part 2 of 2
Due to the September 1, 2000, closing date for the Interface acquisition by Tumbleweed, there is no historical comparisons for the L2i revenue. Total revenue from the Tumbleweed L2i product line for the three and nine months ended September 30, 2000 was $222,000.
COST OF REVENUE. Cost of revenue is comprised of license cost, services cost and transaction fees cost. License cost is primarily comprised of royalties paid to third parties for software licensed by Tumbleweed for inclusion in our products. Services cost is comprised primarily of personnel and overhead costs related to customer support and contract development projects. Transaction fees cost is primarily comprised of royalties paid to third parties for software licensed by us for inclusion in our products and hardware and band-width costs associated with hosting IME servers for some customers. Total cost of revenue for the three months ended September 30, 2000 increased 134% to $3.6 million from $1.5 million for the same three months in 1999. Total cost of revenue for the nine months ended September 30, 2000 increased 154% to $9.0 million from $3.5 million for the same nine months in 1999. The increase in total cost of revenue corresponds to increased revenues.
License cost for the three months ended September 30, 2000 increased 107% to $514,000 from $248,000 for the same three months in 1999. License cost for the nine months ended September 30, 2000 increased 121% to $1.1 million from $490,000 for the same nine months in 1999. License costs increased due to increased sales of products containing software licensed from third parties.
Services cost for the three months ended September 30, 2000 increased 140% to $3.0 million from $1.2 million for the same three months in 1999. Services cost for the nine months ended September 30, 2000 increased 160% to $7.8 million from $3.0 million for the same nine months in 1999. The increase was primarily due to increased personnel costs supporting an increase in new contract development projects and increases in facilities-related expenses.
Transaction fees cost for the three months ended September 30, 2000 increased 121% to $53,000 from $24,000 for the same three months in 1999. Transaction fees cost for the nine months ended September 30, 2000 increased 120% to $97,000 from $44,000 for the same September months in 1999. The increases in transaction fees cost resulted from royalties due on transaction fees revenue and, to a lesser extent, depreciation expense and connectivity costs incurred in generating transaction revenue.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses are comprised of engineering and related costs associated with the development of Tumbleweed applications, quality assurance and testing. Research and development expenses for the three months ended September 30, 2000 increased 83% to $4.2 million from $2.3 million for the same three months in 1999. Research and development expenses for the nine months ended September 30, 2000 increased 66% to $10.2 million from $6.2 million for the same nine months in 1999. The increases were primarily due to an increase in personnel needed to support ongoing development of Tumbleweed's products and new applications for our target markets, increases in average salaries for development personnel in order to provide a competitive salary in today's marketplace and increased facilities related expenses. We expect that research and development expenses will increase in absolute dollars in future periods due to increased personnel required to support new projects that will allow us to expand the functionality of the core IME and MMS platforms, increase the number of vertical applications built for the our target markets and integrate with a wider array of third party software packages.
SALES AND MARKETING EXPENSES. Sales and marketing expenses are comprised of salaries, commissions, travel expenses and costs associated with trade shows, advertising and other marketing efforts. Sales and marketing expenses for the three months ended September 30, 2000 increased 99% to $10.8 million from $5.4 million for the same three months in 1999. Sales and marketing expenses for the nine months ended September 30, 2000 increased 117% to $27.7 million from $12.7 million for the same nine months in 1999. The increase in sales and marketing expenses was primarily due to increased sales staffing, an increase in the number of offices in Europe and increased incentive compensation costs. We expect that sales and marketing expenses will increase in absolute dollars in future periods as we expand into new target markets and geographic areas. We plan to significantly increase the number of our sales and marketing personnel worldwide throughout 2001.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist primarily of personnel and support costs for our finance, legal and human resources departments as well as professional fees. General and administrative expenses for the three months ended September 30, 2000 increased 45% to $2.9 million from $2.0 million for the same three months in 1999. General and administrative expenses for the nine months ended September 30, 2000 increased 76% to $6.9 million from $3.9 million for the same nine months in 1999. The increase in general and administrative expenses was due to an increase in legal fees corresponding to the patent infringement lawsuit we brought against The docSpace Company, Inc., which is still pending, as well as increased staffing expenses and professional fees. We expect that general and administrative expenses will increase in absolute dollars in future periods as we continue to grow our infrastructure.
DEFERRED COMPENSATION EXPENSE. Deferred compensation expense is recorded in connection with the grant of certain stock options to non-employees and employees at exercise prices less than the deemed fair value on the grant date. During the three months ended September 30, 2000, we recorded aggregate deferred stock compensation expense of $5.3 million compared to $2.8 million for the same three months in 1999. The increase in deferred compensation for the three months ended September 30, 2000, is a combination of $2.3 million related to the Interface acquisition and $3.0 million resulting from the volatility of Tumbleweed's stock price combined with certain stock option commitments made to employees which were not processed in a timely fashion. During the nine months ended September 30, 2000, we recorded aggregate deferred stock compensation expense of $7.3 million compared to $7.3 million for the same nine months in 1999. The deferred stock compensation expense is being amortized on an accelerated basis over the vesting period of the options, which is generally four years. Of the total deferred stock compensation expense, $1.9 million and $1.1 million was amortized in the three months ended September 30, 2000 and 1999, respectively. Of the total deferred stock compensation expense, $4.3 million and $2.4 million was amortized in the nine months ended September 30, 2000 and 1999, respectively.
MERGER RELATED AND RESTRUCTURING EXPENSES. Merger related and restructuring expenses, which were recorded in connection with the acquisition of Worldtalk, are primarily comprised of investment banker's fees, legal fees, severance payments and accounting and printer fees. Merger related and restructuring expenses for the nine months ended September 30, 2000 were $10.8 million.
OTHER INCOME, NET. Other income, net, is primarily comprised of interest income earned on investment securities. Other income, net, for the three months ended September 30, 2000 increased 4% to $991,000 from $956,000 for the same three months in 1999. Other income, net, for the nine months ended September 30, 2000 increased 65% to $2.1 million from $1.3 million for the same nine months in 1999. The increases in other income, net, are due to increased cash balances invested in money market accounts and commercial paper. The increase in cash balances available for investment resulted from proceeds from the issuance of equity securities, including common stock issued in our initial public offering completed in August 1999 and our secondary offering completed in August of 2000.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations primarily through the issuance of equity securities. On September 30, 2000, we had $89.5 million in cash and cash equivalents. This amount includes approximately $77.6 million in net proceeds from our public offering completed in August 2000.
Net cash used in operating activities for the nine months ended September 30, 2000 was $34.6 million. Cash used in operating activities was primarily the result of net operating losses, offset by certain non-cash charges and increases in accounts payable and other liabilities, and an increase in accounts receivable.
Net cash used in investing activities for the nine months ended September 30, 2000 was $18.8 million. Net cash used in investing activities was primarily the result of the cost associated with the interface acquisition, capital expenditures related to facilities expansion and increased personnel as well as the TKK stock repurchase.
Net cash provided by financing activities for the nine months ended September 30, 2000 was $82.7 million. Cash provided by financing activities was primarily attributable to net proceeds of the public offering completed in August, 2000, and to a lesser extent, the issuance of common stock upon exercise of stock options, offset by the repayments of credit facilities and capital lease obligations.
As of September 30, 2000, our principal commitments consisted of obligations outstanding under equipment and operating leases. Our equipment leases require payment of rental fees to third party leasing providers at interest rates of approximately 8.45%. In most cases, we have no obligations to
purchase the equipment at the end of the lease term. We anticipate a substantial increase in capital expenditures consistent with potential growth in operations, infrastructure and personnel.
In July 1998, we entered into an agreement with a bank, which included a $1.5 million revolving credit facility, with availability based on outstanding accounts receivable, and a $1.75 million equipment loan facility. Borrowings under the credit facility and equipment facility carry interest at the prime rate plus 0.5% and 0.75%, respectively, with interest payable monthly. Borrowings under the equipment facility are due in 36 equal monthly installments and are secured by certain assets of Tumbleweed. As of September 30, 2000, total borrowings under the equipment loan facility were $1.2 million in the aggregate and $300,000 remained available under the facility. There were no borrowings under the credit facility as of September 30, 2000.
On December 30, 1998, Tumbleweed entered into a loan and security agreement comprised of a $1.5 million line of credit, which expired on December 29, 1999 and a $250,000 term facility, which expires on December 29, 2000, bearing interest at the prime rate (9.5% and 7.75% as of December 1999 and 1998) plus 0.25% and prime rate plus 0.50%, respectively. The agreement is collateralized by the assets of Tumbleweed, contains certain financial covenants and restricts Tumbleweed's ability to incur other indebtedness and pay dividends. As of September 30, 2000, borrowings under the term facility were $42,000.
In September 1999, we entered into a $525,000 financing arrangement with another company to finance our directors' and officers' liability insurance premium. Borrowings under the loan agreement are payable in nine equal monthly installments of $60,000. As of September 30, 2000, there were no borrowings outstanding under this financing arrangement.
Our capital requirements depend on numerous factors, including revenue generated from operations and market acceptance of our products and services, the resources devoted to the development of our products and services and the resources devoted to sales and marketing. We have experienced a substantial increase in capital expenditures and operating expenses since inception consistent with relocation and the growth in operations and staffing. We anticipate that these increases will continue for the foreseeable future. Additionally, we expect to make additional investments in technologies, and plan to expand our sales and marketing programs. We believe that our existing capital resources, including the proceeds from our recent secondary public offering, will enable us to maintain our current and planned operations for at least the next 12 months. However, we may need to raise funds prior to that time.
We intend to continue to consider future financing alternatives, which may include the incurrence of indebtedness, additional public or private equity offerings or an equity investment by a strategic partner. However, other than the revolving credit and equipment loan facilities and the insurance premium financing arrangement, we have no present commitments or arrangements assuring us of any future equity or debt financing, and additional equity or debt financing may not be available to us on favorable terms, if at all. We are not aware of seasonal aspects of our business that will affect our business on a short or long-term basis.
RISKS AND UNCERTAINTIES THAT YOU SHOULD CONSIDER BEFORE INVESTING IN TUMBLEWEED.
BECAUSE TUMBLEWEED IS IN AN EARLY STAGE OF DEVELOPMENT AND TUMBLEWEED HAS A
HISTORY OF LOSSES, IT IS DIFFICULT TO EVALUATE TUMBLEWEED'S BUSINESS AND
TUMBLEWEED MAY FACE EXPENSES, DELAYS AND DIFFICULTIES.
Tumbleweed has only a limited operating history upon which an evaluation can be based. Accordingly, Tumbleweed's prospects must be considered in light of the risks, expenses, delays and difficulties frequently encountered by companies in a similarly early stage of development, particularly companies engaged in new and rapidly evolving markets like secure messaging services and solutions. Tumbleweed incurred net losses of $43.5 million in the nine months ended September 30, 2000 and
$24.2 million in the year ended December 31, 1999. As of September 30, 2000, Tumbleweed had incurred cumulative net losses of $108.8 million.
TUMBLEWEED ANTICIPATES CONTINUED LOSSES.
Tumbleweed's success will depend in large part upon its ability to generate sufficient revenue to achieve profitability and to effectively maintain existing relationships and develop new relationships with customers and strategic partners. If Tumbleweed does not succeed, its revenue may not increase, and it may not achieve or maintain profitability on a timely basis or at all. In particular, Tumbleweed intends to expend significant financial and management resources on product development, sales and marketing, strategic relationships, technology and operating infrastructure. As a result, Tumbleweed expects to incur additional losses and continued negative cash flow from operations for the foreseeable future.
TUMBLEWEED'S QUARTERLY FINANCIAL RESULTS ARE SUBJECT TO SIGNIFICANT
FLUCTUATIONS.
As a result of Tumbleweed's limited operating history and the emerging nature of the markets in which it competes, Tumbleweed may not be able to accurately forecast its revenue or expenses. Tumbleweed's success is dependent upon its ability to enter into and maintain strategic relationships with customers and to develop and maintain volume usage of its products by its customers and their end-users. Tumbleweed's revenue has fluctuated and its quarterly operating results will continue to fluctuate based on the timing of the execution of new customer licenses in a given quarter. Tumbleweed's license revenue is comprised entirely of initial license and distribution fees. As a result, Tumbleweed will be required to regularly and increasingly sign additional customers with substantial initial license fees on a timely basis to realize comparable or increased license revenue.
Tumbleweed's revenue has fluctuated and its quarterly operating results will continue to fluctuate based on the timing of the execution of new customer licenses in a given quarter. Tumbleweed's license revenue is comprised entirely of initial license and distribution fees. As a result, Tumbleweed will be required to regularly and increasingly sign additional customers with substantial initial license fees on a timely basis to realize comparable or increased license revenue.
Tumbleweed's services revenue historically has been comprised largely of implementation, customization and consulting fees. Tumbleweed's ability to receive revenue from services is subject to multiple risks, including the risk that Tumbleweed may not be able to meet increasing customer demand because of a lack of adequately trained personnel, and the risk that customers may not timely accept the services provided and delay payment for such services.
Tumbleweed's transaction revenue historically has been comprised of contractual transaction minimums. Tumbleweed's ability to increase its transaction revenue through increased transaction volume depends on increased usage of Tumbleweed's products by its customers and their end users. Unless and until Tumbleweed has developed a significant and recurring transaction-based revenue stream from communications that are sent with its services, its revenue will continue to fluctuate significantly.
Because of the risks associated with each type of revenue, Tumbleweed may be unable to achieve and recognize quarterly or annual revenue consistent with its historical operating results or expectations.
In addition, Tumbleweed has experienced, and expects to continue to experience, fluctuations in revenue and operating results from quarter to quarter for other reasons, including, but not limited to:
- the amount and timing of operating costs and capital expenditures relating to its business, operations and infrastructure, including its international operations;
- its ability to accurately estimate and control costs;
- its ability to timely collect fees owed by customers;
- the announcement or introduction of new or enhanced products and services in the secure online communications or document delivery markets; and
- acquisitions that it completes or proposes, including Worldtalk and Interface Systems, Inc. ("Interface").
As a result of these factors, Tumbleweed believes that quarter-to-quarter comparisons of its revenue and operating results are not necessarily meaningful, and that these comparisons may not be accurate indicators of future performance. Because Tumbleweed's staffing and operating expenses are based on anticipated revenue levels, and because a high percentage of its costs are fixed, small variations in the timing of the recognition of specific revenue could cause significant variations in operating results from quarter to quarter. If Tumbleweed is unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall, any significant revenue shortfall would likely have an immediate negative effect on its operating results. Moreover, Tumbleweed's operating results in one or more future quarters may fail to meet the expectations of securities analysts or investors due to any of a wide variety of factors, including fluctuations in financial ratios or other metrics used to measure Tumbleweed's performance. If this occurs, Tumbleweed would expect to experience an immediate and significant decline in the trading price of its stock.
A LIMITED NUMBER OF CUSTOMERS ACCOUNT FOR A HIGH PERCENTAGE OF TUMBLEWEED'S
REVENUE AND THE FAILURE TO MAINTAIN OR EXPAND THESE RELATIONSHIPS COULD
HARM ITS BUSINESS.
The loss of one or more of Tumbleweed's major customers, the failure to attract new customers on a timely basis, or a reduction in usage and revenue associated with the existing or proposed customers would harm its business and prospects. Five customers comprised approximately 18% of Tumbleweed's revenue in the first nine months of fiscal 2000, and 24% of its revenue in fiscal 1999. Tumbleweed expects that a small number of customers will continue to account for a substantial portion of its revenue for the foreseeable future.
TUMBLEWEED'S SERVICE PROVIDER CUSTOMERS MAY COMPETE WITH IT OR FAIL TO
PROMOTE ITS PRODUCT.
To date, Tumbleweed has generated a significant amount of Tumbleweed IME revenue from contracts with a limited number of service provider customers, which use or intend to use its products for the communication of third-party documents and data. If these customers do not effectively promote the use of Tumbleweed IME to their end-users, the adoption of Tumbleweed's services and the recognition of associated revenue could be limited. Because Tumbleweed's contracts with its service provider customers are non-exclusive, these customers could elect to offer competing secure online communication services to their customers through its existing or future competitors. The service provider customers also may compete with Tumbleweed's secure online communication services through their traditional physical delivery channels.
IF TUMBLEWEED DOES NOT SECURE KEY RELATIONSHIPS WITH ENTERPRISE CUSTOMERS,
ITS ACCESS TO BROADER MARKETS WILL BE LIMITED.
Tumbleweed's enterprise customers, which use or intend to use its products to intelligently manage the incoming and outgoing online communications of their enterprises, are a significant source of its revenue. A key aspect of Tumbleweed's strategy is to access target markets prior to adoption of alternative online distribution solutions by the larger participants in these markets. The failure to secure key relationships with new enterprise customers in targeted markets could limit or effectively preclude Tumbleweed's entry into these target markets, which would harm its business and prospects.
CUSTOMERS IN A PRELIMINARY PHASE OF IMPLEMENTING TUMBLEWEED'S PRODUCTS
MAY NOT PROCEED ON A TIMELY BASIS OR AT ALL.
Some of Tumbleweed's customers are currently in a pre-production or pre-launch stage of implementing its products and may encounter delays or other problems in introducing them. A customer's decision not to do so or a delay in implementation could result in a delay or loss in related revenue or otherwise harm Tumbleweed's businesses and prospects. Tumbleweed cannot predict when any customer that is currently in a pilot or preliminary phase will implement broader use of its services.
THE MARKETS FOR ENHANCED ONLINE COMMUNICATION SERVICES GENERALLY, AND FOR
TUMBLEWEED'S PRODUCTS SPECIFICALLY, ARE NEW AND MAY NOT DEVELOP.
The market for Tumbleweed's products and services is new and evolving rapidly. If the market for Tumbleweed's products and services fails to develop and grow, or if its products and services do not gain broad market acceptance, its business and prospects will be harmed. In particular, Tumbleweed's success will depend upon the adoption and use by current and potential customers and their end-users of secure online communication services. Tumbleweed's success will also depend upon acceptance of its technology as the standard for providing these services. The adoption and use of Tumbleweed's products and services will involve changes in the manner in which businesses have traditionally exchanged information. In addition, sales and marketing of Tumbleweed's products and services is to a large extent under the control of its customers. In some cases, Tumbleweed's customers have little experience with products, services and technology like those offered by us. Tumbleweed's ability to influence usage of its products and services by customers and end-users is limited. For example, the usage of Tumbleweed IME by the end-users of Tumbleweed's service provider customers has been limited to date. Tumbleweed has spent, and intends to continue to spend, considerable resources educating potential customers and their end-users about the value of its products and services. It is difficult to assess, or to predict with any assurance, the present and future size of the potential market for Tumbleweed's products and services, or its growth rate, if any. Moreover, Tumbleweed cannot predict whether its products and services will achieve any market acceptance. Tumbleweed's ability to achieve its goals also depends upon rapid market acceptance of future enhancements of its products and Tumbleweed's ability to identify new markets as they emerge. Any enhancement that is not favorably received by customers and end-users may not be profitable and, furthermore, could damage Tumbleweed's reputation or brand name. Any failure to identify and address new market opportunities could harm Tumbleweed's business and prospects.
THE MARKETS TUMBLEWEED ADDRESSES ARE HIGHLY COMPETITIVE AND RAPIDLY
CHANGING, AND IT MAY NOT BE ABLE TO COMPETE SUCCESSFULLY.
Tumbleweed may not be able to compete successfully against current and future competitors, and the multiple competitive pressures it faces could harm its business and prospects. For example, Tumbleweed IME is an alternative to traditional mail and courier delivery services, such as those offered by Federal Express Corporation, UPS or the U.S. Postal Service, and to general purpose e-mail applications and services. As such, Tumbleweed competes with these options. Tumbleweed's direct
competition mainly comes from other online communication service providers of various sizes, some of which have products that are intended to compete directly with our products. Examples of online communication service providers include Automatic Data Processing, Inc., Content Technologies (recently acquired by Baltimore Technologies plc), Elron Software, Inc., Entelagent Software, SRA International, Inc., Critical Path, Inc., VeriCert.com, e-Parcel, LLC, PostX Corporation and ZixIt Corporation. In addition, companies with which Tumbleweed does not presently directly compete may become competitors in the future, either through the expansion of their products and services or through their product development in the area of secure online communication services. These companies could include America Online, Inc./Netscape Communications Corporation, International Business Machines Corporation/Lotus Development Corporation, Microsoft Corporation and VeriSign, Inc. |
