RightNow Technologies 10-K 2005
Documents found in this filing:
Washington, D.C. 20549
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 000-31321
RIGHTNOW TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
40 ENTERPRISE BLVD, BOZEMAN, MONTANA 59718
(Address of principal executive offices) (Zip code)
(Registrants telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
The aggregate market value of common stock held by non-affiliates of the registrant as of June 30, 2004, the last business day of the registrants most recently completed second fiscal quarter, was approximately $19,402,978. Market value is based on the number of shares outstanding, on an as-converted basis, less shares held by officers, directors, and 10% or greater stockholders, multiplied by $7. The $7 per share market value was our initial public offering price on August 5, 2004.
The number of shares outstanding of the registrants common stock as of February 28, 2005 was 29,952,446.
DOCUMENTS INCORPORATED BY REFERENCE: None
RightNow Technologies, Inc.
Annual Report on Form 10-K
For The Fiscal Year Ended December 31, 2004
Table of Contents
All statements included or incorporated by reference in this report, other than statements or characterizations of historical fact, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on our current expectations, estimates and projections about our industry, managements beliefs, and certain assumptions made by us, all of which are subject to change. Forward-looking statements can often be identified by words such as anticipates, expects, intends, plans, predicts, believes, seeks, estimates, may, will, should, would, could, potential, continue, ongoing, similar expressions, and variations or negatives of these words, and include, but are not limited to, statements regarding projected results of operations, market acceptance and performance of our products, our ability to retain and hire key executives, sales and technical personnel and other employees in the numbers, with the capabilities, and at the compensation levels needed to implement our business and product plans, the competitive nature of and anticipated growth in our markets, our accounting estimates, assumptions and judgments, the impact of tax accounting elections, and managements future strategic plans. These forward-looking statements are not guarantees of future results and are subject to risks, uncertainties and assumptions that are difficult to predict and that could cause our actual results to differ materially and adversely from those expressed in any forward-looking statement. The risks and uncertainties referred to above include, but are not limited to, risks associated with our business model; our ability to develop or acquire, introduce, market and gain market acceptance for new products and enhancements to existing products in a cost-effective and timely manner; the gain or loss of key customers; competitive pressures and other factors such as the availability and pricing of competing products and technologies and the resulting effects on sales and pricing of our products; the rate at which our present and future customers adopt our existing and future products and services; our ability to expand operations; possible fluctuations in our operating results including our revenue mix and our rate of growth; interruptions or delays in our hosting operations; breaches of our security measures; our ability to expand, retain and motivate our employees and manage our growth; the impact of potential acquisitions, if any; and various other factors, some of which are described under the section below entitled Risk Factors at the end of Item 7 of this Report. These forward-looking statements speak only as of the date of this Report. We undertake no obligation to revise or update publicly any forward-looking statement for any reason.
We are a leading provider of on-demand software solutions for the customer relationship management, or CRM, market. We offer a broad suite of solutions to
address the customer service, sales and marketing requirements of large, medium and small enterprises. Our comprehensive customer service solution features a self-learning knowledgebase to ensure accurate and consistent interactions with customers. Our solution is designed to seamlessly support multiple communications channels, including web, interactive voice, e-mail, chat, telephone and proactive outbound e-mail communications, creating a comprehensive record of customer interactions. The information from these customer interactions can be leveraged with our recently released sales and marketing solutions to more accurately target marketing efforts and enhance revenue opportunities for our customers. We offer our solutions primarily through a multi-tenant, hosted on-demand model that reduces the cost and risk associated with deploying traditional enterprise CRM software. We provide value-added services such as business process optimization and product tune-ups throughout the lifecycle of our relationship with our clients. We currently have more than 1,200 active clients across various industries. In the year ended December 31, 2004, our on-demand clients serviced 502 million customer interactions directly through our customer service solutions, as compared to 249 million customer interactions in 2003.
In November 2004, we released RightNow 7.0, a broad suite of on demand CRM solutions for customer service, sales and marketing. RightNow 7.0 is comprised of three applications, with various add-on capabilities, built on a common base: RightNow Service, an award-winning multi-channel customer service and support application; RightNow Sales, a robust sales force automation application; and RightNow Marketing, a multi-channel marketing automation application.
We were incorporated in Montana in September 1995 and reincorporated in Delaware in August 2000. Our principal executive offices are located at 40 Enterprise Boulevard, Bozeman, Montana 59718-9300, and our telephone number is (406) 422-4200. We have branch offices in Dallas, TX, San Mateo, CA, and Princeton, NJ, and a liaison office in Tokyo, Japan. We also have subsidiary offices in London, England, and Sydney, Australia. In January 2005 we re-activated a subsidiary office in Munich, Germany. Our web site is located at http://www.rightnow.com. Information contained on, or that can be accessed through, our web site does not constitute a part of this report.
Products and Services
Our suite of CRM solutions is based upon a single application platform that is designed to be easy to implement, use and maintain, that supports multiple customer interaction points in a business operations, and that integrates seamlessly with traditional enterprise and/or back office applications. We also offer professional services to help our clients optimize the effectiveness of our solutions within their enterprise. Our solutions are available either on a hosted basis, where they are deployed in our co-location facilities and accessed on-demand by our clients, or on a non-hosted basis, where our clients deploy them in their own facilities. Our solutions are available in 14 languages.
RightNow Service is the flagship solution in our suite of customer service solutions and generates approximately 90% of our revenue. RightNow Service was first released in 1997 with new capabilities added in subsequent releases. At the core of RightNow Service is our self-learning knowledgebase, which provides a comprehensive and unified customer service solution across multiple customer interaction channels, including web, interactive voice, e-mail, chat and telephone. We have developed several proprietary approaches to knowledge management that enable our solution to automatically learn what information is important and relevant without requiring frequent manual intervention of a knowledge expert. In this manner, the knowledgebase structure and content is customer-driven and managed automatically as our solution is used. As a result, our clients are able to serve their customers more efficiently and quickly while providing increased customer satisfaction.
RightNow Service has the following capabilities that may be combined in a number of different configurations to address the specific business process needs of our clients, and all of which can be integrated with our clients other mission-critical enterprise applications:
Web Self-Service Portal. Our self-service capability enables our clients to offer a dynamically updated selection of information delivered to customers of our clients over the web. As customers interact with our solution, our proprietary knowledgebase technology automatically prioritizes and organizes answers in the knowledgebase to anticipate future customer questions. If customers are unable to find answers to their questions, they may submit their questions over the web, e-mail their questions, initiate a live chat with a customer service representative, or CSR, or request a telephone callback from a CSR.
RightNow Voice. Our voice self-service interface allows customers of our clients with the RightNow Service knowledgebase to offer telephone self-service using the same knowledgebase as is used by the web self-service feature. This application uses proprietary technology to provide callers access to frequently asked questions and keyword searching through speech recognition.
Web-Site Search. This feature allows customers accessing the search capability through the Web Portal to receive content from specified portions of a companys Internet or intranet sites. These results are presented along with knowledgebase content.
Intelligent Agent Desktop. The Intelligent Agent Desktop is our CSR interface into RightNow Service. Agents may create, review or update incidents and customer data received via phone, email, or Web Portal, as well as information from other systems through internet-based access. This component provides, within an Internet web browser-based interface, a configurable view of the CSR work queue, all information associated with an inquiry, including a complete interaction history for the inquiry and
customer information specified by our clients business process, as well as information on the organization and individual requesting service, including prior service history. In addition the CSR receives access to the knowledge base, and routing rules to provide a complete call center and email response management solution.
Offer Advisor. The Offer Advisor allows CSRs to present additional suggestions to customers for revenue generation or service quality. Offers may be determined either by rules and/or through our real-time knowledgebase assessment of customer information. Should the agent select an offer, the tool provides a short script to assist the agent in presenting the offer to the customer.
Computer Telephony Integration (CTI) Toolbar. This element of the solution allows CSRs to pick up telephone calls, transfer, conference and dial out within the desktop.
Chat and Collaboration. Our solution allows a customer to chat live (online) or co-browse with CSRs, by request or through automatic escalation. Support staff can push web pages to a visitor within a dialogue as well as escort users though a website and complete web forms for the customer.
Closed-Incident Metrics. This capability provides CSRs with the ability to conduct surveys following closed incidents to track resolution and satisfaction.
RightNow Sales is an integral component of our suite of CRM solutions, and was released in November 2004. The solution automates the sales process functions as well as leverages the information from customer service interactions captured in RightNow Service to drive revenue opportunities for our clients. RightNow Sales has the following modules that can be purchased individually or in combination to enhance sales productivity for our clients.
Sales Force Automation (SFA) Desktop. The SFA desktop is our sales professional interface into the solution. Using this interface, sales professionals may: manage contacts, accounts and opportunities; create and manage sales forecasts; plan, manage and execute sales strategies; create and send quotes; and review service or marketing activities with that customer. The interface includes configurable dashboards, or computer screen presentations, so key opportunity, account and task information is readily accessible, allowing quick views of relevant information, such as in-quarter opportunities, and simultaneous views of specific opportunity details.
RightNow Locator. RightNow Locator is an Internet-based location finder solution that provides online consumers with maps, driving directions, contact information and other location specific information to facilitate offline transaction completion at a retailers physical store.
RightNow Metrics. RightNow Metrics is a survey and measurement tool that allows businesses to design and disseminate custom surveys to external and internal parties to gather information for business decisions and to measure service quality. All survey responses are automatically tabulated and graphed and can then be used by businesses to measure performance, measure reaction to new or improved products, services and programs, identify product and service enhancements, or collect market intelligence on customer demographics
RightNow Analytics incorporates a sophisticated real-time management report capability that is fully integrated across multiple customer interaction channels to all easy tracking, reporting and analysis. A flexible user interface offers standard reports, the ability to modify the standard reports, create new reports, create exception-based notification alerts, and customize dashboard presentations. RightNow Analytics also provides robust output options such as Adobe Acrobat (.pdf) formatted reports, and graphical displays with drilldown capability to enable views of the underlying data. RightNow Analytics is currently included with the RightNow Service, Sales and Marketing modules.
Hosting Services and Technical Support
Our products are available on a hosted basis or can be implemented and maintained by our clients in their own facilities. Our products have been specifically designed to be installed in a hosted fashion in order to minimize implementation requirements and reduce cost of ownership and support. Our Hosting Management System, or HMS, enables businesses to monitor and manage their hosted CRM application. Through HMS, we are able to provide our clients individual control of their site within our hosted environment, including the ability to reliably manage and control their individual upgrade process for new software versions. HMS automatically handles upgrades without RightNow system administrator involvement which has allowed us to efficiently and effectively manage thousands of instances of our solution in our hosted environment. Our Hosting Operations Group manages the online delivery of our software, including designing and testing the architecture, establishing and maintaining security policies, constant monitoring of the data center operations and maintaining and upgrading the HMS.
We serve our clients from two, geographically separate, third-party, hosting co-location facilities located on the East and West coasts of the United States, and a third disaster recovery facility in Montana. Within the East and West coast facilities we operate four independent pods to manage time-zone specific maintenance for customers in Europe, Asia Pacific and North America. We contract with AT&T and SAVVIS Communications Corporation which provide the co-location facilities on the East and West coasts of the United States, respectively. Under the terms of our arrangements, AT&T and SAVVIS provide the physical space and security, access to the Internet and professional services as requested. We own and operate the hardware and software on which our applications run in the co-location facilities. Our agreements were entered into with one to two year terms with fees payable monthly. One contract expires in 2005 and the other in 2006, at which time we will seek to renew the contracts on comparable terms. The two co-location facilities are designed to withstand earthquakes and are supported by on-site backup generators in the event of power failures. To facilitate loss recovery, we operate a multi-tiered system configuration with load balanced web server pools, replicated database servers and fault tolerant storage devices. We perform both real-time and nightly backups, and maintain multiple backups. Every hosted site is secured by redundant firewalls, constant monitoring and physically secured buildings with cameras, recorded tapes, biometric access screening, escort-controlled access, intrusion detection systems and guards.
Our multi-tenant architecture is capable of supporting many different versions of our solution running on the same system and database server. In multi-tenancy, security is of critical importance. We ensure the security of our clients implementation by using separate data stores for each client and operating system level controls to ensure that one client cannot gain access to anothers data.
Our Technical Support Group assists our clients with upgrades and troubleshooting, and promotes client self-sufficiency. The Japanese market is supported
through a partner located in Japan. Certain European partners provide first level technical support for their markets.
Additionally, we have developed a proprietary business activity monitoring system called the Customer Success Index. Key vital signs of our clients customer service operations are monitored daily and translated into a 0-100 score. These scores are made available to all members of our support and sales organizations to monitor the on-going success of every customers use of our solution.
Our Professional Services Group provides consulting, education and development services. The groups consultants, trainers, project managers and application engineers help our clients achieve significant business benefit from our solution through a process of guided discovery, rapid prototyping, testing and deployment. By complementing our clients project team with our product experts, we are able to quickly move our solutions into production, allowing our clients to see a faster return on their investment. Our average deployment timeframe is 50 days.
We offer consulting and implementation services to our clients to facilitate the adoption of our products and solutions. We also provide tune-up services to our clients which consist of an audit of their solution against our library of best practices. We score each one of our client sites on how well they take advantage of our best practices and then make recommendations on which best practices (specific to their solution) they should implement to improve their performance. Our education program consists of a variety of traditional classroom, computer-based and remote education tailored to our clients needs. We also offer customization services that allow our clients to tailor our application to meet their unique business needs through the use of our XML (extensible markup language) APIs (application programming interfaces), and custom tabs. These functions use common web services standards to integrate with other applications, including customer relationship management, enterprise resource planning, computer telephony integration, system configuration management and e-commerce applications.
Sales and Marketing
We sell our products primarily through our direct sales organization and to a lesser extent through indirect channels. Our direct sales organization is separated into new business and installed base sales groups. In our new business sales group, we employ personnel to make initial calls to potential clients and qualify client leads, and direct sales representatives to close sales with clients and arrange client support. Our installed base sales organization focuses on managing existing client relationships, further penetrating those relationships and cross-selling and up-selling into those relationships. We currently have regional field operations offices in Montana, Texas, California, New Jersey, England, Australia, and Germany, and a sales liaison office in Japan. See Note 1(c) of Notes to Consolidated Financial Statements for more information regarding our geographic areas.
We offer pilot programs whereby a prospective client can deploy our full solution suite to either a test group or their entire customer base to ensure our solutions meet their needs prior to committing to any license fees. A pilot program typically lasts 30 to 60 days. The prospective clients objectives are quantified and results measured during the period. As a result of this program, we believe we have experienced shorter sales cycles, higher closure rates and larger deal sizes.
Our indirect channels consist primarily of relationships with resellers of our solutions. At December 31, 2004, we had relationships with over 30 indirect channel distributors. Domestically, our indirect channel consists primarily of relationships with outsourcers and referral partners who refer leads to us. Outsourcers represent a developing indirect channel for our solutions that we intend to expand. We currently have relationships with several outsourcers, including Convergys, ICT and KPN/SNT. We have dedicated staff in our sales organization calling on and servicing these partners. In the future, we intend to establish additional strategic relationships with vertical market distribution partners, telephony infrastructure partners, fulfillment partners and independent software vendor/original equipment manufacturing partners in adjacent markets. In international markets where we do not have a direct selling presence, we rely on system integrators and resellers to sell our solutions. This strategy is primarily employed in Europe, New Zealand and Asia. We intend to continue to broaden our distribution to the Japanese market through resellers. We also have partners in Europe, including Dimension Data, Siemens and Unisys who provide sales coverage for certain European countries. We intend to expand our European partner channel in countries where we do not have a local presence.
Our marketing department coordinates future product and service direction, manages generation of client leads, and manages public and industry analyst relations. We also have developed and will continue to expand innovative marketing initiatives to expand our client base, such as our client roundtables, where existing clients host forums with potential clients and exchange ideas about customer service best practices.
As of December 31, 2004, we had more than 1,200 active clients in various industries, including technology, financial and insurance, consumer products, telecommunications and travel and hospitality, as well as government agencies and educational institutions. For the year ended December 31, 2004, approximately 39% of our revenue was generated from entities with over $1 billion in annual revenue, 47% of our revenue was generated from entities with less than $1 billion in annual revenue and 14% of our revenue was generated from government/educational institutions. No single client accounted for more than 5% of our revenue in the year ended December 31, 2004.
Product Development and Technology
Our product development efforts are focused on improving and enhancing our existing solutions and service offerings as well as developing new proprietary technology. Our product development philosophy incorporates our long-term strategic view of our market and incorporates customer feedback to improve and enhance our products. We currently are developing products and solutions to broaden our offerings within customer service and other segments of the CRM market. We have an applied research group that focuses on knowledgebase, artificial intelligence and novel applications of current research for use within our solutions. Although we allow our clients to run multiple versions of our software, our development efforts are focused on the current and future releases of our products. Our research and development expenses totaled approximately $7.8 million in 2004, $5.9 million in 2003, and $4.1 million in 2002.
We believe we have significant technology expertise in developing and deploying highly scalable and reliable on-demand customer service applications. All of our products have been designed using industry standards for the Internet and are designed to meet the following goals: cost efficient deployment, highly configurable, scaleable, easily integrated, multi-tenant and capable of being internationalized. The following architectural components form the foundation for the delivery of a variety of features within our solution:
Self-learning Knowledgebase. Knowledgebase technologies are used within our solution to provide self-service and automatic e-mail response to users and as an automated assistant for our clients CSRs. Core technologies in the area of the knowledgebase include automatic learning and decay of the relevancy and relatedness of information, natural language processing, word-stemming algorithms, information clustering and classification algorithms, and information retrieval technologies.
Integration with Other Enterprise Applications. Our hosted and non-hosted clients are able to integrate our solution with their other mission-critical enterprise applications through several techniques, including: web services that provide a real-time, two-way, web-based XML (extended mark-up language) API (application program interface); application level triggers that raise real-time events to trigger integration actions with other systems; user interface custom tabs that allow the integration of other applications into our solution; and pass through authentication that allows our solution to inherit user credentials from other applications to identify and enforce access to our clients web sites. In addition, pre-packaged connectors are available for integration with other third-party applications.
User Interface. Although our user interface is based upon an industry standard Internet web browser, we have developed techniques to deliver a look and feel similar to the thick client user interfaces utilized in traditional client/server products. This includes support for functionality not normally associated with web browser interfaces such as
graphical drag and drop, cascading menus, and efficient pop-up dialogs. We also have addressed the typical performance concerns associated with browser-based applications by reducing visible page turns and their associated delays. Consequently, our clients benefit from the ease of administration and maintenance of a web application while still enjoying the user experience of a locally-installed desktop application.
Software Architecture. Our solution has been developed using a logical three-tier Internet architecture consisting of presentation, application logic and data management layers. Because of the tiered separation, our solution is highly scalable, allowing expansion at the presentation and application logic tiers and at the data management tier. We have experience deploying our solution in highly available, highly scalable, load-balanced web server and clustered database server configurations. We support most commonly available operating systems (Linux, Sun Solaris, Microsoft Windows Server) and databases (Oracle, Microsoft SQL Server, MySQL).
Our success depends to a significant degree upon the development and protection of our software and other proprietary technology rights. We believe we have a strong base of intellectual property. As of February 2005, our base of intellectual property included five issued and eight pending U.S. patents, three U.S. trademark registrations, five pending U.S. trademark application, ten foreign trademark registrations and one pending foreign trademark applications. The majority of our patent applications concern our knowledgebase technology, including processes relating to the relative usefulness ranking and the order of display of retrieved information in the knowledgebase; the ability of the knowledgebase to suggest related information to a user accessing the knowledgebase; and the ability of the knowledgebase to produce a relational map of help information items based on the historical usage patterns of customers accessing the knowledgebase.
The following is a summary of our issued US patents:
Implicit Rating of Retrieved Information in an Information Search System. This process relates to an information search and retrieval system through a network, such as the Internet, in which the relative usefulness ranking and the order of display of the retrieved information in the knowledgebase is adjusted based on actions taken by a user. This patent continues until April 2020.
Temporal Updates of Relevancy Rating of Retrieved Information in an Information Search System. This process relates to an information search and retrieval system through a network, such as the Internet, in which the relative usefulness ranking and the order of display of the retrieved information in the knowledgebase is adjusted based on the amount of time elapsed since the particular information was last accessed. This patent continues until April 2020.
Usage Based Strength between Related Information in an Information Retrieval System. This patent, which issued in January 2005, describes an information retrieval system in which information is displayed based on navigation behavior of previous users. This patent continues until January 2025.
System and Method for Generating a Dynamic Interface via a Communications Network. Our most recent patent, issued in February 2005, describes a system for dynamically adapting selections in an automatic phone support system. This invention enables the provision of information from a dynamic knowledgebase via a telephone channel. This patent continues until February 2025.
Display Screen for a Computer. This is a design patent relating to the user interface to our software. This patent continues until March 2016.
Our three registered trademarks in the United States are RIGHTNOW, RIGHTNOW TECHNOLOGIES (stylized) and SMARTASSISTANT. Each of these marks is important to RightNow Service. We use our RightNow mark as a descriptor of all of our products. These marks continue indefinitely subject to continuous use and payment of registration fees at the statutorily required intervals. We also use the following common law marks Locator, RightNow Metrics, RightNow Outbound, RightNow Marketing, RightNow Sales, RightNow Service, Top-Line, Proactive, SmartSense, SmartConversion, ProServices, RightNow Live, RightPractices, RightStart, Talk RightNow, and SmartAttribute Technology. Other trademarks, trade names or service marks appearing in this report are the property of their respective holders.
We also incorporate a number of third party software products into RightNow Service pursuant to relevant licenses. Some of the software is proprietary and some is open source. We use third party software for, among other things, spell checking certain foreign languages, improving graphics in our analytics module, language parsing, and locating and indexing documents on websites. These functions are peripheral in nature, we are not substantially dependent upon these third party software licenses and we believe the licensed software is generally replaceable, by either licensing or purchasing similar software from another vendor or building the software function ourselves.
The CRM software market consists of three separate market segments: (1) customer service, (2) sales force automation and (3) marketing automation. Within this segmentation, vendors are offering solutions through either on-demand or traditional on-premise delivery methods. We compete in all segments of the CRM software market, and believe that we are the leader in on-demand customer service within that market.
The market for CRM solutions is highly competitive and fragmented, and is subject to rapidly changing technology, shifting client requirements, frequent
introductions of new products and services, and increased marketing activities of other industry participants. Competition has increased with our release of RightNow 7.0. We expect the intensity of competition to increase in the future as existing competitors continue to develop their capabilities, as new companies enter our market and as we further expand into the CRM market.
We face competition from other companies currently providing customer service solutions, some of which offer hosted services, including Amdocs Limited, BMC Software Corporation, E.piphany, Inc., eGain Communications Corporation, FrontRange Solutions, Inc., IBM Corporation, Kana Software, Inc., Microsoft Corporation, Oracle Corporation, SAP AG, salesforce.com, inc. and Siebel Systems, Inc. We also expect to compete with these and other companies as we further expand into the CRM market, and as they and others expand into the customer service segment. In addition, our solutions compete with CRM systems that are developed and maintained internally by businesses, as well as CRM products or services that are developed, or bundled with other products or services, and installed on a clients premises by software vendors. We also face competition from outsourced contact center providers who bundle solutions and agent labor in their service offerings. To the extent our competitors have an existing relationship with a potential client, that client may be unwilling to switch vendors due to the time and financial commitments already made with our competitors.
Many of our current and potential competitors have longer operating histories and larger presence in the general CRM market, greater name recognition, access to larger customer bases and substantially greater financial, technical, sales and marketing, management, service, support and other resources than we have. As a result, such competitors may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or client requirements or devote greater resources to the promotion and sale of their products than we can. In addition, many of our current and potential competitors have established or may establish business, financial or strategic relationships among themselves or with existing or potential clients, alliance partners or other third parties, or may combine and consolidate to become more formidable competitors with better resources.
New companies are entering the CRM software market, the on-demand applications market and the on-demand CRM market, or expanding from any one of these markets to the others. We expect that new competitors, such as enterprise software vendors and online service providers that have traditionally focused on enterprise resource planning or back office applications, will continue to enter the on-demand CRM market with competing products as the on-demand CRM market develops and matures. It is possible that these new competitors could rapidly acquire significant market share.
We believe the principal factors that generally determine a companys competitive advantage in the on-demand customer service and broader CRM markets include the following:
Low total cost of ownership and easily demonstrable cost-effective benefits for clients;
Effectiveness in improving the quality of clients customer service departments;
Broad product functionality to meet complex client process requirements;
Ability to leverage information from customer interactions to more accurately target marketing efforts and enhance revenue opportunities;
Speed and ease of implementation;
Ease of use and associated high rates of utilization;
System performance, security, scalability, flexibility and reliability;
Ease of integration with existing applications and data;
Availability and quality of implementation, consulting and education services;
Quality of client care;
Competitive sales and marketing capabilities; and
Financial stability and reputation of the vendor.
We cannot assure you that we will be successful in all or any of these areas that we believe contribute to competitive advantage, or that we will be able to compete successfully against current or potential competitors, or that competition will not have a material adverse effect on our business, financial condition and results of operations.
As of December 31, 2004, we had 403 full-time employees. Of the total employees, we had 163 in sales and marketing, 88 in software development, 71 in professional services, 31 in technical support, 35 in finance and administration and 15 in hosting operations. None of our employees are represented by a labor union. We believe that our relationship with our employees is good.
Our corporate headquarters, including our principal administrative, marketing, technical support and research and development facilities, are located in Bozeman, Montana, where we lease approximately 30,000 square feet with a term that expires in March 2011, and approximately 13,000 square feet under two leases with terms that expire in March and April 2005. We expect to renew the leases that expire in March and April 2005 on similar terms. We plan to enter into a five-year lease for approximately 13,000 square feet of additional office space in Bozeman, Montana, that will be available in mid-2005. We also currently occupy a number of domestic and international sales and service offices in California, New Jersey, Texas, Australia, Japan and the United Kingdom, where we lease an aggregate of approximately 29,000 square feet under multiple leases, which have terms that expire between November 2005 and March 2011. We believe that our current facilities are suitable and adequate to meet our current needs, and that suitable additional or substitute space will be available as needed to accommodate expansion of our operations. See Note 9(a) to the Consolidated Financial Statements and Managements Discussion and Analysis of Financial Condition and Results of OperationsContractual Obligations and Commitments for information regarding our lease obligations.
From time to time, we are involved in legal proceedings arising in the ordinary course of business. We believe that the resolution of these matters will not have a material effect on our consolidated financial position, results of operations or liquidity.
No matters were submitted to a vote of security holders during the fourth quarter of 2004.
Item 5. Market for Registrants Common Equity, Related Stockholder Matters, and Issuer Purchases of Securities
Our common stock is traded on the Nasdaq National Market under the symbol RNOW. The table below reflects the quarterly high and low per share sales prices of our common stock for the period August 5, 2004, the first day of public trading of our common stock, through December 31, 2004, as reported by the Nasdaq National Market. These prices represent prices among dealers, do not include retail markups, markdowns or commissions, and may not represent actual transactions. Prior to August 5, 2004, there was no established public trading market for our common stock.
On February 14, 2005, there were approximately 250 holders of record of our common stock.
We have never declared or paid cash dividends on our capital stock since converting from an S corporation to a C corporation at the end of 1999. We currently intend to retain future earnings, if any, to finance the growth and development of our business, and therefore do not anticipate paying any cash dividends in the foreseeable future. Furthermore, our bank credit facility with our secured lender currently prohibits us from paying cash dividends on our common stock without the banks prior written consent.
Unregistered Sales of Equity Securities
Use of Proceeds from Sales of Registered Securities
In August 2004, we completed the initial public offering of our common stock, par value $0.001 per share. The managing underwriters in the offering were Morgan Stanley & Co. Incorporated, Thomas Weisel Partners LLC, Adams Harkness and D.A. Davidson & Co. The shares of common stock sold in the offering were registered under the Securities Act of 1933, as amended, on a Registration Statement on Form S-1 (Reg. File No. 333-115331) that was declared effective by the Securities and Exchange Commission on August 5, 2004.
The offering commenced on August 5, 2004. Under the registration statement, we registered 7,245,000 shares of common stock, including shares subject to the underwriters over-allotment option, on behalf of RightNow and a selling stockholder, for an aggregate offering price of $50,715,000 and a per share price to the public of $7.00. Of the total shares registered, 6,416,961 shares, including shares sold upon exercise of the underwriters over-allotment option, were sold by us for an aggregate offering price of $44,918,727 and a per share price to the public of $7.00, and 321,945 shares, including shares sold upon exercise of the underwriters over-allotment option, were sold by the selling stockholder for an aggregate offering price of $2,253,615 and a per share price to the public of $7.00. The offering terminated following the sale of the shares described above.
In connection with the offering of the shares sold by us, we paid an aggregate of $3.3 million in underwriting discounts and commissions to the underwriters. In addition, the following table sets forth the costs and expenses, other than underwriting discounts and commissions, incurred by us in connection with the offering, including the shares offered by the selling stockholder (in thousands).
After deducting the underwriting discounts and commissions and the estimated offering expenses described above, we received net proceeds from the offering of approximately $40 million. We did not receive any proceeds from the sale of shares by the selling stockholder. We currently intend to use the offering net proceeds for general corporate purposes as described in the prospectus for the offering. We are currently assessing the specific uses and allocations for these net proceeds. Pending these uses, the net proceeds from the offering are invested in short-term, interest-bearing, investment-grade
securities. None of the expenses and none of our net proceeds from the offering were paid directly or indirectly to any director, officer, general partner of RightNow or their associates, persons owning 10% or more of any class of equity securities of RightNow, or an affiliate of RightNow.
Purchases of Equity Securities by the Issuer or Affiliated Purchasers
We did not repurchase any of our common stock in the fourth quarter of 2004.
The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and Notes thereto and with Managements Discussion and Analysis of Financial Condition and Results of Operations and other financial data included elsewhere in this report. The consolidated statement of operations data for the years ended December 31, 2004, 2003 and 2002, and the consolidated balance sheet data at December 31, 2004 and 2003 are derived from audited consolidated financial statements included elsewhere in this report. The consolidated statement of operations data for the years ended December 31, 2001 and 2000, and the consolidated balance sheet data at December 31, 2002, 2001 and 2000 are derived from audited consolidated financial statements not included in this report. The historical results are not necessarily indicative of results to be expected in any future period.
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation of the calculation of basic and diluted earnings (loss) per share and for an explanation of the determination of the number of weighted average shares used for such calculations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Selected Consolidated Financial Data and our financial statements and related notes appearing elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those projected in the forward-looking statements as a result of certain factors, including those discussed in Risk Factors, Business and elsewhere in this report. We assume no obligation to update the forward-looking statements or such factors.
We are a leading provider of on-demand software solutions for the customer relationship management market. We offer a broad suite of solutions to address the customer service, sales and marketing requirements of large, medium and small enterprises.
We released our initial version of RightNow Service in 1997. This product addressed the new customer service needs resulting from the increasing use of the Internet as a customer service channel. Since then, we have significantly enhanced product features and functionality to address customer service needs across multiple communication channels, including web, interactive voice, e-mail, chat, telephone and proactive outbound e-mail communications. We have also added several products complementary to our RightNow Service solution, including RightNow Metrics and RightNow Locator. In 2003, we introduced an e-mail marketing automation solution, RightNow Outbound. In October 2004, we introduced RightNow CRM 7.0, an integrated solution for customer service, sales and marketing organizations. To date more than 90% of our revenue has been generated by RightNow Service.
Our client base currently consists of more than 1,200 active clients who in the year ended December 31, 2004 served more than 500 million customer interactions, or unique sessions hosted by our solutions. Our solutions, whether sold pursuant to term or perpetual licenses, are available either on a hosted basis, where they are deployed in our co-location facilities and accessed on demand by our clients, or on a non-hosted basis, where our clients deploy them in their own facilities. The percentage of our clients electing the hosted option was approximately 87% at December 31, 2004, an increase from approximately 50% at December 31, 1999.
We distribute our solutions primarily through direct sales efforts and to a lesser extent through indirect channels.
Sources of Revenue
Our revenue is comprised of fees for term and perpetual licenses of our software, fees for hosting and support related to our licenses, and fees for professional services. Our term license agreements, which are generally two years in length but can range from six months to four years, include our software and related upgrades, hosting and support for the term of the agreement. The majority of our revenue in each of our last three years was derived from two-year term license agreements. We also offer monthly term license agreements that contain a minimum commitment period of at least 12 months and include our software and related upgrades, hosting and support. Perpetual licenses are typically sold with annual maintenance contracts that include upgrades, hosting and support.
Hosting and support agreements provide maintenance and management of our software at a third party facility, technical support for our software products, and unspecified product upgrades on a when and if available basis.
Professional services revenue is comprised of revenue from consulting, education and development services, and reimbursement of related travel costs. Consulting and education services include implementation and best practices consulting. Development services include customizations and integrations for a clients specific business application.
Our software license agreements include capacity-based fees, which are measured primarily by web pages served and user seats, and certain fixed fees. A number of our agreements provide for additional fees for usage above established levels, which are billed and recognized into revenue when earned.
Professional services, consisting of consulting, education and development services, are sold with initial license agreements and periodically over the client engagement. The average deployment time for our clients is 50 days. We typically invoice clients for the entire amount at the beginning of the agreement with payment generally due within 30 days for our term and perpetual license agreements, or due monthly for our monthly agreements. Our typical education courses are billed on a per person, per class basis.
Depending on the size and complexity of the client project, our consulting or development services contracts are either fixed price/fixed scope or, less frequently, billed on a time and materials basis. We have determined that the professional services element of our software arrangements is not essential to the functionality of the software. We have also determined that our professional services: a) are available from other vendors; b) do not involve a significant degree of risk or unique acceptance criteria; and c) qualify for separate accounting as we have sufficient experience in providing such services.
Cost of Revenue and Operating Expenses
Cost of Revenue. Cost of revenue consists primarily of salaries and related expenses for our hosting, support and professional services organizations, third-party costs and equipment depreciation relating to our hosting services, third-party costs for interactive voice self-service applications, travel expenses related to providing professional services to our clients, amortization of acquired intangible assets and allocated overhead. We allocate most overhead expenses, such as office supplies, computer supplies, utilities, rent, depreciation for furniture and equipment, payroll taxes and employee benefits, based on headcount. As a result, overhead expenses are reflected in each cost of revenue and operating expense category.
Our hosting costs are affected by the percentage of clients who license our products on a hosted basis and the number of times our clients and their customers use our solutions, which we refer to as customer interactions. As a result of economies of scale in our hosting infrastructure and declines in computer hardware and telecommunications costs, we were able to reduce hosting costs as a percentage of total revenue in 2002, 2003 and 2004, despite significant increases in the number of hosted clients and the level of customer interactions.
As our client base and solutions usage grows, we intend to continue to invest additional resources in our hosting services, technical support and professional services. We expect our professional services costs to increase in absolute dollars as we increase our professional services as a percentage of total revenue. Because cost as a percentage of revenue is higher for professional services revenue than for software, hosting and support revenue, an increase in professional services as a percentage of total revenue reduces gross profit as a percentage of total revenue. During 2002, 2003 and 2004, increases in gross profit as a percentage of total revenue resulting from economies of scale in hosting and technical support were partially offset by increases in professional services as a percentage of total revenue.
Sales and Marketing Expenses. Sales and marketing expenses consist primarily of salaries and related expenses for employees in sales and marketing, including commissions and bonuses, advertising, marketing events, corporate communications, product management expenses, travel costs and allocated overhead. We expense our sales commissions at the time the related sale is invoiced to the client and we recognize the majority of our revenue from our agreements ratably over the terms of the licenses. Accordingly, we generally experience a delay between increasing sales and marketing expenses and the recognition of
corresponding revenue. We expect significant increases in sales and marketing expenses in absolute dollars as we hire additional sales and marketing personnel and increase the level of marketing activities.
Research and Development Expenses. Research and development expenses consist primarily of salary and related expenses for development personnel and costs related to the development of new products, enhancement of existing products, translation fees, quality assurance, testing and allocated overhead. To date, we have not capitalized any software development costs because the timing of the commercial releases of our products has substantially coincided with the attainment of technological feasibility. As a result, research and development costs have been expensed as incurred. We intend to continue to expand and enhance our product offerings. To accomplish this, we plan to hire additional personnel and, from time to time, contract with third parties. We expect that research and development expenses will increase in absolute dollars as we seek to expand our technology and product offerings.
General and Administrative Expenses. General and administrative expenses consist primarily of salary and related expenses for management, finance and accounting, legal, information systems and human resources personnel, professional fees, other corporate expenses and allocated overhead. We expect that general and administrative expenses will increase as we continue to add personnel in connection with the growth of our business. We anticipate that we will also incur additional employee salaries and related expenses, professional service fees and insurance costs related to the growth of our business and compliance with the requirements of a public company.
Critical Accounting Policies and Estimates
Our financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These assumptions are affected by managements application of accounting policies. Our critical accounting policies include: revenue recognition; valuation of receivables and deferred tax assets; and accounting for equity-based compensation.
We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our consolidated financial statements:
Software, hosting and support revenue is comprised of fees from term and perpetual licenses of the Companys software, hosting and support. To date we have not entered into an arrangement solely for the license of products and, therefore we have not demonstrated vendor specific objective evidence, or VSOE, of fair value of the license element. Consequently, we recognize revenue for the fees associated with the term license and the related hosting and support ratably over the term of the agreement, which is generally two years, but can range between six months and four years. We have established VSOE for the annual hosting and support elements sold with each perpetual license based on the price paid when sold separately. Accordingly, we recognize revenue for each perpetual license using the residual method in accordance with Statement of Position (SOP) 98-9, Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain Transactions.
We begin to recognize revenue from the licensing, hosting and support of our products when all the following criteria are met: a) we have entered into a legally binding agreement with the client; b) our products and services have been delivered or made available to the client; c) our fee for providing the products and services is determinable; and d) we believe collection of our fee is reasonably probable.
Amounts that have been invoiced to clients are recorded to accounts or term receivables and deferred revenue. Deferred revenue is then recognized into revenue when earned.
Valuation of Receivables
We regularly assess the collectibility of outstanding customer invoices and, in so doing, we maintain an allowance for estimated losses resulting from the non-collection of customer receivables. In estimating this allowance, we consider factors such as: historical collection experience; a customers current creditworthiness; customer concentration; age of the receivable balance; and general economic conditions that may affect a customers ability to pay. Actual customer collections could differ from our estimates and exceed our related loss allowance.
We record income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. When applicable, a valuation allowance is established to reduce any deferred tax asset when it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.
We have established a valuation allowance equal to the net deferred tax asset due to uncertainties regarding the realization of our net operating loss carryforwards, tax credits, and deductible timing differences. The uncertainty of realizing these tax benefits is based primarily on our lack of historical earnings.
We account for our employee stock-based compensation using the intrinsic value method in accordance with Accounting Principles Board Option, or APB, No. 25, Accounting for Stock Issued to Employees, and we make pro forma disclosure regarding employee stock-based compensation using the fair value method in accordance with Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation Transition and Disclosure. We account for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force, or EITF No. 96-18, Accounting for Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.
In measuring the cost of equity-based compensation, we make assumptions regarding our stock price volatility and the average expected life of our outstanding stock options. Our assumptions are based on historical information, some of which was developed when we were a private company. Actual results could differ from our assumptions.
Recently Issued Accounting Standards
In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123R (SFAS 123R), Share-Based Payment, which replaces SFAS 123 and supersedes Accounting Principles Board Opinion No. 25. Public companies are required to apply 123R as of the first interim or annual reporting period that begins after June 15, 2005. 123R covers a wide range of share-based compensation, including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. The statement requires the recognition of compensation cost related to share-based payment plans to be recognized in financial statements based on the fair value of the equity or liability instruments issued. We expect adoption of the provisions of 123R beginning in our third fiscal quarter ending September 30, 2005 will
materially and adversely affect our reported results of operations because the stock-based compensation expense will be charged directly against our reported earnings. We do not expect the accounting change to materially affect our liquidity because equity-based compensation is a non-cash expense.
Results of Operations
The following table sets forth certain consolidated statements of operations data for each of the periods indicated, expressed as a percentage of total revenue:
Overview of 2004 and Outlook
Years Ended December 31, 2002, 2003 and 2004
Total revenue for 2004 was $61.8 million, an increase of $25.9 million, or 72%, over total revenue of $35.9 million for 2003.
Software, hosting and support revenue for 2004 was $49.8 million, an increase of $20.5 million or 70% over software, hosting and support revenue of $29.3 million for 2003. The revenue growth resulted from a 46% increase in revenue per client, combined with a 16% increase in average number of clients. Recurring revenue per client increased 30% in 2004 over 2003 due to contract upgrades and renewals, and the release of new products in late 2003. Client interactions, a measure of the volume of unique sessions hosted by our software, grew more than 100% in 2004 over 2003. Growth in average number of clients occurred primarily from emphasis within our sales organization on new client acquisition. We had 1,232 active clients at December 31, 2004 compared to 1,036 active clients at December 31, 2003.
Perpetual software license revenue in the second, third and fourth quarters of 2004 ranged from 21% to 26% of total revenue as compared to a range of 12% to 18% of total revenue in prior quarters. As a result, perpetual software license revenue in 2004 increased to 22% of total revenue as compared to 15% in 2003. The mix of perpetual license revenue may affect our profitability in any given period since it is recorded into revenue in full upon delivery instead of being ratably recognized into revenue over time, as is the case with term licenses. We believe perpetual license revenue increased in 2004 because of the growing strategic importance of our products in client organizations, and also because our client planning horizons have lengthened.
Professional services revenue increased 82% to $12 million in 2004 from $6.6 million in 2003. Average professional services revenue per client increased 57% in 2004 over 2003, while average number of clients increased 16%. Revenue per client increased in 2004 largely as a result of our focus on expanding service offerings provided in conjunction with the broader product offerings. We increased our professional services staff to 71 employees at December 31, 2004 from 41 employees at December 31, 2003.
The mix of professional services revenue also affects our profitability from period-to-period due to the lower gross profit earned on professional services as compared to the gross profit earned on software, hosting and support revenue. We expect professional services revenue to gradually increase as a percent of total revenue in 2005 from our emphasis on providing, and anticipated client demand for, best practice consulting services.
Revenue from European customers grew to $12.8 million in 2004 from $6.5 million in 2003, and revenue from Asia Pacific clients grew to $3.8 million in 2004 from $2.3 million in 2003. Total revenue outside the United States was 27% of total revenue in 2004 and 24% of total revenue in 2003. The increase in revenue outside the United States occurred primarily from expansion of our international sales and marketing activities.
Total revenue for 2003 was $35.9 million, an increase of $9 million, or 33%, over total revenue of $26.9 million for 2002.
Software, hosting and support revenue for 2003 was $29.3 million, an increase of $6 million or 26% over software, hosting and support revenue of $23.3 million for 2002. The increase resulted from a 35% increase in revenue per client, partially offset by a 7% decrease in average number of clients. The increase in revenue per client was primarily due to our emphasis on deploying our solution broadly within the client organization as evidenced by an increase in customer interactions. The decrease in average number of clients was primarily due to our emphasis within the sales organization on existing client relationships instead of new client acquisition. We had 1,036 active clients at December 31, 2003 compared to 953 active clients at December 31, 2002. During 2003, term licenses accounted for 67% of our total revenue, as compared to 74% of our total revenue in 2002. Perpetual software license revenue was 15% of total revenue in 2003 as compared to 13% of total revenue in 2002.
Professional services revenue for 2003 was $6.6 million or 18% of total revenue, an increase of $3.0 million or 82% over professional service revenue of $3.6 million for 2002, which was 13% of total revenue. The increase resulted from a 96% increase in professional services revenue per client, partially offset by a 7% decrease in average number of clients. The increase in professional services revenue per client is primarily due to an increase in service offerings for deployment over the lifecycle of the client engagement.
Revenue in Europe and Asia Pacific for the year ended December 31, 2003 was $8.7 million or 24% of total revenue for the year, compared to $5.0 million or 19% of total revenue in 2002. The increase in revenue outside of the United States resulted from expansion of our international sales and marketing activities.
Cost of Revenue
Total cost of revenue for 2004 was $13.9 million, an increase of $4.9 million, or 55%, over total cost of revenue of $9.0 million for 2003.
The cost of software, hosting and support increased 28% to $6.7 million in 2004 from $5.3 million in 2003. The growth in costs was driven by staff additions which increased salaries and related employee costs by $473,000, higher third-party hosting service costs of $316,000, increased equipment depreciation and amortization expenses of $261,000, and incremental third-party costs of security monitoring and interactive voice self-service of $245,000. The average employee count in our hosting and support operations was 43 in 2004 as compared to 34 in 2003. As a percent of the associated revenue, cost of software, hosting and support declined to 14% in 2004 from 18% in 2003, primarily due to economies of scale achieved in providing hosting and support services over a broader base of customers. We increased our hosting capacity with the completion of our Asia Pacific and Europe/Middle-East/Asia pods within our existing data centers in California and New Jersey in 2004.
Professional services costs increased 93% to $7.2 million in 2004 from $3.7 million in 2003 mostly due to growth in professional services staff. We had, on average, 51 employees in our professional services group in 2004 as compared to 32 employees in 2003. The employee growth added approximately $2.6 million in salaries and related expenses and approximately $715,000 in additional travel and living expenses. Professional services costs increased to 60% of the associated revenue in 2004 from 57% in 2003, due to internal requirements for training and education and customer scheduling requirements. We plan to further expand our professional services organization and these costs may continue to vary as a percentage of professional services revenue in the future.
The total cost of revenue for 2003 was $9.0 million, an increase of $2.6 million, or 40%, over total cost of revenue of $6.4 million for 2002.
The cost of revenue for software, hosting and support in 2003 was $5.3 million, an increase of $984,000 or 23%, over the cost of such revenue of $4.3 million in 2002. Cost of revenue for software, hosting and support increased in absolute dollars largely due to increased expenses required to support additional clients and significantly higher levels of our clients customer interactions. Incremental 2003 expenses included salaries and related costs of $471,000, depreciation and amortization expenses of $282,000 and third party services of $131,000. Cost of revenue declined for software hosting and support slightly as a percentage of total revenue to 15% in 2003 from 16% in 2002 as a result of economies of scale in hosting and technical support. Average employee count in hosting and support was 34 in 2003 and 29 in 2002.
The cost of revenue for professional services in 2003 was $3.7 million, an increase of $1.6 million, or 73%, over the cost of such revenue of $2.2 million in 2002. This increase was attributable to an increase in professional services staff to support expanded service offerings. Incremental expenses included salaries and related costs of $1.4 million and travel costs of $248,000. Average employee count in our professional services group was 32 in 2003 compared to 21 in 2002.
Sales and Marketing Expenses
Sales and marketing expenses of $32 million in 2004 were 54%, or $11.2 million, greater than expenses of $20.8 million in 2003 mostly due to employee additions. We had, on average, 147 employees in our sales and marketing organization in 2004 compared to 113 in 2003. The employee growth added approximately $5.3 million in salaries and related expenses, and $782,000 in travel and living expenses. In addition, sales incentive costs increased by $4.6 million in 2004 over 2003 from higher sales volume.
Sales and marketing expenses for 2003 were $20.8 million, an increase of $4.9 million or 31% over sales and marketing expenses of $15.9 million in 2002. Approximately $2.6 million of this increase was due to higher salaries and related costs due to the addition of 25 full-time sales and marketing employees in 2003. Sales and marketing expenses also included higher commission expense of $1.2 million associated with the higher sales, and an increase of $525,000 in public relations and client outreach programs. Average employee count in our sales and marketing organization was 113 in 2003 and 102 in 2002.
Research and development expenses in 2004 were $7.8 million, an increase of $1.9 million or 32% more than costs of $5.9 million in 2003. We added 22 employees to our research and development staff during 2004, which increased salaries and related expenses by approximately $1.5 million. We also incurred higher third-party development costs for language translations and technical manuals. Average employee count in our research and development group was 79 in 2004 as compared to 64 in 2003.
Research and development expenses in 2003 were $5.9 million, an increase of $1.8 million or 44% over research and development expenses of $4.1 million in 2002. The increase in research and development expenses was due to additional salaries and related costs as we increased the number of our research and development employees in order to expand and deepen our software offerings. Average employee count in our research and development group was 64 in 2003 compared to 45 in 2002.
General and Administrative Expenses
General and administrative expenses increased $1.1 million, or 31%, to $4.6 million in 2004 from $3.5 million in 2003. Employee additions to our general and administrative group added $609,000 of salaries and related expenses during the year, while legal and other third-party fees added $450,000. The increase in legal and other professional services was due to fees to obtain technology and patent licenses and the compliance requirements of being a public company. Average employee count in our general and administrative group was 31 in 2004 as compared to 24 in 2003.
General and administrative expenses for 2003 were $3.5 million, an increase of $676,000 or 24% over general and administrative expenses of $2.8 million for 2002. The absolute dollar increase was largely due to a $302,000 increase in salaries and related expenses to support our business growth, and a $214,000 increase in legal fees related to obtaining technology licenses and patent rights. Average employee count in our general and administrative group was 24 in 2003 compared to 22 in 2002.
Interest and Other Income (Expense), Net
Net interest and other income was $146,000 in 2004 as compared to net interest expense of ($215,000) in 2003. Interest income grew to $390,000 in 2004 mostly due to the investment of proceeds from our
initial public offering in short-term, interest-earning securities. Interest expense declined in 2004 to ($249,000) mostly due to the full pay down of debt balances during the year.
Net interest and other expense was ($215,000) in 2003, a decrease in expense of $142,000 or 40% from ($357,000) in 2002. This decrease resulted primarily from reducing debt principal balances by $2.4 million during 2003.
Provision for Income Taxes
The provision for income taxes of ($100,000) in 2004 was approximately 3% of pre-tax income, and consisted of foreign tax withholdings, federal and state alternative minimum taxes, and state minimum taxes paid. Our 2004 effective income tax rate was lower than the statutory rate primarily due to the utilization of net operating loss carry forwards. Our effective tax rate in 2005 will depend on a number of factors, such as the amount of stock compensation expense to be recorded in the latter part of the year under SFAS 123R, the level of business in state and foreign tax jurisdictions, managements expectation of the realization of deferred tax assets and the associated valuation allowance, and other factors.
In filing our 2003 U.S. Federal income tax return in September 2004, we elected to change our method of tax accounting as it relates to prepaid revenues, in accordance with the provisions of Internal Revenue Service Revenue Procedure 2004-34. The election allows the deferral of income over the term of the agreements, subject to certain limitations, resulting in a closer alignment of our taxable income with our book income. The election has the effect of increasing our net operating loss carry forwards by $8.4 million and decreasing deductible timing differences by the same amount. There was no affect on our overall deferred tax assets.
At December 31, 2004, we had $18.3 million of net deferred tax assets that have been reserved in full by a valuation allowance. In the future, if available evidence indicates that it is more likely than not that some or all of our deferred taxes are realizable, we will record a income tax benefit in the amount of the asset recognized. At that time, our effective income tax rate will likely increase.
The provision for income taxes of $539,000 in 2003 represented state income taxes incurred due to the suspension of the use of operating loss carryforwards, other state minimum taxes and the recording of a valuation allowance against foreign tax credits. There was no income tax expense or benefit in 2002.
Quarterly Results of Operations
The following table sets forth selected unaudited quarterly consolidated statements of operations data for each of the eight quarters through December 31, 2004. This information is unaudited but, in managements opinion, has been prepared on the same basis as the audited consolidated financial statements and related notes included elsewhere in this report and includes all adjustments, consisting only of normal recurring adjustments that our management considers necessary for a fair presentation of the information for the quarters presented.
This information should be read in conjunction with the audited consolidated financial statements and related notes included elsewhere in this report. We believe that quarter-to-quarter comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of future performance.
The following table sets forth, for each of the periods indicated, the percentage of total revenue represented by selected items in our consolidated statements of operations:
The following table sets forth our deferred revenue and cash generated (used) from operations, our on-demand customer interactions and percentage of clients hosting and our revenue by type and geography expressed as a percentage of total revenue, for each of the periods indicated:
Total revenue increased sequentially in each of the quarters presented primarily due to increases in the number of new clients, increases in the average transaction sizes, contract renewals and deferred revenue recognition. Professional services revenue as a percentage of the total revenue increased in the quarters ended June 30, 2004 and September 30, 2004 as we expanded our service offerings, and decreased in the quarters ended June 30, 2003 and December 31, 2004 due to a lower number of development and consulting services performed. Cost of revenue for software, hosting and support trended lower in the six quarters ended December 31, 2004 due to increasing efficiencies in our hosting and technical support operations resulting from the higher volume of our clients customer interactions.
The mix of term and perpetual software licenses sold in each quarter impacts our quarterly results of operations. For example, in the quarters ended June 30, 2004, September 30, 2004, and December 31, 2004, perpetual licenses represented a higher proportion of our revenue than in other periods because, we believe, our products are becoming increasingly important in our client operations and our client planning horizons have lengthened. Accordingly, revenue was favorably impacted in those quarters and total operating expenses, particularly research and development and general and administrative, as a percentage of total revenue in those quarters, were lower.
Sales and marketing expenses in absolute dollars were higher in the quarters ended June 30, 2004, September 30, 2004 and December 31, 2004 due to higher rates of commissions earned on new agreements for the quarter. However, sales and marketing expenses as a percentage of revenue were lower in each of the quarters in 2004 compared to 2003 due to higher rates of sales productivity.
The amount and timing of our operating results generally will vary from quarter to quarter depending on our level of actual and anticipated business activities. Factors affecting quarterly operating results can include, but are not limited to:
our ability to retain and increase sales to existing clients, attract new clients and satisfy our clients requirements;
changes in the volume and mix of term and perpetual licenses sold in a particular quarter, because perpetual license revenue is recorded in full into revenue upon delivery whereas term license revenue is recorded ratably over time;
our policy of expensing sales commissions at the time of invoice, while the majority of our revenue is deferred and recognized ratably over future periods;
changes in the mix of revenue between professional services and software, hosting and support;
changes in the mix of voice self-service application sold and/or usage volume, and the corresponding third party fees for voice processing;
the timing and success of new product introductions or upgrades by us or our competitors;
changes in our pricing policies or those of our competitors;
our ability to expand our operations, and the amount and timing of expenditures related to this expansion;
the cost and availability of hosting services at co-location facilities;
our ability to continue to realize efficiencies from our hosting and technical support operations;
changes in the payment terms for our products and services;
the purchasing and budgeting cycles of our clients;
the rate of success of our domestic and international expansion;
our ability to retain, recruit and hire key executives and technical and sales and marketing personnel;
costs related to the development or acquisition of technologies, products or businesses;
seasonality in certain of our clients purchasing habits; and
general economic, industry and market conditions.
Our revenue and operating results are difficult to forecast and may fluctuate, and we believe that quarter-to-quarter comparisons of our operating results will not necessarily be meaningful. As a result, you should not rely upon them as an indication of our future performance. We do not consider our business to be seasonal, although we see some patterns of increased purchasing when our clients fiscal years are ending. Our U.S. federal government clients fiscal years end in September and most of our Japanese clients fiscal years end in March.
Liquidity and Capital Resources
Off-Balance Sheet Arrangements
As of December 31, 2004, we did not have any significant off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated by the SEC.
Contractual Obligations and Commitments
The following table summarizes our contractual payment obligations and commitments as of December 31, 2004:
We lease our office facilities and certain office equipment under operating lease agreements that expire at various dates through 2011. Purchase obligations consist of agreements with third parties to provide co-location services for hosting operations, which do not have contractual payment obligations beyond one year. Except for these hosting service agreements, we generally do not enter into binding purchase commitments.
Before deciding to purchase, hold or sell our common stock, you should carefully consider the risks described below, in addition to the other cautionary statements and risks described elsewhere and the other information contained in this Report and in our other filings with the SEC, including our reports on Forms 10-Q and 8-K. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs with material adverse effects on RightNow, our business, financial condition and results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment.
Risks Related to Our Business
Although we experienced our first year of profitability in 2004, we may not be able to sustain or increase our profitability in the future.
Although we achieved profitability in 2004, we may not be able to continue to achieve profitability and have historically incurred operating losses in all prior years. We incurred net losses of approximately $4.1 million in 2003, $2.7 million in 2002 and $15.3 million in 2001. As of December 31, 2004, we had an accumulated deficit of approximately $41 million. We expect to continue to incur significant sales and marketing, research and development and general and administrative expenses as we expand our operations and, as a result, we will need to generate significant revenue to maintain profitability. Even if we continue to achieve profitability, we may not be able to increase profitability on a quarterly or annual basis in the future, which may cause the price of our stock to decline.
Our quarterly results of operations may fluctuate in the future.
Our quarterly revenue and results of operations may fluctuate as a result of a variety of factors, many of which are outside of our control. If our quarterly revenue or results of operations fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Fluctuations in our results of operations may be due to a number of factors, including, but not limited to, those listed below and identified throughout this Risk Factors section:
our ability to retain and increase sales to existing clients, attract new clients and satisfy our clients requirements;
changes in the volume and mix of term and perpetual licenses sold in a particular quarter, because perpetual license revenue is recorded in full into revenue upon delivery whereas term license revenue is recorded ratably over time;
our policy of expensing sales commissions at the time of invoice, while the majority of our revenue is recognized ratably over future periods;
changes in the mix of revenue between professional services and software, hosting and support;
changes in the mix of voice self-service applications sold and/or usage volume, and the corresponding third party fees for voice processing;
the timing and success of new product introductions or upgrades by us or our competitors;
changes in our pricing policies or those of our competitors;
the amount and timing of expenditures related to expanding our operations;
changes in the payment terms for our products and services; and
the purchasing and budgeting cycles of our clients.
Because the sales cycle for the evaluation and implementation of our solutions typically ranges from 60 to 180 days, we may also experience a delay between increasing operating expenses and the generation of corresponding revenue, if any. Moreover, because the majority of our clients purchase term licenses, and we recognize revenue from these licenses over the term of the agreement, downturns or upturns in sales may not be immediately reflected in our operating results. Most of our expenses, such as salaries and third-party hosting co-location costs, are relatively fixed in the short-term, and our expense levels are based in part on our expectations regarding future revenue levels. As a result, if revenue for a particular quarter is below our expectations, we may not be able to proportionally reduce operating expenses for that quarter, causing a disproportionate effect on our expected results of operations for that quarter.
Due to the foregoing factors, and the other risks discussed in this report, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance.
If our efforts to enhance existing solutions, introduce new solutions or expand the applications for our products and solutions to broader CRM markets do not succeed, our ability to grow our business will be adversely affected.
Approximately 90% of our revenue is derived from RightNow Service, a suite of solutions used to optimize customer service operations. If we are unable to successfully develop and sell new and enhanced versions of RightNow Service, or introduce new products and solutions for the customer service market, our financial performance will suffer. Although to date we have focused our business on providing solutions for customer service operations, we recently introduced RightNow CRM 7.0 to expand our solution offerings to the sales and marketing segments of the CRM market. Our efforts to expand beyond the customer service market may not be successful because certain of our competitors have far greater experience and brand recognition in the broader segments of the CRM market. In addition, our efforts to expand our on-demand software solutions beyond the customer service market may divert management resources from our existing operations and require us to commit significant financial resources to a market where we are unproven, which may harm our business, financial condition and results of operations.
We face intense competition, and our failure to compete successfully could make it difficult for us to add and retain clients and could reduce or impede the growth of our business.
The market for customer relationship management solutions is highly competitive and fragmented, and is subject to rapidly changing technology, shifting client requirements, frequent introductions of new products and services, and increased
marketing activities of other industry participants. Competition has intensified with our release of RightNow CRM 7.0. Increased competition could result in pricing pressure, reduced sales, lower margins or the failure of our solutions to achieve or maintain broad market acceptance. If we are unable to compete effectively, it will be difficult for us to add and retain clients, and our business, financial condition and results of operations will be seriously harmed.
We face competition from:
companies currently providing customer service solutions, some of whom offer hosted services, including Amdocs Limited, BMC Software Corporation, E.piphany, Inc., eGain Communications Corporation, FrontRange Solutions, Inc., IBM Corporation, Kana Software, Inc., Microsoft Corporation, Oracle Corporation, SAP AG, salesforce.com, inc. and Siebel Systems, Inc.;
CRM systems that are developed and maintained internally by businesses;
CRM products or services that are developed, or bundled with other products or services, and installed on a clients premises by software vendors;
outsourced contact center providers who bundle solutions and agent labor in their service offerings; and
new companies entering the CRM software market, the on-demand applications market and the on-demand CRM market, or expanding from any one of these markets to the others.
Many of our current and potential competitors have longer operating histories and larger presence in the general CRM market, greater name recognition, access to larger customer bases and substantially greater financial, technical, sales and marketing, management, service, support and other resources than we have. As a result, such competitors may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or client requirements or devote greater resources to the promotion and sale of their products and services than we can. To the extent our competitors have an existing relationship with a potential client, that client may be unwilling to switch vendors due to the time and financial commitments already made with our competitors.
In addition, many of our current and potential competitors have established or may establish business, financial or strategic relationships among themselves or with existing or potential clients, alliance partners or other third parties, or may combine and consolidate to become more formidable competitors with better resources. We also expect that new competitors, such as enterprise software vendors and online service providers that have traditionally focused on enterprise resource planning or back office applications, will continue to enter the on-demand CRM market with competing products as the on-demand CRM market develops and matures. It is possible that these new competitors could rapidly acquire significant market share.
The market for our on-demand application services is at an early stage of development, and if it does not develop or develops more slowly than we expect, our business will be harmed.
The market for on-demand application services is at an early stage of development, and it is uncertain whether these application services will achieve and sustain high levels of demand and market acceptance. Our success will depend to a substantial extent on the willingness of companies to increase their use of on-demand application services in general and for on-demand customer service applications in particular. Many companies have invested substantial personnel and financial resources to integrate traditional enterprise software into their businesses, and therefore may be reluctant or unwilling to migrate to on-demand application services. While we have supported and continue to support traditional on-site deployment of our software applications, widespread market acceptance of our on-demand software solutions is critical to the success of our business. Other factors that may affect the market acceptance of our solutions include:
on-demand security capabilities and reliability;
concerns with entrusting a third party to store and manage critical customer data;
our ability to meet the needs of broader segments of the CRM market or other on-demand markets;
the level of customization we offer;
our ability to continue to achieve and maintain high levels of client satisfaction;
concerns with purchasing critical CRM solutions from a company with a history of operating losses that only recently turned profitable; and
the price, performance and availability of competing products and services.
If businesses do not perceive the benefits of our on-demand solutions, then the market for these solutions may not develop further, or it may develop more slowly than we expect, either of which would adversely affect our business, financial condition and results of operations.
Failure to effectively develop and expand our sales and marketing capabilities could harm our ability to increase our client base and achieve broader market acceptance of our solutions.
Increasing our client base and achieving broader market acceptance of our solutions will depend to a significant extent on our ability to expand our sales and marketing operations. We plan to continue to expand our direct sales force and engage additional third-party channel partners, both domestically and internationally. This expansion will require us to invest significant financial and other resources. Our business will be seriously harmed if our efforts do not generate a corresponding significant
increase in revenue. We may not achieve anticipated revenue growth from expanding our direct sales force if we are unable to hire and develop talented direct sales personnel, if our new direct sales personnel are unable to achieve desired productivity levels in a reasonable period of time, or if we are unable to retain our existing direct sales personnel. We also may not achieve anticipated revenue growth from our third-party channel partners if we are unable to attract and retain additional motivated channel partners, if any existing or future channel partners fail to successfully market, resell, implement or support our solutions for their customers, or if they represent multiple providers and devote greater resources to market, resell, implement and support competing products and services.
The majority of our solutions are sold pursuant to term license agreements, and if our existing clients elect not to renew their licenses or to renew their licenses on terms less favorable to us, our business, financial condition and results of operations will be adversely affected.
The majority of our solutions are sold pursuant to term license agreements that are subject to renewal every two years or less and our clients have no obligation to renew their licenses. Because a large portion of our clients are in their first or second terms, we are not able to consistently and accurately predict future renewal rates. Our clients renewal rates may decline or fluctuate as a result of a number of factors, including their level of satisfaction with our solutions, their ability to continue their operations or invest in customer service, or the availability and pricing of competing products. If large numbers of existing clients do not renew their licenses, or renew their licenses on terms less favorable to us, and if we cannot replace or supplement those non-renewals with new licenses generating the same or greater level of revenue, our business, financial condition and results of operations will be adversely affected.
We have experienced rapid growth in recent periods. If we fail to manage our growth effectively, we may be unable to execute our business plan, maintain high levels of service or adequately address competitive challenges.
We have substantially expanded our overall business, headcount and operations in recent periods. We have increased our total number of full-time employees to 403 at December 31, 2004 from 322 at December 31, 2003. To achieve our business objectives, we will need to continue to expand our business at a rapid pace. This expansion has placed, and is expected to continue to place, a significant strain on our managerial, administrative, operational, financial and other resources. We anticipate that this expansion will require substantial management effort and significant additional investment in our infrastructure. If we are unable to successfully manage our growth, our business, financial condition and results of operations will be adversely affected.
Part of the challenge that we expect to face in the course of our expansion is to maintain the high level of customer service to which our clients have become accustomed. To date, we have focused on providing personalized account management and customer service on a frequent basis to ensure our clients are effectively leveraging
the capabilities of our solution. We believe that much of our success to date has been the result of high client satisfaction, attributable in part to this focus on client service. To the extent our client base grows, we will need to expand our account management, client service and other personnel, and third-party channel partners, in order to enable us to continue to maintain high levels of client service and satisfaction. If we are not able to continue to provide high levels of client service, our reputation, as well as our business, financial condition and results of operations, could be harmed.
If there are interruptions or delays in our hosting services through third-party error, our own error or the occurrence of unforeseeable events, delivery of our solutions could become impaired, which could harm our relationships with clients and subject us to liability.
As of December 31, 2004, approximately 87% of our clients were using our hosting services for deployment of our software applications. We provide our hosting services through computer hardware that we own and that is currently located in third-party web hosting co-location facilities maintained and operated in California and New Jersey. We do not maintain long-term supply contracts with either of our co-location providers, and neither provider guarantees that our clients access to hosted solutions will be uninterrupted, error-free or secure. Our operations depend on our co-location providers ability to protect their and our systems in their facilities against damage or interruption from natural disasters, power or telecommunications failures, criminal acts and similar events. Our back-up computer hardware and systems located in our Montana headquarters have not been tested under actual disaster conditions and may not have sufficient capacity to recover all data and services in the event of an outage occurring simultaneously at both the California and New Jersey co-location facilities. In the event that our co-location facility arrangements were terminated, or there was a lapse of service or accidental or willful damage to such facilities, we could experience lengthy interruptions in our hosting service as well as delays and/or additional expense in arranging new facilities and services. Any or all of these events could cause our clients to lose access to their important data. In addition, the failure by our third-party co-location facilities to meet our capacity requirements could result in interruptions in our service or impede our ability to scale our operations.
We architect the system infrastructure and procure and own the computer hardware used at our hosting co-location facilities. Design and mechanical errors, spikes in usage volume and failure to follow system protocols and procedures could cause our systems to fail, resulting in interruptions in our clients service to their customers. Any interruptions or delays in our hosting services, whether as a result of third-party error, our own error, natural disasters or security breaches, whether accidental or willful, could harm our relationships with clients and our reputation. This in turn could reduce our revenue, subject us to liability, cause us to issue credits or pay penalties or cause clients to fail to renew their licenses, any of which could adversely affect our business, financial condition and results of operations. In the event of damage or interruption, our insurance policies may not adequately compensate us for any losses that we may incur.
If the security of our clients confidential information contained in our systems or stored by use of our software is breached or otherwise subjected to unauthorized access, our hosting service or our software may be perceived as not being secure and clients may curtail or stop using our hosting service and our solutions.
Our hosting systems and our software store and transmit proprietary information and critical data belonging to our clients and their customers. Any accidental or willful security breaches or other unauthorized access could expose us to a risk of information loss, litigation and other possible liabilities. If security measures are breached because of third-party action, employee error, malfeasance or otherwise, or if design flaws in our software are exposed and exploited, and, as a result, a third party obtains unauthorized access to any of our clients data, our relationships with clients and our reputation will be damaged, our business may suffer and we could incur significant liability. Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we and our third-party hosting co-location facilities may be unable to anticipate these techniques or to implement adequate preventative measures.
We have significant international sales and are subject to risks associated with operating in international markets.
International sales comprised 27%, 24% and 19% of our revenue for the years December 31, 2004, 2003 and 2002, respectively. We intend to continue to pursue and expand our international business activities, and have recently started sales operations in Germany and France. Adverse political and economic conditions could make it difficult for us to increase our international sales or to operate abroad. International operations are subject to many inherent risks, including:
political, social and economic instability, including conflicts in the Middle East and elsewhere, terrorist attacks and security concerns in general;
adverse changes in tariffs and other protectionist laws and business practices that favor local competitors;
fluctuations in currency exchange rates;
longer collection periods and difficulties in collecting receivables from foreign entities;
exposure to different legal standards and burdens of complying with a variety of foreign laws, including employment, tax, privacy and data protection laws and regulations;
reduced protection for our intellectual property in some countries;
expenses associated with localizing products for foreign countries, including translation into foreign languages; and
import and export license requirements and restrictions of the United States and each other country in which we operate.
We believe that international sales will continue to represent a significant portion of our revenue for the foreseeable future, and that continued growth will require further expansion of our international operations. A substantial percentage of our international sales are denominated in the local currency. As a result, an increase in the relative value of the dollar could make our products more expensive and potentially less price competitive in international markets. We typically do not engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations. Any of these factors may adversely affect our future international sales and, consequently, affect our business, financial condition and results of operations.
If we fail to respond effectively to rapidly changing technology and evolving industry standards, particularly in the on-demand CRM industry, our solutions may become less competitive or obsolete.
The CRM industry is characterized by rapid technological advances, changes in client requirements, frequent new product and service introductions and enhancements, changes in protocols and evolving industry standards. Our hosted business model and the on-demand CRM market are relatively new and may evolve even more rapidly than the rest of the CRM market. Competing products and services based on new technologies or new industry standards may perform better or faster, or cost less, than our solutions and could render our solutions less competitive or obsolete. In addition, because our solutions are designed to operate on a variety of network hardware and software platforms using a standard Internet web browser, we will need to continuously modify and enhance our solutions to keep pace with changes in Internet-related hardware, software, communication, browser and database technologies and to integrate with our clients systems as they change and evolve. Furthermore, uncertainties about the timing and nature of new network platforms or technologies, or modifications to existing platforms or technologies, could increase our research and development expenses. If we are unable to successfully develop and market new and enhanced solutions that respond in a timely manner to changing technology and evolving industry standards, and if we are unable to satisfy the diverse and evolving technology needs of our clients, our business, financial condition and results of operations will suffer.
Our failure to attract and retain qualified or key personnel may prevent us from effectively developing, marketing, selling, integrating and supporting our products.
Our success and future growth depends to a significant degree upon the skills, experience, performance and continued service of our senior management, engineering, sales, marketing, service, support and other key personnel. Specifically, we believe that our future success is highly dependent on Greg Gianforte, our founder, Chairman and Chief Executive Officer. In addition, we do not have employment agreements with any of our senior management or key personnel that require them to remain our employees and, therefore, they could terminate their employment with us at any time without penalty. If we lose the services of Mr. Gianforte or any of our other key personnel, our business will be severely disrupted and we may be unable to operate effectively. We do not maintain
key person life insurance policies on any of our key employees except Mr. Gianforte. This life insurance policy would not be sufficient to compensate us for the loss of his services. Our future success also depends in large part upon our ability to attract, train, integrate, motivate and retain highly skilled employees, particularly sales, marketing and professional services personnel, software engineers, product trainers, and senior personnel. Competition for these personnel is intense, especially for engineers with high levels of expertise in designing and developing software and for senior sales executives.
If our solutions fail to perform properly or if they contain technical defects, our reputation will be harmed, our market share would decline and we could be subject to product liability claims.
Our software products may contain undetected errors or defects that may result in product failures, slow response times, or otherwise cause our products to fail to perform in accordance with client expectations. Because our clients use our products for important aspects of their business, any errors or defects in, or other performance problems with, our products could hurt our reputation and may damage our clients businesses. If that occurs, we could lose future sales, or our existing clients could elect to not renew or to delay or withhold payment to us, which could result in an increase in our provision for doubtful accounts and an increase in collection cycles for accounts receivable. Clients also may make warranty claims against us, which could result in the expense and risk of litigation. Product performance problems could result in loss of market share, failure to achieve market acceptance and the diversion of development resources. If one or more of our products fails to perform or contains a technical defect, a client may assert a claim against us for substantial damages, whether or not we are responsible for the product failure or defect. We do not currently maintain any warranty reserves.
Product liability claims could require us to spend significant time and money in litigation or to pay significant settlements or damages. Although we maintain general liability insurance, including coverage for errors and omissions, this coverage may not be sufficient to cover liabilities resulting from such product liability claims. Also, our insurer may disclaim coverage. Our liability insurance also may not continue to be available to us on reasonable terms, in sufficient amounts, or at all. Any product liability claims successfully brought against us would cause our business to suffer.
If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.
Our success depends to a significant degree upon the protection of our software and other proprietary technology rights. We rely on trade secret, copyright and trademark laws, patents and confidentiality agreements with employees and third parties, all of which offer only limited protection. The steps we have taken to protect our intellectual property may not prevent misappropriation of our proprietary rights or the reverse engineering of our solutions. We may not be able to obtain any further patents or trademarks, and our pending applications may not result in the issuance of patents or
trademarks. Any of our issued patents may not be broad enough to protect our proprietary rights or could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in those patents. Furthermore, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in other countries are uncertain and may afford little or no effective protection of our proprietary technology. Consequently, we may be unable to prevent our proprietary technology from being exploited abroad, which could diminish international sales or require costly efforts to protect our technology. Policing the unauthorized use of our products, trademarks and other proprietary rights is generally expensive, difficult and, in some cases, impossible. Litigation may be necessary in the future to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of management resources, either of which could harm our business. Accordingly, despite our efforts, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property.
Our product development efforts may be constrained by the intellectual property of others, and we may become subject to claims of intellectual property infringement, which could be costly and time-consuming.
The software and Internet industries are characterized by the existence of a large number of patents, trademarks and copyrights, and by frequent litigation based upon allegations of infringement or other violations of intellectual property rights. As we seek to extend our CRM product and service offerings, we may be constrained by the intellectual property of others. We have in the past been named as a defendant in lawsuits alleging intellectual property infringement, and we may again in the future have to defend against intellectual property lawsuits. We may not prevail in any future intellectual property infringement litigation given the complex technical issues and inherent uncertainties in litigation. Any claims, regardless of their merit, could be time-consuming and distracting to management, result in costly litigation or settlement, cause product development delays, or require us to enter into royalty or licensing agreements. If any of our products violate third-party proprietary rights, we may be required to re-engineer our products or seek to obtain licenses from third parties, which may not be available on reasonable terms or at all. Because many of our license agreements require us to indemnify our clients from any claim or finding of intellectual property infringement, any such litigation or successful infringement claims could adversely affect our business, financial condition and results of operations. Any efforts to re-engineer our products, obtain licenses from third parties on favorable terms or license a substitute technology may not be successful and, in any case, may substantially increase our costs and harm our business, financial condition and results of operations. Further, our software products contain open source software components that are licensed to us under various public domain licenses, such as the GNU General Public License. While we believe we have complied with our obligations under the various applicable licenses for open source software that we use, there is little or no legal precedent governing the interpretation of many of the terms of certain of these licenses and therefore the potential impact of such
terms on our business is somewhat unknown. Use of open source standards also may make us more vulnerable to competition because the public availability of open source software could make it easier for new market entrants and existing competitors to introduce similar competing products quickly and cheaply.
Future acquisitions could disrupt our business and harm our financial condition and results of operations.
In order to expand our addressable market, we may decide to acquire additional businesses, products and technologies. We have not made any acquisitions to date, and therefore our ability as an organization to make acquisitions is unproven. Acquisitions could require significant capital infusions and could involve many risks, including, but not limited to, the following:
an acquisition may negatively impact our results of operations because it may require incurring large one-time charges, substantial debt or liabilities; it may require the amortization or write down of amounts related to deferred compensation, goodwill and other intangible assets; or it may cause adverse tax consequences, substantial depreciation or deferred compensation charges;
we may encounter difficulties in assimilating and integrating the business, technologies, products, personnel or operations of companies that we acquire, particularly if key personnel of the acquired company decide not to work for us;
our existing and potential clients and the customers of the acquired company may delay purchases due to uncertainty related to an acquisition;
an acquisition may disrupt our ongoing business, divert resources, increase our expenses and distract our management;
the acquired businesses, products or technologies may not generate sufficient revenue to offset acquisition costs;
we may have to issue equity securities to complete an acquisition, which would dilute our stockholders and could adversely affect the market price of our common stock; and
acquisitions may involve the entry into a geographic or business market in which we have little or no prior experience.
We cannot assure you that we will be able to identify or consummate any future acquisitions on favorable terms, or at all. If we do pursue any acquisitions, it is possible that we may not realize the anticipated benefits from the acquisitions. It is also possible that the financial markets or investors will negatively view the acquisitions. Even if we successfully complete an acquisition, it could adversely affect our business, financial condition and results of operations.
We may not be able to secure additional financing on favorable terms, or at all, to meet our future capital needs.
We may require additional capital to respond to business challenges, including the need to develop new solutions or enhance our existing solutions, enhance our operating infrastructure, fund expansion, respond to competitive pressures and acquire complementary businesses, products and technologies. Absent sufficient cash flow from operations, we may need to engage in equity or debt financings to secure additional funds to meet our operating and capital needs. In addition, even though we may not need additional funds, we may still elect to sell additional equity or debt securities or obtain credit facilities for other reasons. We may not be able to secure additional debt or equity financing on favorable terms, or at all, at the time when we need such funding. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution in their percentage ownership of our company, and any new equity securities we issue could have rights, preferences and privileges senior to those of holders of our common stock. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital, to pay dividends and to pursue business opportunities, including potential acquisitions. In addition, if we decide to raise funds through debt or convertible debt financings, we may be unable to meet our interest or principal payments.
Changes in the accounting treatment of stock options will adversely affect our results of operations.
The Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R). The statement requires that the compensation cost relating to share-based payment transactions be recognized in financial statements based on the fair value of the equity or liability instruments used, and is effective for interim and annual periods beginning after June 15, 2005. SFAS 123R replaces FASB Statement 123, Accounting for Stock-Based Compensation, and supercedes APB No. 25, Accounting for Stock Issued to Employees. SFAS 123R requires us to value our employee stock option grants, transactions under our Employee Stock Purchase Plan, and other possible equity-based transactions, pursuant to a fair value formula, and then amortize that value against our reported earnings over the vesting period in effect for those transactions. We currently account for stock-based awards to employees in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and provide the disclosure-only alternative of SFAS 123. This change in accounting treatment will materially and adversely affect our reported results of operations because the stock-based compensation expense would be charged directly against our reported earnings. We do not expect the accounting change to materially affect our liquidity because equity-based compensation is a non-cash expense. For an illustration of the effect of such a change on our recent results of operations, see Note 1(p) of Notes to Consolidated Financial Statements.
Risks Related to Our Industry
The success of our products and our hosted business depends on the continued growth and acceptance of the Internet as a business and communications tool, and the related expansion of the Internet infrastructure.
The future success of our products and our hosted business depends upon the continued and widespread adoption of the Internet as a primary medium for commerce, communication and business applications. Our business growth would be impeded if the performance or perception of the Internet was harmed by security problems such as viruses, worms and other malicious programs, reliability issues arising from outages and damage to Internet infrastructure, delays in development or adoption of new standards and protocols to handle increased demands of Internet activity, increased costs, decreased accessibility and quality of service, or increased government regulation and taxation of Internet activity.
Federal, state or foreign government bodies or agencies have in the past adopted, and may in the future adopt, laws or regulations affecting data privacy, the solicitation, collection, processing or use of personal or consumer information, the use of the Internet as a commercial medium and the use of e-mail for marketing or other consumer communications. In addition, government agencies or private organizations may begin to impose taxes, fees or other charges for accessing the Internet or for sending commercial e-mail. These laws or charges could limit the growth of Internet-related commerce or communications generally, result in a decline in the use of the Internet and the viability of Internet-based services such as ours and reduce the demand for our products, particularly our RightNow Marketing solution.
The Internet has experienced, and is expected to continue to experience, significant user and traffic growth, which has, at times, caused user frustration with slow access and download times. If Internet activity grows faster than Internet infrastructure or if the Internet infrastructure is otherwise unable to support the demands placed on it, or if hosting capacity becomes scarce, our business growth may be adversely affected.
Privacy concerns and laws or other domestic or foreign regulations may adversely affect our business or reduce sales of our solutions.
Businesses using our solutions collect personal information regarding their customers when those customers contact them with customer service inquiries. A valuable component of our solutions is their ability to allow our clients to use and analyze their customers information to increase sales, marketing and up-sell or cross-sell opportunities. Federal, state and foreign government bodies and agencies, however, have adopted and are considering adopting laws and regulations regarding the collection, use and disclosure of personal information obtained from consumers. The costs of compliance with, and other burdens imposed by, such laws and regulations that are applicable to the businesses of our clients may limit the use and adoption of this component of our solutions and reduce overall demand for our solutions. Furthermore, even where a client desires to make full use of these features in our solutions, privacy concerns may cause our clients customers to resist providing the personal data necessary
to allow our clients to use our solutions most effectively. Even the perception of privacy concerns, whether or not valid, may inhibit market acceptance of our products. For example, regulations such as the Gramm-Leach-Bliley Act, which protects and restricts the use of consumer credit and financial information, and the Childrens Online Privacy Protection Act of 1998, which restricts the ability of companies to collect personal information online from children under the age of 13 without their parents consent, impose significant requirements and obligations on businesses that may affect the use and adoption of our solutions by existing and potential clients.
The European Union has also adopted a directive that requires member states to impose restrictions on the collection and use of personal data that are far more stringent, and impose more significant burdens on subject businesses, than current privacy standards in the United States. All of these domestic and international legislative and regulatory initiatives may adversely affect our clients ability to collect and/or use demographic and personal information from their customers, which could reduce demand for our solutions.
In addition to government activity, privacy advocacy groups and the technology and direct marketing industries are considering various new, additional or different self-regulatory standards that may place additional burdens on us. If the gathering of profiling information were to be curtailed in this manner, customer service CRM solutions would be less effective, which would reduce demand for our solutions and harm our business.
Non-solicitation concerns, laws or regulations may adversely affect our clients ability to perform outbound marketing and other e-mail communications, which could reduce sales of our solutions.
In January 2004, the federal Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003, or CAN-SPAM Act, became effective. The CAN-SPAM Act regulates the transmission and content of commercial e-mails and, among other things, obligates the sender of such e-mails to provide recipients with the ability to opt-out of receiving future e-mails from the sender, and establishes penalties for the transmission of e-mail messages which are intended to deceive the recipient as to source or content. Many state legislatures also have adopted laws that impact the delivery of commercial e-mail, and laws that regulate commercial e-mail practices are being developed or adopted in many of the international jurisdictions in which we do business, including Europe and Australia. In addition, Internet service providers and licensors of software products have introduced a variety of systems and products to filter out certain types of commercial e-mail, without any common protocol to determine whether the recipient desired to receive the e-mail being blocked. As a result, it is difficult for us to determine in advance whether or not e-mails generated by our clients using our solutions will be permitted by spam filters to reach the intended recipients.
Our RightNow Marketing solution specifically serves the market for mass distribution marketing and other e-mail communications. The increasing regulation of e-mail delivery, both domestically and internationally, and the spam filtering practices of
Internet service providers and e-mail users generally, will place significant additional burdens on our clients who have outbound communication programs, and may cause those clients to substantially change their outbound communications programs or abandon them altogether. The concerns and legal requirements surrounding non-solicitation and compliance with the CAN-SPAM Act and other laws may reduce sales of our RightNow Marketing solution, may make it necessary to redesign our RightNow Outbound solution to make it easier for our clients to conform to the requirements of the CAN-SPAM Act and other laws and standards, which would increase our expenses, or may make it necessary for us to redefine the market for and use of our RightNow Marketing solution, which could reduce our revenue.
Risks Related to Our Ownership and Corporate Structure
The significant control over stockholder voting matters and our office leases that may be exercised by our founder and Chief Executive Officer will limit your ability to influence corporate actions and may require us to find alternative office space to lease or buy in the future.
At December 31, 2004, Greg Gianforte, our founder and Chief Executive Officer, and his spouse, Susan Gianforte, together beneficially owned approximately 44.7% of our outstanding common stock and, together with our other officers and directors, beneficially owned approximately 68.5% of our outstanding stock. In addition, none of the shares of common stock held by Mr. and Mrs. Gianforte are subject to vesting restrictions. As a result, Mr. and Mrs. Gianforte, acting alone or together with some of our other officers or directors, will be able to control all matters requiring stockholder approval, including the election of directors, management changes and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying, preventing or deterring a change in control of RightNow, could prevent our stockholders of an opportunity to receive a premium for their common stock as part of a sale of RightNow and might reduce the market price of our common stock.
In addition, Mr. Gianforte beneficially owns, directly or indirectly, a 50% membership interest in Genesis Partners, LLC, our landlord from whom we lease our principal offices in Bozeman, Montana. Consequently, Mr. Gianforte has significant control over any decisions by Genesis Partners regarding renewal, modification or termination of our Bozeman, Montana leases. In the event that our current leases with Genesis Partners were terminated or otherwise could not be renewed, or came up for renewal on commercially unreasonable terms, we would be required to find alternative office space to lease or buy.
Our management has broad discretion over the use of the proceeds from our initial public offering and might not apply the proceeds of our initial public offering in ways that enhance our results of operations.
Our management has broad discretion to use the net proceeds from our initial public offering. We expect to use the net proceeds from our initial public offering for general corporate purposes, including working capital and capital expenditures, and for