purchases postage at cost and is charged a monthly convenience fee of 10% of the value of postage printed during a month. There is a monthly minimum fee of $1.99 and a monthly maximum fee of $19.99. Beginning in November 10 2000, the monthly minimum fee will be increased to $4.49. The Power Plan was introduced at the beginning of our second quarter of 2000, in response to customer requests for a fixed monthly pricing plan. Under the Power Plan, a user purchases postage at cost and pays $15.99 per month for unlimited use of our service. For the third quarter of 2000, approximately 50% of our service fee revenues was generated from Power Plan customers and the remaining 50% was from Simple Plan customers. Service fees are calculated and charged at the end of a monthly billing cycle. The revenues from our Internet-based shipping services are primarily generated from recurring, transaction-based service fees. Also, we generate revenues from advertising and revenue share arrangements. We expect revenues to increase in 2000 as we continue to grow our customer base in the Internet Postage service and as we fully rollout our Internet-based shipping services. Enterprise Services: We offer companies with more than 100 employees an Internet-based, multi-carrier mailing and shipping service. The enterprise service will allow corporations to centrally manage and control costs from mailing and shipping activities across multiple carriers and can be distributed to thousands of corporate desktops using only a Web browser. The largest customer to date of the enterprise service is Mail Boxes Etc. USA, Inc., a retail business, communication and postal services franchiser. There are currently over 1,100 Mail Boxes Etc. franchises utilizing our services. Under our current agreement with Mail Boxes Etc., we are to receive a fixed service fee of $500,000 per month. Due to delays in delivering our products and a dispute with Mail Boxes Etc. relating to certain product features, we have not received payment under this contract since July 2000. We are currently working with Mail Boxes Etc. in an effort to resolve this dispute and have taken a reserve for unpaid amounts. On January 1, 2001, the fixed monthly service fee converts to a per transaction fee. Given current transaction volume being produced by Mail Boxes Etc. franchises, we do not expect in the short term to achieve the level of monthly revenue that has been produced under the current fixed monthly service fee arrangement. Furthermore, if transaction volumes do not increase or if we are unable to resolve our current disputes with Mail Boxes Etc., we can provide no assurances that our agreement will provide historical levels of revenue or significant revenues at all. E-commerce Services: Our e-commerce services strategic business unit will be combined with our enterprise services strategic business unit as part of our new business strategy. Although we currently have no plans to deploy e-commerce services independent of our enterprise services, we may deploy e-commerce services in the future. If we choose to apply our technologies to e-commerce services our objective will be to address the growing shipping needs of e- tailers and other online businesses, including auctioneers. These services could be embedded in auction Web sites, e-tailer "shopping carts" and other points-of- purchase on various Web sites, enabling buyers and sellers to select precise pricing and delivery terms from among a variety of carrier choices. Revenues from our e-commerce services, if any, will likely be primarily generated from recurring, transaction-based service fees. The markets for our Internet postage and shipping are new, and their development is subject to substantial uncertainty. Our success and financial results are highly contingent upon our ability to address and develop these markets. We cannot assure you that these markets will fully develop, if at all. If a significant market for any of our services fails to develop or develops slower than we expect, our business will fail. Additionally, if we do not effectively manage, market and sell our Internet mailing and shipping services, we may never achieve profitability and our business will be substantially harmed and could fail. More specifically, we cannot be sure that our services will be widely available in a timely manner or adopted, that they will successfully process large numbers of user transactions or that our services will contain features that appeal to the broad range of customers that we target. If we experience problems with the availability, adoption, scalability or functionality of our services or if we are unable to offer attractive service enhancements in a timely manner, our ability to attract and retain customers and our results of operations would be adversely impacted. See "Risk Factors--The Internet postage and shipping markets are new and uncertain and our business may not develop" and "-If we do not effectively manage, market and sell our Internet mailing and shipping services or if we fail to make our services widely available, we may never achieve profitability and our business will be substantially harmed and could fail." From time to time, we may offer special promotions to attract new customers to our mailing and shipping services. Currently, these promotions involve waiving or discounting service fees, discounts on supplies offered through our online store, or free postage, supplies or services. We cannot predict the impact of any promotion or pricing plan changes and our ability to generate revenues or achieve profitability could be adversely affected by special promotions or changes to the pricing plans. Furthermore, given the lack of an established or proven commercial market for our services, we are unable to quantify the total impact of these promotions on revenue and profitability. See "Risk Factors--We have a history of losses and expect to incur losses in the future, and we may never achieve profitability." 11 Results of Operations Revenues Small Business. Revenues from small business were approximately $3.7 million and $7.4 million for the three-month and nine-month periods ended September 30, 2000, respectively. There were no revenues during the three-month or nine-month periods ended September 30, 1999 as we launched our first service, Internet Postage, on October 22, 1999. The increase for both periods was due primarily to the acquisition of new customers and recurring revenue from existing customers. The increase in the current quarter was due also to the success of the Power Plan, which was introduced in the second quarter and generates eight times the monthly revenue of a Simple Plan customer that incurs the minimum Simple Plan monthly fee. We expect revenues to increase as we continue to add new customers from both service plans. Enterprise. Revenues from the enterprise segment were $0.5 million and $2.5 million for the three-month and nine-month periods ended September 30, 2000, respectively. There were no revenues during the three-month or nine-month periods ended September 30, 1999 as we did not have any shipping service offerings until March 2000. Enterprise revenues were generated from Mail Boxes, Etc., our largest customer to date of the enterprise service. Under our current agreement with Mail Boxes Etc., we are to receive a fixed service fee of $500,000 per month. On January 1, 2001, this fixed monthly service fee converts to a per transaction fee under the terms of the agreement. We did not recognize $1.0 million in revenue from Mail Boxes Etc. during the third quarter due to delays in delivering our products and a dispute over certain product features. The service is currently deployed at other customer sites on a free trial basis. We expect that revenues will decrease as service fees from Mail Boxes Etc. convert from a fixed monthly service fee to a transaction-based fee structure pursuant to the terms of our agreement with them, and will thereafter increase as we roll out our services on a commercial scale and attract more customers to use our enterprise services to ship significant volumes of postage. E-commerce. There were no revenues from the e-commerce segment for the three-month or nine-month periods ended September 30, 2000 or 1999. In future reports, revenue from e-commerce services, if any, will be reported as part of the enterprise segment. Cost of Revenues. Cost of revenues primarily consist of costs related to customer service activities and network operations and, to a lesser extent, bank processing charges for customer fees paid by credit card, Internet connection charges, depreciation of server and network equipment, allocation of overhead and costs related to promotional items, such as free postage and scales. Costs of revenues were $5.6 million and $19.1 million for the three-month and nine- month periods ended September 30, 2000, respectively. As of September 30, 1999, there were no costs of revenues because we had not recognized any revenues to date. In accordance with EITF 00-14, "Accounting for Certain Sales Incentives," the Company reclassified from sales and marketing expense to cost of revenues costs related to free postage and free scales given as promotional items to new customers. The total reclassification was approximately $1.2 million and $5.3 million for the three and nine-month periods ended September 30, 2000, respectively. We expect costs of revenues to increase as we continue to add new customers and expand our service offerings in the enterprise segment. Sales and Marketing Expenses. Sales and marketing expenses include costs to acquire and retain customers, including costs associated with strategic relationships, advertising and promotions and compensation and related expenses for personnel engaged in marketing, sales or business development activities. Sales and marketing expenses were $20.6 million and $59.5 million for the three- month and nine-month periods ended September 30, 2000, respectively, compared to $7.6 and $10.9 for the corresponding periods in 1999. The increase in sales and marketing is principally due to our marketing campaigns and advertising of our Internet-based services. We expect sales and marketing expenses to decrease significantly as a result of our new business strategy. Research and Development Expenses. Research and development expenses principally consist of compensation for personnel involved in the development of our Internet mailing and shipping services and expenditures for consulting services and third-party software. Research and development expenses for the three-month and nine-month periods ended September 30, 2000 were $10.3 million and $21.7 million, respectively, compared to $2.4 million and $5.0 million for the corresponding periods in 1999. The increase is due to higher personnel and consulting costs associated with the ongoing development of our Internet-based mailing and shipping services. Although we expect a reduced level of spending on research and development activity, we believe that significant investments in research and development are required to remain competitive and expect to continue incurring significant research and development expenses. 12 General and Administrative Expenses. General and administrative expenses primarily consist of compensation and related costs for executive and administrative personnel, facility costs, and fees for legal and other professional services. General and administrative expenses for the three-month and nine-month periods ended September 30, 2000 were $11.4 million and $25.8 million, respectively, compared to $3.4 million and $5.8 million for the corresponding periods in 1999. The increase is principally due to increased headcount and the expansion of our facilities related to the growth of our business, as well as legal fees related to the Pitney Bowes patent infringement claim. Amortization of Goodwill and Other Intangibles. Amortization of goodwill and other intangibles is principally due to the goodwill resulting from the acquisition of iShip.com in March 2000. Amortization expense is expected to increase significantly as the goodwill and other intangibles resulting from our acquisition are amortized over useful lives ranging from three to four years. Acquired In-Process Research and Development. We incurred a charge of $2.0 million in acquired in-process research and development in March 2000 related to our acquisition of iShip.com. Deferred Compensation. During 1998 and 1999, we granted stock options with exercise prices that were less than the estimated fair value of the underlying shares of common stock for accounting purposes on the date of grant. This will result in amortization expenses of deferred compensation over the period that these options vest, which ranges from three to four years from the date of grant. Interest Income (Expense), Net. Interest income (expense), net consists of income from our cash and cash equivalents net of interest expense related to financing our obligations. Interest income (expense), net for the three-month and nine-month periods ended September 30, 2000 was $5.3 million and $14.9 million, respectively, compared to $0.7 million and $1.1 million for the three-month and nine-month periods ended September 30, 1999, respectively. The increase is due to earnings on a higher average cash equivalent balance that resulted from our initial public offering in June 1999 and our follow-on public offering in December 1999. Liquidity and Capital Resources As of September 30, 2000, the Company had approximately $290.1 million in cash and short-term investments. In June 1999, we completed our initial public offering, which resulted in net proceeds of $57.8 million. In December 1999, we completed a follow-on public offering, which resulted in net proceeds of $355.5 million. We regularly invest excess funds in short-term money market funds and commercial paper and do not engage in hedging or speculative activities. Through April 2000, our majority-owned subsidiary, EncrypTix, raised approximately $35.8 million in private financing from a group of financial and strategic investors. The proceeds of this financing are being used by EncrypTix for research and development, sales and marketing and general working capital purposes. EncrypTix has entered into four agreements to provide lease financing in the aggregate amount of $9.7 million. Net cash used in operating activities was $79.7 million and $22.6 million for the nine months ended September 30, 2000 and 1999, respectively. The increase in net cash used in operating activities resulted primarily from increases in net loss, principally due to higher sales and marketing expenses. Net cash used in investing activities was $160.5 million for the nine months ended September 30, 2000 compared to $24.4 million for the corresponding period in 1999. The increase in net cash used in investing activities resulted primarily from net purchases of short-term investments and increased capital expenditures for computer equipment, purchased software and office equipment. Net cash provided by financing activities was $36.0 million and $85.1 million for the nine months ended September 30, 2000 and 1999, respectively. The difference in net cash provided by financing activities is primarily attributed to our receipt of cash proceeds of approximately $57.8 million from our initial public offering in June 1999. 13 If our current cost-cutting programs associated with our new business strategy are implemented successfully, we anticipate that our current cash balances will be sufficient to fund our operations through June 2002. However, we may require substantial working capital to fund our business and may need to raise additional capital. We cannot be certain that additional funds will be available on satisfactory terms when needed, if at all. See "Risk Factors--Our growth and operating results could be impaired if we are unable to meet our future capital requirements." 14 RISK FACTORS BEFORE DECIDING TO INVEST IN OUR COMPANY OR TO MAINTAIN OR INCREASE YOUR INVESTMENT, YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW, IN ADDITION TO THE OTHER INFORMATION IN THIS REPORT AND OUR OTHER FILINGS WITH THE SEC. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES FACING OUR COMPANY. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT WE CURRENTLY DEEM IMMATERIAL MAY ALSO AFFECT OUR BUSINESS OPERATIONS. THE OCCURRENCE OF ANY OF THE FOLLOWING RISKS COULD SERIOUSLY HARM OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS. IN SUCH CASE, THE MARKET PRICE FOR OUR COMMON STOCK COULD DECLINE AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. We face risks associated with our operations The Internet postage and shipping markets are new and uncertain and our business may not develop. The markets for Internet postage and shipping are new, and their development is subject to substantial uncertainty. Our success and financial results are highly contingent upon our ability to address and develop these markets. We cannot assure you that these markets will fully develop, if at all. We depend heavily on the commercial acceptance of our Internet Postage service. We cannot predict if our target customers will choose the Internet as a means of purchasing postage, if customers will be willing to pay a fee to use our service, or if potential users will select our services over services offered by our competitors. Our target customers often have alternatives to the US Postal Service and shipping services, including online invoicing, bill payment and financial transactions. The General Accounting Office, in a report issued on October 21, 1999, stated that competition from these alternatives could lead to substantial declines in the US Postal Service's First Class Mail volume in the next decade. These trends could limit the market opportunity for our Internet Postage service. In addition, the US Postal Service could suspend, terminate or offer services that compete against Internet postage, any of which could stop or negatively impact the commercial adoption of our Internet Postage service. While Internet postage is extremely important to our business, we also depend heavily on the commercial acceptance of our enterprise Internet mailing and shipping services. There can be no assurance that we will succeed in these businesses. Similar to Internet postage, Internet mailing and shipping services are at a very early stage and the market for these services has yet to develop. We have not released these services on a commercial scale and we cannot be sure that our services or that a substantial market for Internet mailing and shipping services will develop, if at all. If a significant market for any of our services fails to develop or develops slower than we expect, our business will fail. If we do not successfully attract and retain skilled personnel for permanent management positions, we may not be able to effectively implement our business plan. In October 2000, we experienced significant personnel changes at the senior management level including the resignation of our Chief Executive Officer and Chairman of the Board, our President and Chief Operating Officer, our Chief Financial Officer and our Controller. Additionally, our Chief Marketing Officer departed in connection with our recent restructuring. Although the Board has appointed Bruce Coleman as interim Chief Executive Officer and Kenneth McBride, our previous Senior Director of Finance, as our an acting Chief Financial Officer, permanent replacements have not been appointed and the positions of Chief Operating Officer and Controller remain open. We do not currently anticipate that we will have a new Chief Marketing Officer. On November 13, 2000, the Board appointed Bruce Coleman to the Board, filling the vacancy created by Thomas H. Bruggere, who resigned on September 30, 2000. We cannot predict how these changes in management will effect our business. However, if we fail to attract and retain qualified individuals for these senior management positions, our business, financial condition and results of operations will be seriously harmed. 15 Our success depends largely on the skills, experience and performance of the members of our senior management and other key personnel. Any of the individuals can terminate his or her employment with us at any time. If we lose additional key employees and are unable to replace them with qualified individuals, our business and operating results could be seriously harmed. In addition, our future success will depend largely on our ability to continue attracting and retaining highly skilled personnel. Like other companies in the Internet and high technology industries, we face intense competition for qualified personnel. As a result, we may be unable to successfully attract, assimilate or retain qualified personnel. The failure to attract and retain the necessary personnel could seriously harm our business, financial condition and results of operations. If our new business strategy is not successfully implemented, our financial condition and results of operations will be adversely affected. In October 2000, we implemented a new business strategy that involved refocusing our resources on the most productive areas of our business in order to more effectively capture the highest margin customer base. This new strategy was accompanied by the appointment of a new management team, a 40% reduction in our headcount, a plan to significantly reduce other expenditures, including sales and marketing expense, and an increase in monthly service fees for our Internet postage service. Our new strategy entails risks relating to our ability to attract our targeted customers to offset potential customer losses in other areas and the ability of our new management team to implement this strategy. There is no guarantee our new management team will be able to effectively or efficiently implement our new business strategy or that, if effectively implemented, our business strategy will benefit us or help us achieve profitability. Failure to execute our plan to significantly reduce expenses or to attract new customers in high margin lines of business in significant numbers will adversely effect our financial condition and results of operations. In addition, a substantial loss of customers resulting from our new business strategy could have an adverse impact on our financial condition and results of operations. If we do not effectively manage, market and sell our Internet mailing and shipping services or if we fail to make our services widely available, we may never achieve profitability and our business will be substantially harmed and could fail. We face numerous risks coincident with the introduction, sale and commercial availability of our services because of our very limited experience with the commercial rollout and use of our services. Specifically, our Internet Postage service was introduced on October 22, 1999, our enterprise services have yet to be deployed on any significant commercial scale, and our e-commerce services are not yet, and may never be, available for commercial use. As a result, we cannot be sure that our services will be widely available or adopted, that they will successfully process large numbers of user transactions or that our services will contain features that appeal to the broad range of customers that we target. If we experience problems with the availability, adoption, scalability or functionality of our services or if we are unable to offer attractive service enhancements in a timely manner, our ability to attract and retain customers and our results of operations will be adversely impacted. On the other hand, if we experience extensive interest in our services, we may fail to meet the expectations of customers due to limited experience in operating our services and the strains this demand will place on our Web site, customer service operations, professional services group, network infrastructure or systems. In order to acquire customers and achieve wide distribution and use of our services, we must develop and execute cost-effective marketing campaigns and sales programs. Given the limited amount of time that our services have been commercially available, we have very limited experience conducting marketing campaigns. In addition, we have recently increased our emphasis on direct selling efforts and have only recently retained the resources necessary to support a direct sales channel. However, we have very limited experience regarding our ability to acquire customers through a direct sales channel. As a result of these limited marketing and sales experiences, we cannot predict our ability to attract customers for our services, and we may fail to generate significant interest in any of our services. Furthermore, we may be unable to generate significant interest in our services in a cost-effective manner. If we fail to generate interest in our services or to acquire customers in a cost- effective manner, our results of operations will be adversely affected and we may never achieve profitability. The continued availability of our Internet Postage service is dependent upon our service continuing to meet US Postal Service performance specifications and regulations. If at any time our Internet Postage service fails to meet US Postal Service requirements, we may be prohibited from offering this service and our business would be severely negatively impacted. Meanwhile, our Internet mailing and shipping services must meet the commercial demands of our customers, which are expected to range from small businesses to large enterprises. We cannot be sure that our 16 services will appeal to or be adopted by such a wide range of customers. In addition, given our limited experience selling our services to and implementing our services with enterprise customers, we cannot predict the length of enterprise sales cycles, the implementation times for our services or the extent to which an enterprise will employ our services. If we fail to meet the demands of our customers or if our customers implement and employ our services slower than we expect, our business, results of operation and ability to achieve profitability will be negatively affected. Finally, our ability to obtain and retain customers depends on our customer service capabilities. As part of our new business strategy, we are planning to cut back some of our support offerings. If we are unable at any time to address customer service issues adequately or to provide a satisfactory customer experience for current or potential customers, our business and reputation may be harmed. Success by Pitney Bowes in its suits against us alleging patent infringement could prevent us from offering our Internet Postage service and severely harm our business or cause it to fail. On June 16, 1999, Pitney Bowes filed a patent infringement lawsuit against us in the United States District Court for the District of Delaware. The suit originally alleged that we are infringing two patents held by Pitney Bowes related to postage application systems and electronic indicia. The suit seeks treble damages, a preliminary and permanent injunction from further alleged infringement, attorneys' fees and other unspecified damages. We answered the complaint on August 6, 1999, denying the allegations of patent infringement and asserting a number of affirmative defenses. Pitney Bowes filed a similar complaint in early June 1999 against one of our competitors, E-Stamp Corporation, alleging infringement of seven Pitney Bowes patents. On April 13, 2000, Pitney Bowes asked the court for permission to amend its complaint against us to drop allegations of patent infringement with respect to one patent and to add allegations of patent infringement with respect to three other patents. On July 28, 2000 the court entered Pitney Bowes' amended complaint. On September 18, 2000, Pitney Bowes filed another patent infringement lawsuit against us in the United States District Court for the Eastern District of Texas, alleging that we are infringing four patents owned by Pitney Bowes related to shipping. The suit seeks unspecified damages and a permanent injunction from further alleged infringement. The outcome of the litigation that Pitney Bowes has brought against us is uncertain. Therefore, we can give no assurance that Pitney Bowes will not prevail against us. If Pitney Bowes prevails in one or both of its suits against us, we may be prevented from selling our mailing or shipping services on the Internet. Additionally, the Pitney Bowes suits could result in limitations on how we implement our services, delays and costs associated with redesigning our services and payments of license fees, damages and other payments. Thus, if Pitney Bowes prevails in either of its suits against us, our business could be severely harmed or fail. In addition, the litigation could result in significant expenses and diversion of management time and other resources. On August 17, 1998, Pitney Bowes issued a press release stating that it holds dozens of US patents related to computer-based postage metering and that it intended to engage in discussions with other marketers of computer-based postal products to license Pitney Bowes technology. Prior to Pitney Bowes filing a lawsuit against us on June 16, 1999, we were in license discussions with Pitney Bowes. We intend to continue these discussions; however, we cannot predict whether these discussions will continue, the outcome of these discussions or the impact of Pitney Bowes' intellectual property claims on our business or the Internet postage market. If Pitney Bowes is able to prevail in its claims against us and if we do not enter into a license relationship with Pitney Bowes, our business could be impacted severely or fail. In addition, as described above, Pitney Bowes could obtain monetary and injunctive relief against us. 17 We have a history of losses and expect to incur losses in the future, and we may never achieve profitability. As of September 30, 2000, we had an accumulated deficit of $205.2 million. For the nine months ended September 30, 2000, we only generated $9.9 million of revenue and had a negative gross profit of $9.2 million. This minimal revenue amount can be attributed primarily to the fact that our Internet Postage service has only been available since October 22, 1999 and that our enterprise and e- commerce services have yet to be released on a commercial scale. Although we have announced a new business strategy aimed at achieving positive gross margins and eventual profitability, we expect to continue to incur significant sales and marketing, research and development, and administrative expenses and therefore could continue to incur net losses for several years. As a result of the iShip.com acquisition in March 2000, our losses have increased because of additional costs and expenses related to amortization of goodwill, other intangibles and deferred compensation resulting from this acquisition; to an increase in the number of employees; an increase in sales and marketing activities; additional facilities and infrastructure; and assimilation of operations and personnel. Overall, we will need to generate significant revenues and successfully implement our new business strategy to achieve and maintain profitability. In connection with the iShip.com acquisition that we completed in March 2000, we recorded a significant amount of intangibles, the amortization of which will significantly and adversely affect our operating results. To the extent we do not generate sufficient cash flow to recover the amount of the investment recorded, the investment may be considered impaired and could be subject to an immediate write-down of up to the full amount of the investment. In this event, our net loss in any given period could be greater than anticipated and the market price of our stock could decline. Our ability to generate gross margins generally assumes that if a market for our services develops, we must generate significant revenues from a large base of active customers and a consistent stream of transactions through our shipping services. We currently charge our customers a fee to use our Internet Postage service. Similarly, we 18 expect to charge transaction fees for our enterprise services. In order to attract customers, we may run special promotions and offer discounts on fees, postage and supplies. However, given the lack of an established or proven commercial market for our services, we cannot be sure that customers will be receptive to our fee structures. Even if we are able to establish a sizeable base of users, we still may not generate sufficient gross margins to become profitable. In addition, our ability to generate revenues or achieve profitability could be adversely affected by special promotions or changes to our pricing plans. The change in payment terms associated with a significant contract could adversely affect our financial condition and results of operations. In the three month and nine month periods ending September 30, 2000, we derived 12% and 20% of our revenue, respectively, from Mail Boxes Etc. Currently, under the terms of our contract with Mail Boxes Etc., we receive fixed monthly service fees of $500,000 from Mail Boxes Etc. until December 31, 2000. Thereafter, our contract with Mail Boxes Etc. calls for a transaction- based fee structure. We expect the amount of monthly revenue that we will receive from Mail Boxes Etc. under a transaction-based fee structure to initially be lower than the fixed fee structure. If we fail to increase our customer base or our transaction-based fee structure with Mail Boxes Etc. yields lower than expected revenues, our financial condition and results of operations will be seriously affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Overview." Third party assertions of violations of their intellectual property rights could adversely affect our business. In addition to the Pitney Bowes claims described above, as is customary with technology companies, we may receive or become aware of correspondence claiming potential infringement of other parties' intellectual property rights. We could incur significant costs and diversion of management time and resources to defend claims against us regardless of their validity. We may not have adequate resources to defend against these claims and any associated costs and distractions could have a material adverse effect on our business, financial condition and results of operations. As an alternative to litigation, we may seek licenses for other parties' intellectual property rights. We may not be successful in obtaining all of the necessary licenses on commercially reasonable terms, if at all. Any loss resulting from intellectual property litigation could severely limit our operations, cause us to pay license fees, or prevent us from doing business. A failure to protect our own intellectual property could harm our competitive position. We rely on a combination of patent, trade secret, copyright and trademark laws and contractual restrictions to establish and protect our rights in our products, services, know-how and information. We have three issued US patents and have filed 61 patent applications in the United States, and 13 international patent applications. We have also applied to register a number of trademarks and service marks. We plan to apply for other patents, trademarks and service marks in the future. We may not receive patents for any of our patent applications. Even if patents are issued to us, claims issued in these patents may not protect our technology. In addition, a court might hold any of our patents, trademarks or service marks invalid or unenforceable. If our patents fail to protect our technology or our trademarks and service marks are successfully challenged, our competitive position could be harmed. Even if our patents are upheld or are not challenged, third parties may develop alternative technologies or products without infringing our patents. We generally enter into confidentiality agreements with our employees, consultants and other third parties to control and limit access and disclosure of our confidential information. These contractual arrangements or other steps taken to protect our intellectual property may not prove to be sufficient to prevent misappropriation of technology or deter independent third party development of similar technologies. Additionally, the laws of foreign countries may not protect our services or intellectual property rights to the same extent as do the laws of the United States. If we cannot effectively manage our growth, our ability to provide services will suffer. Our reputation and ability to attract, serve and retain our customers depend upon the reliable performance of our Web site, network infrastructure and systems. We have a limited basis upon which to evaluate the capability of our systems to handle controlled or full commercial availability of our Internet Postage service or our enterprise mailing and shipping services. Prior to the recent restructuring related to our new business strategy, we had expanded our operations significantly, and additional expansion may be required to address the anticipated growth in our user base and market opportunities. To manage any growth of operations, we may need to improve existing, and implement new, systems, procedures and controls. In addition, we have substantially reduced our rate of hiring; however, we may need to expand, train and manage an increasing employee base. We may also need to expand our finance, administrative and operations staff. 19 We may not be able to manage our growth effectively. Our prior expansion has placed, and our current restructuring will place, a significant strain on our managerial, operational and financial resources. Our current and planned personnel, systems, procedures and controls may be inadequate to support our future operations. If we are unable to manage our growth effectively or experience disruptions during our expansion, our business will suffer and our financial condition and results of operations will be seriously affected. If we are unable to maintain and develop our strategic relationships and distribution arrangements, our services may not achieve commercial acceptance. We have established strategic relationships with a number of third parties. To date, our strategic relationships generally involve the promotion and distribution of our services through our partners' products, services and Web sites. Recently, we have increased our focus on the direct sales channel and have entered into arrangements to have a third party direct sales force offer our services. In return for promoting or selling our services, our partners may receive revenue-sharing opportunities or per customer bounties. In order to achieve wide distribution of our services, we believe we must establish additional strategic relationships to market our services effectively. If one or more of our partners terminates or limits its relationship with us, our business could be severely harmed or fail. We have limited experience in establishing and maintaining strategic relationships, and we may fail in our efforts to establish and maintain these relationships. Our current strategic relationships have not yet resulted in significant revenues, primarily because we have only recently commercially released our Internet Postage service and our enterprise services have yet to be released on a commercial scale. As a result, our strategic partners may not view their relationships with us as significant or vital to their businesses and consequently, may not perform according to our expectations. We have little ability to control the efforts of our strategic partners and, even if we are successful in establishing strategic relationships, these relationships may not be successful. We face risks typical of early stage companies and of new and rapidly changing markets. You should consider our prospects in light of the risks and difficulties frequently encountered by early stage companies and those in new and rapidly evolving markets. These risks include, among other things, our (a) complete dependence on Internet mailing and shipping services that currently do not have broad market acceptance; (b) need to effectively deploy our sales and support organizations; (c) ability to establish and promote our brand name; (d) ability to manage our operations to meet the commercial demand for our services; (e) development of and reliance on strategic and distribution relationships; (f) ability to prevent and respond quickly to service interruptions; (g) ability to minimize fraud and other security risks; (h) ability to compete with companies with greater capital resources and brand awareness; (i) the effectiveness of our new management team and its ability to successfully implement our new business strategy, and (j) ability to maximize return on investment and manage our expenditures. If we do not achieve the brand recognition necessary to succeed in the Internet mailing and shipping markets, our business will suffer. We must quickly build our brands for our mailing and shipping service in order to gain market acceptance for our services. We believe it is imperative to our long-term success that we obtain significant market share for our services before other competitors enter the Internet postage and shipping markets. We must make substantial expenditures on product development, strategic relationships and marketing and sales initiatives in an effort to establish our brand awareness and services. We cannot be certain that we will effectively deploy or have sufficient resources to build our brands and realize commercial acceptance of our services. If we fail to gain market acceptance for our services, our business will suffer dramatically or may fail. System and online security failures could harm our business and operating results. Our services depend on the efficient and uninterrupted operation of our computer and communications hardware systems. In addition, we must provide a high level of security for the transactions we execute. We rely on internally developed and third party technology to provide secure transmission of postage and other confidential information. Any breach of these security measures would severely impact our business and reputation and would likely result in the loss of customers. Furthermore, if we are unable to provide adequate security, the US Postal Service could prohibit us from selling postage over the Internet and our enterprise customers could discontinue use of our mailing and shipping services. Our systems and operations are vulnerable to damage or interruption from a number of sources, including fire, flood, power loss, telecommunications failure, break-ins, earthquakes and similar events. We have entered into an Internet hosting agreement with Exodus Communications, Inc. to maintain our Internet postage servers at Exodus' data centers in Southern California. Our operations depend on Exodus' ability to protect its and our systems in its data center against damage or interruption. Exodus does not guarantee that our Internet access will be uninterrupted, error-free or secure. Our servers are also vulnerable to computer viruses, physical, electrical or electronic break- ins and similar disruptions. We have obtained insurance for some of these disruptions; however, we cannot be certain that our coverage will be sufficient to compensate us for losses that may occur due to these types of disruptions. We have experienced unplanned system interruptions in the past and may experience them again in the future. Unplanned interruptions that we have had in the past have resulted in instances where current customers could not access their accounts or purchase postage or supplies from our online store and potential customers could not register for our services. Some of these past interruptions have lasted several hours. Any substantial interruptions in the future could result in the loss of data and could completely impair our ability to process transactions, register new customers and generate revenues from our services and our online store. We do have a business interruption plan that we continue to refine and update; however, we do not presently have a full disaster recovery plan in effect to cover loss of facilities and equipment. In addition, we do not have a "fail-over" site that mirrors our infrastructure to allow us to operate from a second location. We have business interruption insurance; however, we cannot be certain that our coverage will be sufficient to compensate us for losses that may occur as a result of business interruptions. A significant barrier to electronic commerce and communications is the secure transmission of confidential information over public networks. Anyone who is able to circumvent our security measures could misappropriate 20 confidential information or cause interruptions in our operations. We may be required to expend significant capital and other resources to protect against potential security breaches or to alleviate problems caused by any breach. We rely on specialized technology, both within our own infrastructure and that provided by Exodus, to provide the security necessary for secure transmission of postage and other confidential information. Advances in computer capabilities, new discoveries in security technology, or other events or developments may result in a compromise or breach of the algorithms we use to protect customer transaction data. Should someone circumvent our security measures, our reputation, business, financial condition and results of operations could be seriously harmed. Security breaches could also expose us to a risk of loss or litigation and possible liability for failing to secure confidential customer information. As a result, we may be required to expend a significant amount of financial and other resources to protect against security breaches or to alleviate any problems that they may cause. The effects of expansion may adversely affect our financial condition, results of operations and existing stockholders. We may establish subsidiaries, enter into joint ventures or pursue the acquisition of new or complementary businesses, products or technologies in an effort to enter into new business areas, diversify our sources of revenue and expand our product and service offerings. Although we have no commitments or agreements and are not currently engaged in discussions for any material acquisitions or investments, we continue to evaluate strategic alternatives, incremental revenue opportunities and derivative applications of our technology and may pursue and develop those opportunities with strategic partners and investors, both domestically and internationally. To the extent we pursue new or complementary businesses, we may not be able to expand our service offerings and related operations in a cost- effective or timely manner. We may experience increased costs, delays and diversions of management's attention when integrating any new businesses or service. We may lose key personnel from our operations or those of any acquired business. Furthermore, any new business or service we launch that is not favorably received by users could damage our reputation and brand name in the Internet postage and shipping or other markets that we enter. We also cannot be certain that we will generate satisfactory revenues from any expanded services or products to offset related costs. Any expansion of our operations would also require significant additional expenses, and these efforts may strain our management, financial and operational resources. Additionally, future acquisitions may also result in potentially dilutive issuances of equity securities, the incurrence of additional debt, the assumption of known and unknown liabilities, and the amortization of expenses related to goodwill and other intangible assets, all of which could have a material adverse effect on our business, financial condition and operating results. New issuances of securities may also have rights, preferences and privileges senior to those of our common stock. Fluctuations in our operating results could cause our stock price to fall. Given our limited operating history, we have not generated any significant revenues from our operations. In addition, the market for Internet mailing and shipping services is very new and uncertain. Accordingly, we have a limited basis upon which to predict future operating results. We expect that our revenues, margins and operating results will fluctuate significantly due to a variety of factors, many of which are outside of our control. These factors include: (a) the success of the commercial release of services; (b) the costs of defending ourselves in the Pitney Bowes litigation or against other intellectual property claims; (c) the costs of our marketing and sales programs to establish, promote and distribute our brand names and services; (d) the demand for our services; (e) our ability to develop and maintain strategic distribution relationships and a direct sales channel; (f) the number, timing and significance of new products or services introduced by both us and our competitors; (g) our ability to develop, market and introduce new and enhanced services on a timely basis; (h) the level of service and price competition; (i) the increases in our operating expenses as we expand operations; (j) US Postal Service regulation and policies and (k) general economic factors. Our cost of revenues includes costs for systems operations, free postage and other promotional items, customer service, Internet connection and security services; all of these costs will fluctuate depending upon the demand for our services. In addition, a substantial portion of our operating expenses is related to personnel costs, marketing programs and overhead, which cannot be adjusted quickly and are therefore relatively fixed in the short term. Our operating expense levels are based, in significant part, on our expectations of future revenues. If our expenses precede increased revenues, both gross margins and results of operations would be materially and adversely affected. 21 Due to the foregoing factors and the other risks discussed in this report, you should not rely on period-to-period comparisons of our results of operations as an indication of future performance. It is possible that in some future periods our results of operations will be below the expectations of public market analysts and investors. In this event, the market price of our common stock is likely to decline. We may need to raise additional capital in the future through the issuance of additional equity or convertible debt securities or by borrowing money, and additional funds may not be available on terms acceptable to us. If our cost-cutting program associated with our new business strategy is successfully implemented, we believe that our current cash balances will allow us to fund our operations through June 2002. However, we may require substantial working capital to fund our business and we may need to raise additional capital. Our future capital needs depend on many factors, including market acceptance of our postage and shipping services; the level of promotion and advertising of our postage and shipping services; the level of our development efforts; our rate of customer acquisition and retention for our Internet mailing and shipping services; and changes in technology. In addition, the various elements of our business and growth strategies, including our plans to support fully the commercial release of our services, our introduction of new products and services and our investments in infrastructure will require additional capital. We cannot be certain that additional funds will be available on satisfactory terms when needed, if at all. If we are unable to raise additional necessary capital in the future or generate sufficient working capital, we may be required to curtail our operations significantly or obtain funding through the relinquishment of significant technology or markets. Raising additional capital through the sale of equity or convertible debt securities would have a dilutive effect on existing stockholders, and securities we issue may have rights superior to our common stock. We could be required to register as an investment company and become subject to substantial regulation that would interfere with our ability to conduct our business. We invest in short-term instruments consistent with prudent cash management and not primarily for the purpose of achieving investment returns. This could result in our being treated as an investment company under the Investment Company Act of 1940 and therefore being required to register as an investment company under the Investment Company Act. The Investment Company Act requires the registration of companies which are engaged primarily in the business of investing, reinvesting or trading in securities or which are engaged in investing, reinvesting, owning, holding or trading in securities and over 40% of whose assets on an unconsolidated basis (other than government securities and cash) consist of investment securities. While we do not believe that we are engaged primarily in the business of investing, reinvesting or trading in securities, we may invest our cash and cash equivalents in government securities to the extent necessary to avoid having over 40% of our assets consist of investment securities. Government securities are defined as securities issued by the U.S. government and certain federal agencies. These securities generally yield lower rates of income than other short-term instruments in which we have invested to date. Accordingly, investing substantially all of our cash and cash equivalents in government securities could result in lower levels of interest income, which could cause our losses to increase. If we were required to register as an investment company under the Investment Company Act, we would become subject to substantial regulation with respect to our capital structure, management, operations, transactions with affiliated persons, if any, and other matters, incur substantial costs and experience a disruption of our business. Application of the provisions of the Investment Company Act to us would materially and adversely affect our business, prospects, financial condition and results of operations. If the software, hardware, computer technology and other systems and services we use are not Year 2000 compliant, our operations could suffer and we could lose customers. Many existing computer systems and software products are coded to accept only two digit entries in the date code field and cannot distinguish 21st century dates from 20th century dates. If these systems have not been properly corrected, there could be system failures or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in normal business activities. As a result, many companies' software and computer systems may need to be upgraded or replaced to become "Year 2000" compliant. In addition, despite the fact that many computer systems are currently processing 21st century dates correctly, these companies, including us, could experience latent Year 2000 problems. 22 We use and depend on third party equipment and software that may not be Year 2000 compliant. If Year 2000 issues prevent our customers from accessing the Internet or our Web site, processing transactions or using their credit cards, our business will suffer. Any failure of our third party equipment, software or services to operate properly could require us to incur unanticipated expenses, which could seriously harm our business and operating results. We face risks associated with our markets If we do not respond effectively to technological change, our services could become obsolete and our business will suffer. The development of our services and other technology entails significant technical and business risks. To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our online operations. The Internet and the electronic commerce industry are characterized by rapid technological change; changes in user and customer requirements and preferences; frequent new product and service introductions embodying new technologies; and the emergence of new industry standards and practices. The evolving nature of the Internet or the Internet mailing and shipping markets could render our existing technology and systems obsolete. Our success will depend, in part, on our ability to license or acquire leading technologies useful in our business; enhance our existing services; develop new services or features and technology that address the increasingly sophisticated and varied needs of our current and prospective users; and respond to technological advances and emerging industry and regulatory standards and practices in a cost- effective and timely manner. Future advances in technology may not be beneficial to, or compatible with, our business. Furthermore, we may not be successful in using new technologies effectively or adapting our technology and systems to user requirements or emerging industry standards on a timely basis. Our ability to remain technologically competitive may require substantial expenditures and lead-time. If we are unable to adapt in a timely manner to changing market conditions or user requirements, our business, financial condition and results of operations could be seriously harmed. If we are unable to compete successfully, particularly against large, traditional providers of postage products such as Pitney Bowes who enter the online postage and shipping markets, our revenues and operating results will suffer. The market for Internet postage products and services is new and is intensely competitive. At present, E-Stamp has a hardware-based product commercially available and has announced that it begun testing a Web-based product through the Information Based Indicia Program. Pitney Bowes has a software-based product commercially available and has a hardware-based product in beta testing. Neopost Industrie has received commercial approval for a software-based product and has a hardware-based product in beta testing. Envelope Manager has a software product in beta testing. If any of our competitors, including Pitney Bowes, provide the same or similar service as we provide, our operations could be adversely impacted. Internet postage may not be widely adopted by customers. These customers may continue to use traditional means to purchase postage, including purchasing postage from their local post office. If Internet postage becomes a viable market, we may not be able to establish or maintain a competitive position against current or future competitors as they enter the market. Many of our competitors have longer operating histories, larger customer bases, greater brand recognition, greater financial, marketing, service, support, technical, intellectual property and other resources than us. As a result, our competitors may be able to devote greater resources to marketing and promotional campaigns, adopt more aggressive pricing policies and devote substantially more resources to Web site and systems development than us. This increased competition may result in reduced operating margins, loss of market share and a diminished brand. We may from time to time make pricing, service or marketing decisions or acquisitions as a strategic response to changes in the competitive environment. These actions could result in reduced margins and seriously harm our business. 23 If the market for Internet postage develops, we could face competitive pressures from new technologies or the expansion of existing technologies approved for use by the US Postal Service. We may also face competition from a number of indirect competitors that specialize in electronic commerce and other companies with substantial customer bases in the computer and other technical fields. Additionally, companies that control access to transactions through a network or Web browsers could also promote our competitors or charge us a substantial fee for inclusion. Our competitors may also be acquired by, receive investments from or enter into other commercial relationships with larger, better-established and better-financed companies as use of the Internet and other online services increases. In addition, changes in postal regulations could adversely affect our service and significantly impact our competitive position. We may be unable to compete successfully against current and future competitors, and the competitive pressures we face could seriously harm our business. As a result of the iShip.com acquisition in March 2000, we also compete with companies that provide shipping solutions to businesses. Customers may continue using the direct services (including online services) of the US Postal Service, UPS, FedEx and other major carriers, instead of adopting our multi- carrier, online service. Successful adoption of our shipping solutions may also be impeded by insufficient cooperation from major carriers that we need to provide our online services. Alternatively, traditional and/or potential competitors with greater resources than us, like Pitney Bowes, may develop more successful Internet solutions or deter acceptance of our service offerings. In addition, companies including TanData Corporation, GoShip.com, BITS, Inc./Intershipper.net, Kewill Systems, Accuship, Neopost Industrie, Virtan, Inc./SmartShip, Return.com and ClickReturns.com are competing in shipping services and/or offering their services through alliances with traditional major shippers. We also face a significant risk that large shipping companies will collaborate in the development and operation of an online shipping system that could make our Internet shipping services obsolete. The success of our business will depend on the continued growth of the Internet and the acceptance by customers of the Internet as a means for purchasing postage and shipping services. Our success depends in part on widespread acceptance and use of the Internet as a way to purchase postage and shipping services. This practice is at an early stage of development, and market acceptance of Internet postage and shipping services is uncertain. We cannot predict the extent to which customers will be willing to shift their purchasing habits from traditional to online postage and/or shipping services. To be successful, our customers must accept and utilize electronic commerce to satisfy their product needs. Our future revenues and profits, if any, substantially depend upon the acceptance and use of the Internet and other online services as an effective medium of commerce by our target users. The Internet may not become a viable long-term commercial marketplace due to potentially inadequate development of the necessary network infrastructure or delayed development of enabling technologies and performance improvements. The commercial acceptance and use of the Internet may not continue to develop at historical rates. Our business, financial condition and results of operations would be seriously harmed if use of the Internet and other online services does not continue to increase or increases more slowly than expected; the infrastructure for the Internet and other online services does not effectively support future expansion of electronic commerce or our services; concerns over security and privacy inhibit the growth of the Internet; or the Internet and other online services do not become a viable commercial marketplace. US Postal Service regulation may cause disruptions or the discontinuance of our business. Additionally, the US Postal Service could assess fees that would increase the cost of our service and possibly affect the adoption of Internet postage as a new method of mailing. We are subject to continued US Postal Service scrutiny and other government regulations. The US Postal Service could change its certification requirements or specifications for Internet postage or revoke the approval of our service at any time. Any changes in requirements or specifications for Internet postage could adversely affect our pricing, cost of revenues, operating results and margins by increasing the cost of providing our Internet postage service. For example, the US Postal Service could decide to charge Internet postage vendors fees for the enrollment of each unique customer of the Internet postage product, which would be a cost that we would either absorb or pass through to customers. The US Postal Service has in fact invoiced each Internet postage vendor $8 for each digital certificate required for each consumer of Internet postage to securely print postage. We are currently discussing the necessity of this charge with the US Postal Service. If we are required to pay this per customer charge, the cost of 24 our service could increase and the adoption of Internet postage as a new method of mailing could be adversely affected. The US Postal Service could also decide that Internet postage should no longer be an approved postage service due to security concerns or other issues. Our business would suffer dramatically if we are unable to adapt our Internet Postage service to any new requirements or specifications or if the US Postal Service were to discontinue Internet postage as an approved postage method. Alternatively, the US Postal Service could introduce competitive programs or amend Internet postage requirements to make certification easier to obtain, which could lead to more competition from third parties or the US Postal Service itself. See "Risk Factors-If we are unable to compete successfully, particularly against large, traditional providers of postage products like Pitney Bowes who enter the online postage and shipping markets, our revenues and operating results will suffer." In addition, US Postal Service regulations may require that our personnel with access to postal information or resources receive security clearance prior to doing relevant work. We may experience delays or disruptions if our personnel cannot receive necessary security clearances in a timely manner, if at all. The regulations may limit our ability to hire qualified personnel. For example, sensitive clearance may only be provided to US citizens or aliens who are specifically approved to work on US Postal Service projects. Our operating results could be impaired if our business or the Internet become subject to additional government regulation and legal uncertainties. With the exception of US Postal Service and Department of Commerce regulations, we are not currently subject to direct regulation by any domestic or foreign governmental agency, other than regulations applicable to businesses generally, and laws or regulations directly applicable to electronic commerce. However, due to the increasing popularity and use of the Internet, it is possible that a number of laws and regulations may be adopted with respect to the Internet, relating to user privacy; pricing; content; copyrights; distribution; characteristics and quality of products and services; and export controls. The adoption of any additional laws or regulations may hinder the expansion of the Internet. A decline in the growth of the Internet could decrease demand for our products and services and increase our cost of doing business. Moreover, the applicability of existing laws to the Internet is uncertain with regard to many issues, including property ownership, export of specialized technology, sales tax, libel and personal privacy. Our business, financial condition and results of operations could be seriously harmed by any 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 and other online services could also harm our business. We have employees and offer our services in multiple states and plan to expand both domestically and internationally. These jurisdictions may claim that we are required to qualify to do business as a foreign corporation in each state or foreign country. Our failure to qualify as a foreign corporation in a jurisdiction where we are required to do so could subject us to taxes and penalties. Other states and foreign countries may also attempt to regulate our services or prosecute us for violations of their laws. Further, we might unintentionally violate the laws of foreign jurisdictions as those laws may be modified or as new laws may be enacted in the future. If we market our services internationally, government regulation could disrupt our operations. One element of our strategy is to provide services in international markets. Our ability to provide our Internet Postage service in international markets would likely be subject to rigorous governmental approval and certification requirements similar to those imposed by the US Postal Service. For example, our Internet Postage service cannot currently be used for international mail because foreign postal authorities do not currently recognize information-based indicia postage. If foreign postal authorities accept postage generated by our service in the future, and if we obtain the necessary foreign certification or approvals, we would be subject to ongoing regulation by foreign governments and agencies. To date, efforts to create a certification process in Europe and other foreign markets are in a preliminary stage and these markets may not prove to be a viable opportunity for us. As a result, we cannot predict when, or if, international markets will become a viable source of revenues for a postage service similar to ours. 25 Even though the US government has recently adopted more flexible export rules for software, our ability to provide service in international markets may still be impacted by the export control laws of the United States. Our software technology may make us subject to stronger export controls in some instances, and may prevent us from being able to export our products and services. Regulations and standards of the Universal Postal Union and other international bodies may also limit our ability to provide international mail services. If we achieve significant international acceptance of our services, our business activities will be subject to a variety of potential risks, including the adoption of laws and regulatory requirements, political and economic conditions, difficulties protecting our intellectual property rights and actions by third parties that would restrict or eliminate our ability to do business in these jurisdictions. If we begin to transact business in foreign currencies, we will become subject to the risks attendant to transacting in foreign currencies, including the potential adverse effects of exchange rate fluctuations. Our charter documents could deter a takeover effort, which could inhibit your ability to receive an acquisition premium for your shares. The provisions of our Amended and Restated Certificate of Incorporation, Bylaws and Delaware law could make it difficult for a third party to acquire us, even it would be beneficial to our stockholders. In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, which could prohibit or delay a merger or other takeover of our company, and discourage attempts to acquire us. Additional shares held by existing stockholders may be sold into the public market, which could cause our stock price to decline. Public sales of substantial amounts of common stock purchased in private financings prior to our initial public offering or upon the exercise of stock options or warrants could adversely affect the prevailing market price of our common stock. All of these shares are available for immediate sale, subject to the volume and other restrictions under Rule 144 of the Securities Act of 1933. Sales of substantial amounts of common stock in the public market, or the perception that these sales could occur, could adversely affect the prevailing market price for our common stock and could impair our ability to raise capital through a public offering of equity securities. Item 3. Quantitative and Qualitative Disclosures About Market Risk. We are exposed to interest rate risk from the short-term investments and line of credit. At September 30, 2000, the short-term investments, which consist principally of corporate debt and commercial paper, approximated $167.5 million and had a related weighted average interest rate of 6.6%. At September 30, 2000, the line of credit balance totaled $1.9 million and the related interest rate was 10.5 % (the bank's prime rate plus 1%). If market interest rates continue to rise, the value of the short-term investments will continue to decrease. We currently hold no derivative instruments and do not earn foreign-source income. We expect to invest only in short-term, investment grade and interest-bearing instruments. 26 PART II OTHER INFORMATION Item 1. Legal Proceedings. On June 16, 1999, Pitney Bowes sued us for alleged patent infringement in the United States District Court for the District of Delaware. The suit originally alleged that we are infringing two patents held by Pitney Bowes related to postage application systems and electronic indicia. The suit seeks treble damages, a preliminary and permanent injunction from further alleged infringement, attorneys' fees and other unspecified damages. We answered the complaint on August 6, 1999, denying the allegations of patent infringement and asserting a number of affirmative defenses. Pitney Bowes filed a similar complaint in early June 1999 against one of our competitors, E-Stamp Corporation, alleging infringement of seven Pitney Bowes patents. On April 13, 2000, Pitney Bowes asked the court for permission to amend its complaint to drop allegations of patent infringement with respect to one patent and to add allegations of patent infringement with respect to three other patents. On July 28, 2000 the court entered Pitney Bowes' amended complaint. On September 18, 2000, Pitney Bowes filed another patent infringement lawsuit against us in the United States District Court for the Eastern District of Texas, alleging that we are infringing four patents owned by Pitney Bowes related to shipping. The suit seeks unspecified damages and a permanent injunction from further alleged infringement. The outcome of the litigation that Pitney Bowes has brought against us is uncertain. Therefore, we can give no assurance that Pitney Bowes will not prevail in its suit against us. See "Risk Factors-Success by Pitney Bowes in its suit against us alleging patent infringement could prevent us from offering our Internet Postage service and severely harm our business or cause it to fail." On December 29, 1999, three individual plaintiffs filed a suit against us for alleged breach of oral contract, quantum meruit, fraud and negligent representation in the California Superior Court for the County of Los Angeles. The complaint was amended on January 28, 2000 to add Mohan Ananda, one of our directors, as a defendant and to remove one of the plaintiffs from the suit. The suit alleges that the plaintiffs were due cash consideration in the amount of $13.3 million plus other unspecified compensatory damages, punitive and exemplary damages for securing a board member and investors for Stamps.com. On November 6, 2000, the trial court granted summary judgment on the entire action in favor of us and Mr. Ananda. While the plaintiffs may appeal the grant of summary judgment, we believe that the grant of summary judgment will be upheld in the event of appeal. Nevertheless, the outcome of this litigation is uncertain and we can give no assurance that the plaintiffs will not prevail. On August 23, 2000, DraftWorldwide, Inc., which formerly served as one of our advertising and promotions agencies, filed a suit against us for alleged breach of contract in the Circuit Court of Cook County, Illinois. The suit alleges that we improperly terminated our contract with DraftWorldwide and seeks damages of approximately $3.9 million plus interest and costs associated with the lawsuit. The alleged damages consist primarily of monthly retainers that DraftWorldwide claims to be due and owing as a result of the alleged improper termination for the seven month period beginning June 2000 and ending December 2000. We believe that the agreement was terminated effective June 1, 2000, which termination resulted from our belief that DraftWorldwide failed to perform adequately under the contract, among other reasons. We are currently evaluating the claims against us as well as potential counterclaims, and have not responded to the suit. The outcome of this litigation is uncertain and we can give no assurance that DraftWorldwide will not prevail. 27 We are not currently involved in any other material legal proceedings, nor have we been involved in any such proceeding that has had or may have a significant effect on our company. We are not aware of any other material legal proceedings pending against us. Item 2. Changes in Securities and Use of Proceeds. On August 1, 2000, we entered into a Warrant Issuance Agreement with Cydcor Limited ("Cydcor"). Under the terms of the agreement, we are obligated to issue warrants to purchase shares of our common stock on a monthly basis. The number of shares underlying each warrant is based upon a calculation that determines net new customers that Cydcor obtains from direct sales of our Internet Postage service. The warrants issuable under the agreement are exercisable for a period of two years from the issuance date. Under the terms of this agreement, on September 30, 2000, we issued Cydcor a warrant to purchase 5,281 shares of our common stock at a price per share of $3.844. The Warrant Issuance Agreement and form of warrant are filed as Exhibits 4.1 and 10.49 and to this Form 10-Q. The offer and sale of this warrant and the shares of common stock issuable upon conversion thereof is exempt from the registration requirements of the Securities Act by virtue of Section 4(2) thereof. Item 3. Defaults Upon Senior Securities. Not applicable. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. Item 5. Other Information. In October 2000, we experienced significant personnel changes at the senior management level including the resignation of our Chief Executive Officer and Chairman of the Board, our President and Chief Operating Officer, our Chief Financial Officer and our Controller. Additionally, our Chief Marketing Officer departed in connection with our recent restructuring. Although the Board has appointed Bruce Coleman as interim Chief Executive Officer and Kenneth McBride, our previous Senior Director of Finance, as our acting Chief Financial Officer, permanent replacements have not been appointed and the positions of Chief Operating Officer and Controller remain open. We do not currently anticipate that we will hire a Chief Marketing Officer. On November 13, 2000, the Board appointed Bruce Coleman to the Board, filling the vacancy created by Thomas H. Bruggere, who resigned on September 30, 2000. We cannot predict how these changes in management will affect our business. However, if we fail to attract and retain qualified individuals for these senior management positions, our business, financial condition and results of operations will be seriously harmed. In October 2000, we implemented a new business strategy in an effort to more rapidly decrease our operating losses and enhance our ability to achieve profitability. This strategy involved a restructuring that reduced our total headcount by approximately 40%, which included full time, part time and contract employees. We also announced that we would implement other cost-cutting programs, including a significant reduction in and redeployment of our sales and marketing efforts to those programs that have demonstrated higher returns on investment. Finally, we are combining our Enterprise and E-Commerce Business Units to reduce duplication of costs and effort. We expect to take a one-time charge in the fourth quarter of 2000 relating to this restructuring. If our new business strategy is not successful, we will not achieve profitability as currently planned, if at all. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. 4.1 Form of Common Stock Purchase Warrant between the Company and Cydcor Limited. 10.47 + Manifest System Services and Co-Branding Agreement, dated as of April 27, 1999, by and between iShip.com, Inc. and Mail Boxes Etc. USA, Inc. 10.48+ Amendment No. 1 to Manifest System Services and Co-Branding Agreement, dated as of March 7, 2000, by and between iShip.com, Inc. and Mail Boxes, Etc. USA, Inc. 10.49 Warrant Issuance Agreement, dated as of August 1, 2000 between the Company and Cydcor Limited. _______________________ + Confidential treatment has been requested for certain portions of this exhibit pursuant to 24b-2 under the Securities and Exchange Act, as amended. In accordance with Rule 24b-2, these confidential portions have been omitted from this exhibit and filed separately with the Securities and Exchange Commission. 28 27.1 Financial Data Schedule. 99.1* Press Release issued October 12, 2000 relating to resignation of John M. Payne from position of Chairman of the Board of Directors and Chief Executive Officer. 99.2 Press Release issued October 23, 2000 relating to the Company's headcount reduction. 99.3 Press Release issued October 31, 2000 relating to appointment of Bruce Coleman as interim Chief Executive Officer. 99.4 Press Release issued October 31, 2000 relating to the Company's financial results for the third quarter of 2000 and cost-cutting measures. ---------------- * Incorporated by reference to Exhibit 99.2 on the Form 8-K filed by the Company on October 13, 2000. (b) Reports on Form 8-K. On September 25, 2000, the Company filed a report on Form 8-K relating to (1) an action filed against the Company by DraftWorldwide, Inc. alleging breach of contract and (2) an action filed against the Company by Pitney Bowes alleging patent infringement. 29 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Stamps.com Inc. (Registrant) November 14, 2000 /s/ Bruce Coleman ---------------------------- --------------------------------------- Date Bruce Coleman Chief Executive Officer November 14, 2000 /s/ Kenneth McBride ---------------------------- --------------------------------------- Date Kenneth McBride Chief Financial Officer (Principal Financial Officer) 30