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RightNow Technologies 10-Q 2006

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

ý

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

 

 

 

For the quarterly period ended March 31, 2006

 

 

 

or

 

 

o

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

 

 

 

For the transition period from             to              

 

000-31321

(Commission File No.)

 

RIGHTNOW TECHNOLOGIES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

81-0503640

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

40 Enterprise Boulevard

Bozeman, Montana 59718-9300

 (Address of Principal Executive Offices) (Zip Code)

 

(406) 522-4200

 (Registrant’s Telephone Number, Including Area Code)

 

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by 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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

 

Accelerated filer ý

 

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o           No ý

 

The number of shares outstanding of the registrant’s common stock, $0.001 par value, as of April 30, 2006 was 32,143,005.

 

 



 

RightNow Technologies, Inc.

Quarterly Report on Form 10-Q

 

For the Quarterly Period Ended March 31, 2006

 

INDEX

 

Part I.

 

FINANCIAL INFORMATION

 

Item 1.

Financial Statements

 

 

a)

Condensed consolidated balance sheets

 

 

b)

Condensed consolidated statements of operations

 

 

c)

Condensed consolidated statements of cash flows

 

 

d)

Notes to condensed consolidated financial statements

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

Item 4.

Controls and Procedures

 

 

 

 

Part II.

 

OTHER INFORMATION

 

Item 1. Legal Proceedings

 

 

 

 

Item 1A. Risk Factors

 

 

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

Item 3. Defaults Upon Senior Securities

 

 

 

 

Item 4. Submission of Matters to a Vote of Security Holders

 

 

 

 

Item 5. Other Information

 

 

 

 

Item 6. Exhibits

 

 

 

 

SIGNATURES

 

 



 

Part I. FINANCIAL INFORMATION

 

Item 1. Financial Statements
 

RightNow Technologies, Inc.

Condensed Consolidated Balance Sheets

(In thousands) (Unaudited)

 

 

 

December
31, 2005

 

March 31,
2006

 

Assets

 

 

 

 

 

Cash and cash equivalents

 

$

40,874

 

$

42,444

 

Short-term investments

 

23,314

 

27,063

 

Accounts receivable

 

25,462

 

31,615

 

Term receivables, current

 

15,376

 

17,268

 

Allowance for doubtful accounts

 

(2,209

)

(2,090

)

Receivables, net

 

38,629

 

46,793

 

Prepaid & other current assets

 

1,993

 

2,439

 

Total current assets

 

104,810

 

118,739

 

 

 

 

 

 

 

Property and equipment, net

 

6,451

 

6,632

 

Term receivables, non-current

 

10,697

 

12,611

 

Intangible assets, net

 

1,487

 

1,340

 

Other

 

231

 

107

 

Total Assets

 

$

123,676

 

$

139,429

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Accounts payable

 

$

2,308

 

$

2,983

 

Commissions and bonuses payable

 

2,910

 

3,706

 

Other accrued liabilities

 

5,733

 

6,248

 

Current portion of long-term debt

 

30

 

30

 

Current portion of deferred revenue

 

48,673

 

54,191

 

Total current liabilities

 

59,654

 

67,158

 

 

 

 

 

 

 

Long-term debt, less current portion

 

117

 

109

 

Deferred revenue, net of current portion

 

19,250

 

26,715

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock

 

32

 

32

 

Additional paid-in capital

 

78,312

 

79,536

 

Accumulated other comprehensive loss

 

(401

)

(393

)

Accumulated deficit

 

(33,288

)

(33,728

)

Total stockholders’ equity

 

44,655

 

45,447

 

Total Liabilities and Stockholders’ Equity

 

$

123,676

 

$

139,429

 

 

See accompanying notes to condensed consolidated financial statements.

 

2



 

RightNow Technologies, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts) (Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2006

 

Revenue:

 

 

 

 

 

Software, hosting and support

 

$

13,874

 

$

19,310

 

Professional services

 

4,468

 

5,321

 

Total revenue

 

18,342

 

24,631

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

Software, hosting and support

 

2,064

 

2,771

 

Professional services

 

2,696

 

4,104

 

Total cost of revenue

 

4,760

 

6,875

 

 

 

 

 

 

 

Gross profit

 

13,582

 

17,756

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Sales and marketing

 

9,457

 

13,726

 

Research and development

 

2,161

 

3,130

 

General and administrative

 

1,410

 

2,056

 

Total operating expenses

 

13,028

 

18,912

 

 

 

 

 

 

 

Income (loss) from operations

 

554

 

(1,156

)

 

 

 

 

 

 

Interest and other income (expense), net

 

292

 

672

 

 

 

 

 

 

 

Income (loss) before income taxes

 

846

 

(484

)

(Provision) benefit for income taxes

 

(45

)

44

 

Net income (loss)

 

$

801

 

$

(440

)

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

Basic

 

$

0.03

 

$

(0.01

)

Diluted

 

$

0.02

 

$

(0.01

)

 

 

 

 

 

 

Shares used in the computation:

 

 

 

 

 

Basic

 

29,816

 

31,943

 

Diluted

 

33,564

 

31,943

 

 

See accompanying notes to condensed consolidated financial statements.

 

3



 

RightNow Technologies, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands) (Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2006

 

Operating activities:

 

 

 

 

 

Net income (loss)

 

$

801

 

$

(440

)

Non-cash adjustments:

 

 

 

 

 

Depreciation and amortization

 

742

 

1,105

 

Provision (recoveries) for uncollectible accounts receivable

 

52

 

(248

)

Stock-based compensation

 

 

783

 

Changes in operating accounts:

 

 

 

 

 

Receivables

 

(2,402

)

(9,798

)

Prepaid expenses

 

(44

)

(167

)

Accounts payable

 

776

 

688

 

Commissions and bonuses payable

 

(663

)

787

 

Other accrued liabilities

 

208

 

503

 

Deferred revenue

 

3,819

 

12,976

 

Other

 

(50

)

(137

)

Cash provided by operating activities

 

3,239

 

6,052

 

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

Net change in short-term investments

 

11,490

 

(3,749

)

Acquisition of property and equipment

 

(1,080

)

(1,140

)

Acquisition of intangible assets

 

 

(10

)

Cash provided by (used in) investing activities

 

10,410

 

(4,899

)

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

Proceeds from issuance of common stock under employee benefit plans

 

588

 

433

 

Payments on long-term debt

 

 

(8

)

Cash provided by financing activities

 

588

 

425

 

 

 

 

 

 

 

Effect of foreign exchange rates on cash and cash equivalents

 

(26

)

(8

)

 

 

 

 

 

 

Increase in cash and cash equivalents

 

14,211

 

1,570

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

18,944

 

40,874

 

Cash and cash equivalents at end of period

 

$

33,155

 

$

42,444

 

 

See accompanying notes to condensed consolidated financial statements.

 

4



 

RightNow Technologies, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

(1)                     Business Description and Basis of Presentation

 

Business Description

 

RightNow Technologies, Inc. (the “Company” or “RightNow”) provides customer experience management software solutions for companies of all sizes. The Company’s on demand software is designed to go beyond traditional customer relationship management (“CRM”) solutions to support a business’s external customer-facing channels as well as sales, marketing and customer service operations. Founded in 1997, RightNow is headquartered in Bozeman, Montana, with additional offices in Chicago, Illinois; Dallas, Texas; San Mateo, California; Princeton, New Jersey; Rochester, New York; London, England; Sydney, Australia, Munich, Germany; and a liaison office in Tokyo, Japan. The Company operates in one segment, which is the customer experience management market.

 

Basis of Presentation

 

The accompanying interim consolidated financial statements are unaudited. These financial statements and notes should be read in conjunction with the audited consolidated financial statements and related notes, together with management’s discussion and analysis of financial condition and results of operations, contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

 

The accompanying interim consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles. In the opinion of management, the interim consolidated financial statements and notes have been prepared on the same basis as the audited consolidated financial statements in the Annual Report on Form 10-K and include all adjustments necessary for the fair presentation of the Company’s financial position at March 31, 2006, and results of operations and cash flows for the three month periods ended March 31, 2005 and 2006. The interim period results are not necessarily indicative of the results to be expected for the full year.

 

The preparation of financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. Management evaluates these estimates and assumptions on an on-going basis. Significant estimates and assumptions made by management include the identification and fair value of individual elements in multiple-element sales arrangements, whether the fees charged for our products and services are fixed and determinable, valuation allowances for trade receivables and deferred income tax assets, and assumptions used in estimating the fair value of stock options granted for stock-based compensation.

 

5



 

(2) Certain Risks and Concentrations

 

The Company’s revenue is derived from the license, hosting and support of its software products and provision of related professional services. The markets in which the Company competes are highly competitive and rapidly changing. Significant technological changes, changes in customer requirements, or the emergence of competitive products with new capabilities or technologies could adversely affect the Company’s operating results. The Company has historically derived a majority of its revenue from customer service software solutions. These products are expected to continue to account for a significant portion of revenue for the foreseeable future. As a result of this revenue concentration, the Company’s business could be harmed by a decline in demand for, or in the prices of, these products or as a result of, among other factors, any change in pricing model, a maturation in the markets for these products, increased price competition or a failure by the Company to keep up with technological change.

 

The Company’s customers are worldwide with approximately 70% to 75% of sales in the United States. No individual customer accounted for more than 10% of the Company’s revenue in 2005 or the first three months of 2006. One customer represented more than 10% of term receivables at December 31, 2005, and one customer represented 12% of accounts receivable at March 31, 2006.

 

As of December 31, 2005 and March 31, 2006, assets located outside the United States were 11% of total assets. The loss from operations outside of the United States totaled $1.6 million and $1.9 million for the three months ended March 31, 2005 and 2006, respectively. Revenue by geographical region follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

United States

 

$

13,757

 

$

17,368

 

Europe

 

2,751

 

5,014

 

Asia Pacific

 

1,834

 

2,249

 

 

 

$

18,342

 

$

24,631

 

 

6



 

(3) Net Income (Loss) Per Share

 

A reconciliation of the denominator used in the calculation of basic and diluted net income (loss) per share is as follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

Weighted average common shares outstanding for basic net income (loss) per share

 

29,816

 

31,943

 

Effect of dilutive securities:

 

 

 

 

 

Employee stock options

 

3,684

 

 

Warrants

 

64

 

 

Weighted average shares outstanding for dilutive net income (loss) per share

 

33,564

 

31,943

 

 

The following common stock equivalents were excluded from the computation of diluted earnings per share because their impact was anti-dilutive (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

Employee stock options

 

288

 

4,052

 

 

(4) Comprehensive Income (Loss)

 

Comprehensive loss for the comparative periods was as follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

Net income (loss)

 

$

801

 

$

(440

)

Other comprehensive income (loss):

 

 

 

 

 

Unrealized gain (loss) on short-term investments

 

(41

)

14

 

Foreign currency translation adjustments

 

28

 

(6

)

Comprehensive income (loss)

 

$

788

 

$

(432

)

 

7



 

(5) Stock-Based Compensation

 

The Company’s 1998 Long-Term Incentive and Stock Option Plan, as amended, and the 2004 Equity Incentive Plan (the “plans”) provide for stock options to be granted to employees, consultants, independent contractors, officers and directors. The plans have been approved by stockholders. Except for director automatic grants, options are granted at the discretion of the Company’s board of directors, at an exercise price and term determined by the board. However, exercise prices are not less than the fair market value at the date of grant, and the term of the options is not greater than ten years. Options generally vest over a period of four years in eight equal increments. The Company also has an employee stock purchase plan (“ESPP”) that allows employees to purchase shares of common stock at a discount to the fair market value at the date of purchase. Purchase periods under the ESPP are consecutive six-month periods ending on the last day in June and December each year. Shares issued to satisfy stock option exercises and ESPP are newly issued. At March 31, 2006, the Company had approximately 4.3 million shares available for future issuance under the plans and ESPP.

 

On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123(R), Share Based Payment, (“SFAS 123R”), for its stock-based compensation plans. Under SFAS 123R, stock-based compensation costs are recognized based on the estimated fair value at the grant date for all stock-based awards. The Company estimates grant date fair values using the Black-Scholes-Merton option pricing model, which requires assumptions of the life of the award and the stock price volatility over the term of the award. The Company records compensation cost of stock-based awards using the straight line, single option method, which is recorded into earnings over the vesting period of the award.

 

The Company previously accounted for its stock-based compensation plans under the intrinsic value recognition and measurement provisions of Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, and related interpretations, and adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (“SFAS 123”), Accounting for Stock-Based Compensation, as amended by Statement of Financial Accounting Standards No. 148 (“SFAS 148”), Accounting for Stock-Based Compensation – Transition and Disclosures. Under APB 25, no compensation expense was recorded in earnings for the Company’s stock-based awards. The pro forma effects on net income and earnings per share for stock-based awards were instead disclosed in the footnotes to the consolidated financial statements.

 

The Company has elected to use the modified prospective transition method as permitted under SFAS 123R and therefore has not restated its financial results for prior periods. Under this transition method, compensation cost recorded in the three months ended March 31, 2006 includes the cost for all stock-based awards granted prior to, but not yet vested as of December 31, 2005, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123. Compensation expense for all stock-based awards granted after December 31, 2005 was based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.

 

Compensation expense recognized in the statement of operations for the three months ended March 31, 2006 is based on awards ultimately expected to vest and reflects an estimate of awards that will be forfeited. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Prior to the adoption of SFAS 123R, forfeitures were recorded as they occurred. The cumulative effect of estimated forfeitures was $160,000 for the three months ended March 31, 2006.

 

8



 

The following table illustrates the stock-based compensation expense resulting from stock-based awards included in the condensed consolidated statement of operations (amounts in thousands):

 

 

 

Three months ended
Mar 31, 2006

 

Stock-based compensation expense:

 

 

 

 

Cost of software, hosting and support

 

$

38

 

Cost of professional services

 

97

 

Sales and marketing

 

366

 

Research and development

 

159

 

General and administrative

 

123

 

Stock-based compensation expense before income taxes

 

783

 

Income tax provision (benefit)

 

 

Stock-based compensation expense, net of income taxes

 

$

783

 

 

No stock-based compensation expense was capitalized during the three months ended March 31, 2006.

 

The following table presents the impact of our adoption of SFAS 123R on selected line items from our condensed consolidated financial statements for the three months ended March 31, 2006 (amounts in thousands, except per-share amounts):

 

 

 

As Reported
Following
SFAS 123R

 

If Reported
Following
APB 25

 

Condensed consolidated statement of operations:

 

 

 

 

 

Income (loss) from operations

 

$

(1,156

)

$

(373

)

Income (loss) before income taxes

 

(484

)

299

 

Net income (loss)

 

(440

)

343

 

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

Basic

 

$

(0.01

)

$

0.01

 

Diluted

 

(0.01

)

0.01

 

 

 

 

 

 

 

Condensed consolidated statement of cash flows:

 

 

 

 

 

Cash provided by operating activities

 

$

6,052

 

$

6,052

 

Cash provided by financing activities

 

425

 

425

 

 

Unrecognized compensation expense of outstanding stock options at March 31, 2006 was approximately $10 million, which is expected to be recognized over a weighted average period of 2.5 years.

 

The following table illustrates the effect on reported net income and net income per share for the three months ended March 31, 2005 as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based awards (in thousands, except per-share data):

 

 

 

Three months ended
Mar 31, 2005

 

Net income, as reported

 

$

801

 

Less: stock-based compensation

 

(591

)

Pro forma net income

 

$

210

 

 

 

 

 

Net income per share:

 

 

 

Basic:

 

 

 

As reported

 

$

0.03

 

Pro forma

 

0.01

 

Diluted:

 

 

 

As reported

 

$

0.02

 

Pro forma

 

0.01

 

 

9



 

The estimated weighted average fair value per share of stock options granted in the three months ended March 31, 2005 and 2006 was $8.01 and $9.59, respectively. The estimated fair value of shares purchased under the ESPP for the three months ended March 31, 2005 was $5.79. There was no compensation expense under the ESPP for the three months ended March 31, 2006 because the terms of the plan for the purchase period ending June 30, 2006 were deemed noncompensatory under SFAS 123R. Assumptions used to obtain the estimated fair values were: 

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2006

 

Employee Stock Options

 

 

 

 

 

Weighted average risk free rate

 

3.9

%

4.4

%

Expected term

 

5 yrs

 

4.8 yrs

 

Volatility

 

74

%

57

%

Dividend yield

 

0

%

0

%

 

 

 

 

 

 

Employee Stock Purchase Plan

 

 

 

 

 

Risk free rate

 

2.9

%

 

Expected term

 

0.5 yrs

 

 

Volatility

 

74

%

 

Dividend yield

 

0

%

 

 

Key assumptions used to estimate the fair value of stock awards are as follows:

 

Risk Free Rate: The risk-free rate is determined by reference to the U.S. Treasury yield curve in effect at or near the time of grant for the expected term of the award.

 

Expected Term: The expected term represents the period that the Company’s stock-based awards are expected to be outstanding and is determined based on historical experience of similar awards, giving consideration to the contractual term of the awards, vesting schedules and expectations of employee exercise behavior.

 

Volatility: The Company’s estimate of expected volatility for the three month period ended March 31, 2006 is based on a combination of the Company’s historical volatility and peer-company volatilities. The Company has a limited history of volatility, as well as limited traded options from which to derive implied volatility. The Company believes the combination of its historical and peer-company volatilities is more representative of future stock price trends than its historical volatility alone.

 

Dividend Yield: The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.

 

Activity under the Company’s stock option plans for the three months ended March 31, 2006 was as follows (option shares in thousands):

 

10



 

 

 

Shares
available
for grant

 

Outstanding
options

 

Weighted
average
exercise
price per
share

 

Aggregate
intrinsic
value (in
thousands)

 

Weighted
average
remaining
contractual
life (in years)

 

Balance at December 31, 2005

 

3,007

 

3,898

 

$

6.41

 

 

 

 

 

Annual reserve addition (1)

 

1,000

 

 

 

 

 

 

 

Granted

 

(347

)

347

 

18.48

 

 

 

 

 

Exercised

 

 

(151

)

2.87

 

 

 

 

 

Forfeited, expired, exchanged or canceled (2)

 

25

 

(42

)

10.41

 

 

 

 

 

Balance at March 31, 2006

 

3,685

 

4,052

 

$

7.53

 

$

34,964

 

7.4

 

 

 

 

 

 

 

 

 

 

 

 

 

Vested or expected to vest at March 31, 2006

 

 

 

3,745

 

$

7.15

 

$

33,628

 

7.2

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercisable at March 31, 2006

 

 

 

1,855

 

$

3.85

 

$

22,309

 

5.8

 

 


(1)          The 2004 Equity Incentive Plan provides for an automatic, annual increase on the first of each year in an amount equal to the lesser of: a) 1,000,000 shares; b) 4% of the number of outstanding common shares on the last day of the previous fiscal year; or c) such lesser amount as determined by the board of directors. The annual automatic increase has been approved by shareholders through December 31, 2014.

 

(2)          Shares forfeited, expired, exchanged or canceled under the 1998 Long-Term Equity Incentive and Stock Option Plan are not available for re-grant under the 2004 Equity Incentive Plan.

 

The total intrinsic value of options exercised during the three months ended March 31, 2005 and 2006 was $13.6 million and $2.1 million, respectively.

 

From time to time the Company may grant options to purchase stock to consultants. The Company accounts for consultant stock options in accordance with SFAS 123 and Emerging Issues Task Force Consensus Issue No. 96-18 (“EITF 96-18”), Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction With Selling, Goods or Services. Compensation expense for the grant of stock options to consultants is determined based on the estimated fair value of the stock options at the measurement date as defined in EITF 96-18 and is recognized over the vesting period. There were no stock options granted to non-employees for the three months ended March 31, 2005 or 2006.

 

11



 

(6)                     Commitments and Contingencies

 

Warranties and Indemnification

 

The Company’s on-demand application service is typically warranted to perform in accordance with its user documentation.

 

The Company’s arrangements generally include certain provisions for indemnifying customers against liabilities if its products or services infringe a third-party’s intellectual property rights. To date, the Company has not incurred any material costs as a result of such indemnifications and has not accrued any liabilities related to such obligations in the accompanying consolidated financial statements.

 

The Company has entered into service level agreements with a small number of its customers warranting certain levels of uptime reliability and permitting those customers to receive credits or terminate their license agreements in the event that the Company fails to meet those levels. To date, the Company has not provided any material credits, or cancelled any agreements related to these service level agreements.

 

The Company has also agreed to indemnify its directors and executive officers for costs associated with any fees, expenses, judgments, fines and settlement amounts incurred by any of these persons in any action or proceeding to which any of those persons is, or is threatened to be, made a party by reason of the person’s service as a director or officer, including any action by the Company, arising out of that person’s services as the Company’s director or officer or that person’s services provided to any other company or enterprise at the Company’s request.

 

Litigation

 

From time to time, the Company is involved in legal proceedings arising in the normal course of business. The Company believes that the resolution of these matters will not have a material effect on the Company’s consolidated financial position, results of operations or liquidity.

 

12



 

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

 

Cautionary Statement

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the financial statements and related notes in this report. This discussion contains forward-looking statements that involve risks and uncertainties. These forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s 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 and management’s future strategic plans. Our actual results could differ significantly from those projected in the forward-looking statements as a result of factors, including those discussed under “Risk Factors” and elsewhere in this report. We assume no obligation to update the forward-looking statements or such risk factors.

 

Overview

 

We are a leading provider of customer experience management software solutions for companies of all sizes. Our on demand software is designed to go beyond traditional customer relationship management (“CRM”) solutions to support a business’s external customer-facing channels as wall as sales, marketing and customer service operations.

 

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 that are complementary to our RightNow Service solution, including RightNow Marketing and RightNow Sales, which automate aspects of marketing campaigns and sales operations. In May 2005, we purchased the assets of Convergent Voice, and added voice self-service capabilities to our product portfolio. To date, approximately 90% of our revenue has been generated by the RightNow Service suite.

 

During the three months ended March 31, 2006, we acquired 97 new customers to bring our customer base to more than 1,500, and our products served more than 280 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. Approximately 87% of our clients have elected the hosted option as of March 31, 2006. 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 are generally two years in length, but can range from six months to five years, and include our software and related upgrades, and hosting and support services over the term of the agreement. The majority of our revenue in each of our last three years and the three months ended March 31, 2006 was derived from two-year term license agreements. We also offer monthly term license agreements that contain a minimum commitment period 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.

 

13



 

Our software license agreements generally include capacity-based fees, which are measured primarily by web pages served, user seats, outgoing email transactions, or minutes used, 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.

 

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 client’s specific business application.

 

Professional services are sold with initial license agreements and periodically over the client engagement. The average deployment time for our clients is approximately 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 (e.g. employee benefits and payroll taxes) 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. Beginning January 1, 2006, cost of revenue also includes stock-based compensation expense.

 

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 2003, 2004 and 2005, 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.

 

14



 

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. Beginning January 1, 2006, sales and marketing expenses also include stock-based compensation expense. We expense our sales commissions when earned, which is typically 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 additional increases in sales and marketing expenses in absolute dollars as we continue to 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. Beginning January 1, 2006, research and development expenses also include stock-based compensation expense. 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. Beginning January 1, 2006, general and administrative expenses also include stock-based compensation expense. We anticipate that we will incur additional employee salaries and related expenses, professional service fees and insurance costs related to the growth of our business and operations.

 

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 management’s 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:

 

Revenue Recognition

 

We account for our sales arrangements in accordance with the American Institute of Certified Public Accountants Statement of Position (“SOP”) 97-2, Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition With Respect to Certain Transactions. The application of these SOPs requires judgment, including the identification of individual elements in multiple element arrangements, and whether vendor specific objective evidence (“VSOE”) exists for those elements. Customers may receive certain elements upon delivery or over time. For example, under our sales arrangements customers typically receive the software license up front, and receive hosting and support services continuously over the length of the agreement. Under our term arrangements, revenues for the software, hosting and support elements are aggregated and recognized ratably over the length of the agreement because VSOE for the individual elements does not exist. Under a perpetual license arrangement, VSOE of the hosting and support elements is based on the price charged at renewal, and therefore the license element is recognized immediately into revenue upon delivery using the residual

 

15



 

method, and the hosting and support elements are recognized ratably over the contractual term. Changes to the elements in our software arrangements, the ability to establish VSOE for those elements, and the fair value of the respective elements could materially effect the amount of our earned and deferred revenue.

 

Our standard payment terms are net 30, although payment within 90 days is considered normal. We provide extended payment terms in certain circumstances. In such cases, judgment is required in determining whether our fee is fixed and determinable and the appropriate timing of revenue recognition. Changes in our business practices for providing extended payment terms and/or providing concessions following a sale, may effect our assessment of fixed and determinable fees and result in a material change to the amount of revenue recorded in a given period.

 

Allowance for doubtful accounts

 

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 customer’s current creditworthiness; customer concentration; age of the receivable balance; and general economic conditions that may affect a customer’s ability to pay. Actual customer collections could differ from our estimates and exceed our related loss allowance.

 

Income Taxes

 

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 our net deferred tax assets due to uncertainties regarding the realization of our net operating loss carryforwards, tax credits, and deductible timing differences. The uncertainty of realizing these benefits is based primarily on our lack of taxable earnings.

 

Equity-Based Compensation

 

We have adopted the provisions of Statement of Financial Accounting Standards No. 123(R), Share Based Payment, (“SFAS 123R”) beginning January 1, 2006 utilizing the modified prospective method. This statement requires the cost of share-based payment arrangements to be recorded in the statement of operations. Prior to 2006, the estimated cost of share-based payment arrangements was disclosed in a footnote to the financial statements. Share-based compensation amounts are affected by our stock price as well as our assumptions regarding the expected volatility of our stock, our employee stock option exercise behaviors, and the related income tax effects. Our assumptions are based primarily on our historical information, some of which was developed when we were a private company.

 

Recently Issued Accounting Standards

 

In February 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 155, Accounting for Certain Hybrid Instruments, which amends SFAS 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Debt. The new standard allows financial instruments that have embedded derivatives to be accounted for as a whole, thereby eliminating the need to bifurcate the derivative from the host instrument, if the holder elects to account for the whole instrument on a fair value basis. The new standard also clarifies certain items that are not subject to SFAS

 

16



 

133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. We do not believe the adoption of SFAS 155 will have a material effect on our financial statements.

 

Results of Operations

 

The following table sets forth certain consolidated statement of operations data expressed as a percentage of total revenue for the periods indicated:

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2006

 

Revenue:

 

 

 

 

 

Software, hosting and support

 

76

%

78

%

Professional services

 

24

 

22

 

Total revenue

 

100

 

100

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

Software, hosting and support

 

11

 

11

 

Professional services

 

15

 

17

 

Total cost of revenue

 

26

 

28

 

 

 

 

 

 

 

Gross profit

 

74

 

72

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Sales and marketing

 

51

 

56

 

Research and development

 

12

 

13

 

General and administrative

 

8

 

8

 

Total operating expenses

 

71

 

77

 

 

 

 

 

 

 

Income (loss) from operations

 

3

 

(5

)

 

 

 

 

 

 

Interest and other income (expense), net

 

1

 

3

 

 

 

 

 

 

 

Income (loss) before income taxes

 

4

 

(2

)

Provision for income taxes

 

 

 

Net income (loss)

 

4

%

(2

)%

 

The following table sets forth our on-demand customer interactions and percent of clients hosting and our revenue by type and geography expressed as a percentage of total revenue for each of the periods indicated:

 

 

 

Three Months Ended
March 31,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

Customer interactions (in millions)

 

166

 

281

 

Percentage of clients hosting

 

86

%

87

%

 

 

 

 

 

 

Revenue by type:

 

 

 

 

 

Recurring (term licenses, hosting and support)

 

58

%

57

%

Perpetual licenses

 

18

 

22

 

Professional services

 

24

 

22

 

 

 

 

 

 

 

Revenue by geography in:

 

 

 

 

 

United States

 

75

%

71

%

Europe

 

15

 

20

 

Asia Pacific

 

10

 

9

 

 

17



 

Overview of Current Period and Outlook

 

Revenue for the quarter ended March 31, 2006 of $24.6 million was 34% more than the first quarter of 2005, and represented our 33rd consecutive quarter of top-line growth. Revenue growth has been driven by new customer acquisitions, the release of new products, and customer purchases of additional capacity. We signed 97 new customers during the quarter ended March 31, 2006 to bring our total customer base to more than 1,500 and our deferred revenue balance to $80.9 million. Growth in revenue and deferred revenue during the quarter ended March 31, 2006 increased sales commissions, which increased sales and marketing expenses to 56% of revenue in the first quarter of 2006 as compared to 51% of revenue in the first quarter of 2005. Beginning January 1, 2006 we adopted the provisions of the new accounting standard for stock-based compensation and recorded $783,000 of stock-based compensation expenses in the first quarter of 2006. The higher sales and marketing expenses combined with the stock-based compensation expenses caused a negative operating margin in the first quarter of 2006.

 

For the three months ended March 31, 2006, we generated $6.1 million of cash from operations compared to $3.2 million of cash from operations in the first quarter of 2005.

 

As of March 31, 2006 we had an accumulated deficit of $33.7 million. This deficit resulted primarily from costs incurred in the development, sales and marketing of our products and for general and administrative purposes. We intend to continue to invest in our sales and marketing activities, product development and business infrastructure. During periods of investment and growth, because the majority of expenses are recorded as incurred and the majority of revenue is deferred, we anticipate that any growth in revenue will be largely offset by an increase in cost of revenue and operating expenses.

 

Three Months Ended March 31, 2005 and 2006

 

Revenue

 

 

 

Three Months Ended March 31,

 

(Amounts in thousands)

 

2005

 

2006

 

Percent
Change

 

 

 

 

 

 

 

 

 

Software, hosting and support

 

$

13,874

 

$

19,310

 

39

%

Professional services

 

4,468

 

5,321

 

19

 

Total revenue

 

$

18,342

 

$

24,631

 

34

%

 

Software, hosting and support

 

For the quarter ended March 31, 2006, software, hosting and support revenue increased $5.4 million, or 39%, over the first quarter of 2005. The increase resulted primarily from a 16% increase in average revenue per client and a 20% increase in the average number of clients. Average revenue per client has grown from additional usage capacity and upgrades and enhancements purchased by clients. Additional usage capacity purchased by clients is reflected by customer interactions, which grew to 281 million for the quarter ended March 31, 2006 from 166 million in the comparable 2005 quarter. We added 97 new clients during the quarter ended March 31, 2006 primarily due to the addition of sales representatives focused on new client acquisition. Recurring software, hosting and support revenue was $14 million in the quarter ended March 31, 2006, or 32% more than the comparable 2005 quarter.  In addition, beginning January 1, 2006, average software, hosting and support revenue per client includes the value of certain tools that had been categorized as professional services revenue in prior periods. This change in revenue categorization follows the transfer of ongoing development and support responsibility for these tools from the professional services organization to the software, hosting and support organization effective January 1, 2006.

 

Perpetual license fee revenue represented 22% of total revenue in the quarter ended March 31, 2006 compared to 18% in the quarter ended March 31, 2005. The mix of perpetual license revenue affects our overall profitability in any given period since it is recorded into revenue in full upon delivery instead of

 

18



 

being ratably recognized into revenue, as is the case with term licenses. Perpetual license revenue has ranged between 18% and 29% of total revenue over the past eight quarters, but has been declining over the past four quarters. We believe there are many factors that cause our perpetual license revenue to fluctuate as a percentage of total revenue, including the strategic importance of our products in client organizations, client planning horizons, and client purchasing preferences and patterns. For these reasons, we expect perpetual license revenue to continue to fluctuate in future periods.

 

Professional services

 

For the quarter ended March 31, 2006, professional services revenue increased $853,000, or 19%, over the first quarter of 2005. Average professional services revenue per client decreased slightly in the first quarter of 2006 compared to the first quarter of 2005, while average number of clients increased 20%. Average professional services revenue per client decreased slightly during the first quarter ended March 31, 2006 primarily because of a prospective change in classification of certain tools from professional services revenue to software, hosting and support revenue. These tools, consisting of connectors to other general-use software applications and customization tools, had been created by our professional services organization and included in professional services revenue in 2005 and prior years. Effective January 1, 2006, we transferred the ongoing development and support responsibilities for these tools to our product group, and accordingly, the associated revenue is classified as software, hosting and support revenue beginning in 2006.

 

The mix of professional services revenue to total revenue will also affect our operating results from period-to-period, due to the lower gross profit earned on professional services revenue as compared to software, hosting and support revenue. We expect professional services revenue to range between 20% and 25% of total revenue in future periods.

 

Cost of Revenue

 

 

 

Three Months Ended March 31,

 

(Amounts in thousands)

 

2005

 

2006

 

Percent
Change

 

 

 

 

 

 

 

 

 

Software, hosting and support

 

$

2,064

 

$

2,771

 

34

%

Professional services

 

2,696

 

4,104

 

52

 

Total cost of revenue

 

$

4,760

 

$

6,875

 

44

%

 

Software, hosting and support

 

For the quarter ended March 31, 2006, cost of software, hosting and support revenue increased $707,000, or 34%, over the comparable 2005 quarter mostly due to the additions of staff and capacity to our hosting data centers. Staff additions in our software, hosting and support organization increased salaries and related employee costs by $331,000 in the first quarter of 2006 over the first quarter of 2005. Stock-based compensation expense included in the cost of software, hosting and support was $38,000 and zero in the first quarter of 2006 and 2005, respectively. Additional hosting capacity increased equipment depreciation expenses and third-party hosting service costs by $172,000 in the first quarter of 2006 over the first quarter of 2005. Average employee count in our hosting and support organization was 59 in the first quarter of 2006 compared to 52 in the first quarter of 2005. As a percent of the associated revenue, cost of software, hosting and support declined slightly to 14% in the first quarter of 2006 from 15% in the first quarter of 2005, primarily due to efficiencies gained in our hosting operations.

 

Professional services

 

For the quarter ended March 31, 2006, professional services costs increased $1.4 million, or 52%, over the comparable 2005 quarter. The growth in absolute dollars in the first quarter of 2005 resulted primarily from staff additions, which increased salaries and related expenses by $920,000. Travel and living expenses increased by $279,000 in the first quarter of 2006 over the first quarter of 2005 mostly due to a training forum held in January 2006. Stock-based compensation expense in the cost of professional services was $97,000 in the first quarter of 2006 as compared to zero in the first quarter of 2005. Average employee count in our professional services group was 108 in the first quarter of 2006 compared to 77 in the first quarter of 2005. As a percent of the associated revenue, professional services costs were 77% in

 

19



 

the 2006 quarter as compared to 60% in the 2005 quarter, mostly due to the 2006 reclassification noted above in the discussion under professional services revenue. We expect the cost of professional services to range between 65% and 75% of the associated revenue in the future.

 

Operating Expenses

 

 

 

Three Months Ended March 31,

 

(Amounts in thousands)

 

2005

 

2006

 

Percent
Change

 

 

 

 

 

 

 

 

 

Sales and marketing

 

$

9,457

 

$

13,726

 

45

%

Research and development

 

2,161

 

3,130

 

45

 

General and administrative

 

1,410

 

2,056

 

46

 

Total operating expenses

 

$

13,028

 

$

18,912

 

45

%

 

Sales and Marketing Expenses

 

For the quarter ended March 31, 2006, sales and marketing expense increased $4.3 million, or 45%, over the comparable 2005 quarter primarily due to the addition of sales representatives and increased sales incentive costs. Average employee count in our sales and marketing organization increased to 235 in the first quarter of 2006 from 188 in the first quarter of 2005. The employee growth added $1.5 million in salaries and related expenses, $309,000 in travel and living expenses, and $282,000 in recruiting and employee relations expenses. Stock-based compensation expense in our sales and marketing organization was $366,000 in the quarter ended March 31, 2006 as compared to zero in the quarter ended March 31, 2005. In addition, sales commissions increased $1.4 million in the quarter ended March 31, 2006 over the quarter ended March 31, 2005 due to growth in the value of new customer contracts invoiced. As a percent of total revenue, sales and marketing expenses increased to 56% in the first quarter of 2006 from 51% in the first quarter of 2005 mostly due to the current expense of sales incentives while the majority of revenue is deferred and recognized over the contractual periods.

 

Research and Development Expenses

 

For the quarter ended March 31, 2006, research and development expenses increased $969,000, or 45%, over the comparable 2005 quarter due to higher salaries and related costs of $753,000. Average employee count in our research and development organization grew to 112 employees in the first quarter of 2006 from 89 employees in the first quarter of 2005. Stock-based compensation expense in the first quarter of 2006 for the research and development group was $159,000 as compared to zero in the first quarter of 2005.

 

General and Administrative Expenses

 

For the quarter ended March 31, 2006, general and administrative expenses increased $646,000, or 46%, over the first quarter of 2005 due to employee growth and increased costs for Sarbanes-Oxley compliance. Average employees in our general and administrative organization were 52 in the first quarter of 2006 and 37 in the first quarter of 2005, which increased payroll and related costs by approximately $289,000. Sarbanes-Oxely compliance costs increased $115,000 in the 2006 quarter over the 2005 quarter primarily due to higher fees from our independent public accounting firm for the estimated costs of their attestation work on our 2006 internal control procedures. Stock-based compensation expense for the first quarter of 2006 in our general and administrative group was $123,000 as compared to zero in the first quarter of 2005.

 

20



 

Stock-based Compensation

 

We adopted the provisions of Statement of Financial Accounting Standards No. 123(r), Share Based Payment, using the modified prospective method, on January 1, 2006. Under the modified prospective method, prior periods have not been restated to conform with the current period accounting treatment. Adoption of this accounting standard required the recognition of $783,000 of stock-based compensation expense in the first quarter of 2006, which has been recorded to each cost and expense category in our statement of operations. Amounts recorded to each cost and expense category have been noted in the above discussion. At March 31, 2006, we had approximately $10 million of deferred stock-based compensation expense that is expected to be recorded into earnings over a weighted-average period of 2.5 years. Total stock-based compensation expense for the year ended December 31, 2006 is anticipated to be approximately $5 million. This estimate is based on assumptions regarding our stock price, the number and timing of stock awards granted and forfeited, our stock price volatility, and employee exercise behaviors. Actual stock-based compensation expense could differ materially from our estimates.

 

Interest and Other Income (Expenses), Net

 

 

 

Three Months Ended
March 31,

 

(Amounts in thousands)

 

2005

 

2006

 

 

 

 

 

 

 

Interest income

 

$

303

 

$

674

 

Interest expense

 

 

(2

)

Other income (expense)

 

(11

)

 

Total interest and other income (expense)

 

$

292

 

$

672

 

 

Interest income of $674,000 in the quarter ended March 31, 2006 increased 122% over interest income of $303,000 in the quarter ended March 31, 2005 due to growth in the average yield-to-maturity in our investment portfolio, as well as growth in our cash and short-term investment balances. Investment yields have risen along with the periodic increases in the federal funds rate. Our investment portfolio consists primarily of investment-grade, short-term government and corporate debt instruments. Interest expense in the 2006 quarter resulted from a capitalized lease obligation. Other income (expense) consists of gains or losses on equipment disposals and realized foreign currency exchange gains or losses, which has not been material individually or in the aggregate for the periods presented.

 

Provision for Income Taxes

 

Our effective tax rate was 9% of the pre-tax loss in the three months ended March 31, 2006 as compared to 5% of pre-tax income in the quarter ended March 31, 2005. The effective tax rate is based on our expectations for the full year results, and is dependent on many factors, including actual tax deductions for stock-based compensation as compared to book deductions, the level of business conducted in state and foreign tax jurisdictions, management’s expectations of the realization of deferred tax assets and the associated valuation allowance, and other factors.

 

At March 31, 2006, we had $22.6 million of net deferred income 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 we will be able to utilize some or all of our deferred tax assets, we will record an income tax benefit or a credit to additional paid-in capital in the amount of the asset recognized. At that time, we expect that our effective tax rate would increase to more closely approximate the U.S. federal statutory rate.

 

Liquidity and Capital Resources

 

Information regarding deferred revenue and cash provided by operating activities follows (in thousands):

 

21



 

 

 

Quarter Ended

 

(Amounts in thousands)

 

Mar 31,
2005

 

Jun 30,
2005

 

Sep 30,
2005

 

Dec 31,
2005

 

Mar 31,
2006

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred revenue

 

$

52,810

 

$

57,368

 

$

63,752

 

$

67,923

 

$

80,906

 

Cash provided by operating activities

 

3,239

 

2,564

 

5,248

 

3,844

 

6,052

 

 

We have historically funded our operations with cash from operations, equity financings and debt borrowings. In August 2004 we completed our initial public offering of 6.4 million shares of common stock and received net proceeds of approximately $40 million. The offering proceeds are invested in short-term, interest-bearing securities.

 

At March 31, 2006, cash and cash equivalents, and short-term investments, totaled $69.5 million. In addition to our cash and short-term investments, other sources of liquidity at March 31, 2006 included a $3.0 million bank line of credit facility under which there have been no borrowings to date.

 

Operating activities provided $6.1 million of cash during the three months ended March 31, 2006, as compared to $3.2 million of cash from operations in the corresponding period of the prior year. The majority of our cash from operations in the first quarter of 2006 was from growth in deferred revenue and collections of accounts receivable. We typically bill customers on net 30-day terms at the beginning of the license period, which is reflected in accounts receivable and deferred revenue. In periods of increasing sales, we would expect growth in accounts receivable and deferred revenue which, historically, has provided funding for operations. A change in our billing practice resulting in delayed payment terms could have a material adverse effect on cash provided from operations and growth in deferred revenue.

 

The allowance for uncollectible accounts receivable represented 4% and 5% of current accounts and term receivables at March 31, 2006 and December 31, 2005, respectively. We regularly assess the adequacy of the allowance for uncollectible accounts. Actual customer collections could differ from our estimates and exceed the related loss allowance.

 

We do not expect to pay significant cash income taxes in 2006 primarily because of the availability of operating loss carryforwards that may be utilized to offset taxable income, if any, in 2006.

 

Investing activities used $4.9 million in cash during the three months ended March 31, 2006 due to net purchases of short-term investments and capital expenditures. Capital expenditures consist primarily of capacity additions to our hosting operations and are expected to range between $8 million and $9 million for the full year 2006.

 

Financing activities provided $0.4 million in the three months ended March 31, 2006 from the exercise of employee stock options.

 

We believe our existing cash and short-term investments, together with funds generated from operations, should be sufficient to fund operating and investment requirements for at least the foreseeable future. Our future capital requirements will depend on many factors, including our rate of revenue growth and expansion of our sales and marketing activities, the possible acquisition of complementary products or businesses, the timing and extent of spending required for research and development efforts, and the continuing market acceptance of our products. To the extent that available funds are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financings. Additional equity or debt financing may not be available on terms favorable to us or at all.

 

Off-Balance Sheet Arrangements

 

As of March 31, 2006, 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.

 

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Contractual Obligations and Commitments

 

We did not incur any material new or increased contractual obligations or commitments during the quarter ended March 31, 2006.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Foreign Currency Exchange Risk

 

Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro, British pound, Australian dollar, and Japanese yen, because our contracts are frequently denominated in local currency. To date, we have not entered into any hedge transactions since exchange rate fluctuations have had little impact on our operating results and cash flows. In the future, we may utilize foreign currency forward and option contracts to manage currency exposures.

 

Interest Rate Sensitivity

 

Interest income and expense are sensitive to changes in the general level of U.S. interest rates. Net proceeds of our initial public offering of common stock are invested in short-term, interest-bearing securities, which are subject to credit and interest rate risk. Our investment portfolio is investment-grade and diversified among issuers and types to reduce credit risk. The average maturity of our investment portfolio is less than 90 days and we expect to hold the investments until maturity. If market interest rates were to increase by 100 basis points from the level at March 31, 2006, the fair value of our investment portfolio would decline by approximately $141,000.

 

Item 4. Controls and Procedures

 

(a)                                 Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission and (ii) accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

(b)                                 Changes to Internal Control over Financial Reporting

During the most recent completed fiscal quarter covered by this report, there has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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Part II. Other Information

 

Item 1. Legal Proceedings

 

From time to time, we are involved in legal proceedings in the ordinary course of business. We believe that the resolution of these matters will not have a material effect on the Company’s consolidated financial position, results of operations or liquidity.

 

Item 1A. Risk Factors

 

                A restated description of the risk factors associated with our business is set forth below.  This description includes any changes (whether or not material) to, and supercedes, the description of the risk factors associated with our business previously disclosed in Part 1, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2005.

 

                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 Securities and Exchange Commission, including our reports on Forms 10-K, 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.

 

                We may not be able to achieve, sustain or increase profitability in the future.

 

Prior to 2004, we incurred significant operating losses of approximately $4.1 million in 2003, $2.7 million in 2002 and $15.3 million in 2001. We also incurred an operating loss of $440,000 in the first quarter of 2006. As of March 31, 2006, we had an accumulated deficit of approximately $33.7 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 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 into revenue upon delivery whereas term licenses are recorded into revenue ratably over the period of license;

•               our policy of expensing sales commissions when earned, which is typically 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, because the gross margin on professional services is typically lower than the gross margin on software, hosting and support;

•               changes in the mix of voice self service applications sold and/or usage volume, because the gross margin on voice self service applications is typically lower than the gross margin on our sales, marketing and service applications;

•               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;

 

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         changes in the payment terms for our products and services, including changes in the mix of payment options chosen by our customers;

         the purchasing and budgeting cycles of our clients; and

         general economic, industry and market conditions.

 

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 the majority of business has been focused on providing solutions for customer service operations, we recently introduced RightNow CRM 7.5 and voice-enabled CRM applications to expand our solution offerings. 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 most recent product releases. 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 BMC Software Corporation, Inc., eGain Communications Corporation, FrontRange Solutions, Inc., IBM Corporation, Kana Software, Inc., Microsoft Corporation, Netsuite, Oracle Corporation/Siebel Systems, SAP AG, salesforce.com, inc., and SSA Global;

         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 client’s premises by software vendors;

         outsourced contact center providers who bundle solutions and agent labor in their service offerings;

         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; and

 

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         voice system integrators and voice-enabled IVR technology providers, such as Edify, Unveil Technologies, Apptera, Voxify, TuVox, Microsoft, IBM, and Intervoice.

 

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. For example, in January 2006, Oracle Corporation completed its acquisition of Siebel Systems, Inc. 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 relationship management applications in particular. The willingness of companies to increase their use of any on-demand application services is in part dependent on the actual and perceived reliability of hosted solutions. In addition, 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 on-demand solutions in general, or our on-demand solutions in particular, 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

 

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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 our clients may elect not to renew, we may not be 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 578 at March 31, 2006 from 530 at December 31, 2005. 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 March 31, 2006, approximately 87% of our clients were using our hosting services for deployment of our software applications. We provide our hosting services for our non-voice applications 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 provide hosting services for our voice

 

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applications through a third-party hosting facility based in Georgia, using hardware owned and operated by the third party. We do not maintain long-term supply contracts with any of our hosting providers, and providers do not guarantee that our clients’ access to hosted solutions will be uninterrupted, error-free or secure. Our operations depend on our 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 (non-voice) and in New York (voice) 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 all hosting facilities. In the event that our hosting 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 hosting facilities to meet our capacity requirements could result in interruptions in our service or impede our ability to scale our operations.

 

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 29% and 25% of our revenue for the quarters ended March 31, 2006 and 2005, respectively. We intend to continue to pursue and expand our international business activities. 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 abroad, 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;

 

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         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 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

 

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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 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 rights of others. We have in the past been named as a defendant in a lawsuit 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

 

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or at all. Because our license agreements typically 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. 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. In May 2005, we acquired the intellectual property and other assets of Convergent Voice, Inc., our first acquisition since becoming a public company. 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 future acquisitions, it is possible that we may not realize the anticipated benefits from the acquisitions or 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.

 

Changes to financial accounting standards may affect our results of operations and financial condition.

 

Generally accepted accounting principles and accompanying accounting pronouncements, implementation guidelines and interpretations for many aspects of our business, such as software revenue recognition and accounting for stock-based compensation, are complex and involve subjective judgments by management. Changes to generally accepted accounting principles, their interpretation, or changes in our products or business could significantly change our reported earnings and financial condition and could add significant volatility to those measures. For example, since our inception in 1997, we have used stock options as a fundamental component of our employee compensation programs. New accounting

 

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requirements that began January 1, 2006 make the use of stock-based compensation much more expensive and introduce additional volatility in our results of operations. See Note 5 to the Condensed Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies in this report for additional information on recently enacted changes to generally accepted accounting principles.

 

Volatility in the price of our common stock may adversely affect our ability to predict the fair value of our stock awards and the resulting stock-based compensation expense.

 

The fair value of stock awards under SFAS 123R is estimated using several factors, including the underlying price of the stock option, which is not known until the date of grant, and Company assumptions of expected stock price volatility, the expected term of the award, and other factors. These factors can cause significant variations in the estimated fair value of the awards, and therefore cause significant fluctuations in our operating results. For example, the estimated fair value of stock options granted in our third quarter ended September 30, 2005 was $6.93 per share. However, due to an increase in the underlying price of our common stock, the estimated fair value of a like award granted in our fourth quarter ended December 31, 2005 would have increased 67% to $11.57 per share. Volatility in the market value of our stock could cause us to incur significantly higher or lower stock-based compensation expense in future periods. The trading price of our common stock depends in part on our ability to accurately forecast our results, and if we were to miss our forecasts, we may lose credibility with investors and research analysts, which in turn could cause the price of our common stock to decline.

 

The required adoption of SFAS 123R makes stock options a less attractive form of employee compensation, and our use of alternative forms of employee compensation in response to SFAS 123R could adversely affect our ability to attract and retain personnel.

 

We have historically used stock options as a key component of our employee compensation because, we believe it aligns employees’ interests with our stockholders’ interest, encourages employee retention, and provides a competitive component of our overall compensation program. Due to the required adoption of SFAS 123R, and the recording of stock option expense on our operating statements, we may determine that it is in our best interest to reduce the number or size of our stock-based awards, or change the type of awards granted. In doing so, we may not be able to attract, retain and motivate our employees.

 

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.

 

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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, or companies providing hosted solutions, 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.

 

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,

 

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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 have been enacted in many of the international jurisdictions in which we do business, including Europe, Australia, and Canada. 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. These factors may lead to a reduction in sales of our RightNow Marketing solution, may make it necessary to redesign our RightNow Marketing solution to make it easier for our clients to conform to the requirements of such 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.

 

General economic conditions could adversely affect our clients’ ability or willingness to purchase our products, which could materially and adversely affect our results of operations.

 

Our clients consist of large and small companies in nearly all industry sectors and geographies. Potential new clients or existing clients could defer purchases of our products because of unfavorable macroeconomic conditions, such as rising interest rates, fluctuations in currency exchange rates, industry or national economic downturns, industry purchasing patterns, and other factors. Our ability to grow revenues may be adversely affected by unfavorable economic conditions.

 

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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 March 31, 2006, Greg Gianforte, our founder and Chief Executive Officer, and his spouse, Susan Gianforte, together beneficially owned approximately 35% of our currently outstanding common stock and, together with our other officers and directors, beneficially owned approximately 51% of our currently outstanding common stock. In addition, none of the shares of common stock held by Mr. Gianforte and Mrs. Gianforte are subject to vesting restrictions. As a result, Mr. Gianforte and Mrs. Gianforte, acting alone or together with some of our other officers and 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 deprive 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.

 

Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or prevent a change in control of our company and may affect the trading price of our common stock.

 

Provisions of our certificate of incorporation and bylaws and Delaware law may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable and may limit the market price of our common stock. These provisions include the following:

 

      establishing a classified board in which only a portion of the total board members will be elected at each annual meeting;

      authorizing the board to issue preferred stock;

      providing the board with sole authority to set the number of authorized directors and to fill vacancies on the board;

      limiting the persons who may call special meetings of stockholders;

      prohibiting certain transactions under certain circumstances with interested stockholders;

      requiring supermajority approval to amend certain provisions of the certificate of incorporation; and

      prohibiting stockholder action by written consent.

 

It is possible that the provisions contained in our certificate of incorporation and bylaws, the existence of super voting rights held by insiders and the ability of our board of directors to issue preferred stock without stockholder action may have the effect of delaying, deferring or preventing a change in control of our company without further action by the stockholders, may discourage bids for our common stock at a premium over the market price of our common stock and may adversely affect the market price of our common stock and the voting and other rights of the holders of our common stock.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

(a)                                  Sales of Unregistered Securities

None.

 

(b)                                  Use of Proceeds from Sales of Registered Securities

 

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On August 5, 2004, the Securities and Exchange Commission declared effective our Registration Statement on From S-1 (Reg. File No. 333-115331) under the Securities Act of 1933, as amended, in connection with the initial public offering of our common stock, par value $.0001 per share. Of the 7,245,000 shares registered under the registration statement for an aggregate offering price of $50,715,000, we sold 6,416,961 shares, including shares sold upon exercise of the underwriters’ over-allotment option, for an aggregate offering price of $44,918,727, and 321,945 shares, including shares sold upon exercise of the underwriters’ over-allotment option, were sold by a selling stockholder for an aggregate offering price of $2,253,615. After deducting $3.3 million in underwriting discounts and commissions and $1.8 million in other offering costs, we received net proceeds from the offering of approximately $40 million. 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.

 

In May 2005, we spent $1 million of the offering proceeds for the acquisition of the assets of Convergent Voice. We currently intend to use the remaining proceeds for general corporate purposes as described in the prospectus for the offering. Pending these uses, the net proceeds from the offering are invested in short-term, interest-bearing, investment-grade securities.

 

(c)                                  Not applicable.

 

Item 3.          Defaults Upon Senior Securities.

 

None.

 

Item 4.          Submission of Matters to a Vote of Security Holders.

 

None.

 

Item 5.          Other Information.

 

None.

 

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Item 6.           Exhibits

 

Exhibits

 

The exhibits listed below are part of this Form 10-Q, unless otherwise indicated.

 

Exhibit 3.1†

 

Amended and Restated Certificate of Incorporation of the Registrant.

Exhibit 3.2*

 

Amended and Restated Bylaws of the Registrant.

Exhibit 10.9**(1)

 

Form of Executive Officer Offer Letter and schedule of omitted material details thereto.

Exhibit 10.20(1)

 

Form of Incentive Stock Option Agreement.

Exhibit 10.21(1)

 

Form of Non-Incentive Stock Option Agreement.

Exhibit 31.1

 

Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a) or 15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Exhibit 31.2

 

Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a) or 15(d)-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

Exhibit 32.1

 

Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith).

 


                  Incorporated by reference to Exhibit 4.2 to the Company’s registration statement on Form S-8 (File No. 333-118515) filed with the Securities and Exchange Commission on August 24, 2004.

*                 Incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K (File No. 000-31321) filed with the Securities and Exchange Commission on January 25, 2006.

**          Incorporated by reference to the exhibit of the same number from the Company’s registration statement on Form S-1 (File No. 333-115331) initially filed with the Securities and Exchange Commission on May 10, 2004, as amended, and to Exhibit 10.19 to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 18, 2006.

(1)          Denotes management contract or compensatory plan or arrangement.

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated: May 8, 2006

 

 

 

RightNow Technologies, Inc.

 

(Registrant)

 

 

 

By:

/s/ Susan J. Carstensen

 

 

 

Susan J. Carstensen

 

 

Chief Financial Officer, Vice President,

 

 

Treasurer and Assistant Secretary

 

 

(Principal Financial and Accounting Officer)

 

 

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