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Vocus 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1
e10vq
 

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Form 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
For the Quarter Ended March 31, 2006
Commission File Number 000-51644
 
 
 
 
 
     
Delaware
  58-1806705
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
 
4296 Forbes Boulevard
Lanham, Maryland 20706
(301) 459-2590
 
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 þ     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 o     Non-Accelerated Filer þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o     No þ
 
As of May 5, 2006, 15,080,147 shares of common stock, par value $0.01 per share, of the registrant were outstanding.
 


 

 
 
             
        Page
 
PART I — FINANCIAL INFORMATION
   
           
  Consolidated Financial Statements   2
    Consolidated Balance Sheets as of December 31, 2005 and March 31, 2006   2
    Consolidated Statements of Operations for the three months ended March 31, 2005 and 2006   3
    Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2006   4
    Notes to Consolidated Financial Statements   5
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   12
  Quantitative and Qualitative Disclosures about Market Risk   17
  Controls and Procedures   17
 
PART II — OTHER INFORMATION
           
  Legal Proceedings   18
  Risk Factors   18
  Unregistered Sales of Equity Securities and Use of Proceeds   30
  Other Information   30
  Exhibits   30
       
  31


1


 

 
Item 1.   Consolidated Financial Statements
 
Vocus, Inc. and Subsidiaries
 
 
 
                 
    December 31,
    March 31,
 
    2005     2006  
          (Unaudited)  
    (Dollars in thousands, except per share data)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 40,027     $ 40,109  
Short-term investments
    1,400       3,399  
Accounts receivable, net of allowance for doubtful accounts of $193 and $199 at December 31, 2005 and March 31, 2006, respectively
    6,012       4,744  
Prepaid royalty fees
    493       491  
Other current assets
    695       879  
                 
Total current assets
    48,627       49,622  
Property and equipment, net
    4,161       4,019  
Intangible assets, net:
               
Customer relationships, net
    2,217       1,962  
Purchased technology, net
    294       207  
Other intangible assets, net
    8        
                 
Intangible assets, net
    2,519       2,169  
Other assets
    529       546  
                 
Total assets
  $ 55,836     $ 56,356  
                 
 
LIABILITIES, REDEEMABLE STOCK AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 268     $ 321  
Accrued compensation
    1,451       1,128  
Accrued expenses
    1,333       1,241  
Current portion of notes payable and capital lease obligations
    642       721  
Current portion of deferred revenue
    20,018       20,740  
                 
Total current liabilities
    23,712       24,151  
Notes payable and capital lease obligations, net of current portion
    765       563  
Other liabilities
    105       110  
Deferred revenue, net of current portion
    678       606  
                 
Total liabilities
    25,260       25,430  
                 
Redeemable common stock, $0.01 par value, 29,128 shares issued and outstanding
    189       191  
Commitments and contingencies
               
Stockholders’ equity:
               
Preferred stock $0.01 par value, 10,000,000 shares authorized, no shares issued and outstanding
           
Common stock, $0.01 par value, 90,000,000 shares authorized; 15,805,018 and 15,967,512 shares issued at December 31, 2005 and March 31, 2006, respectively; 14,794,241 and 14,956,735 shares outstanding at December 31, 2005 and March 31, 2006, respectively
    158       160  
Additional paid-in capital
    70,470       70,987  
Treasury stock, 1,010,777 shares at cost
    (3,283 )     (3,283 )
Deferred compensation
    (19 )      
Accumulated other comprehensive income
    52       44  
Accumulated deficit
    (36,991 )     (37,173 )
                 
Total stockholders’ equity
    30,387       30,735  
                 
Total liabilities, redeemable stock and stockholders’ equity
  $ 55,836     $ 56,356  
                 
 
See accompanying notes.


2


 

Vocus, Inc. and Subsidiaries

Consolidated Statements of Operations

                 
    Three Months Ended March 31,  
    2005     2006  
    (Unaudited)
 
    (Dollars in thousands except per share data)  
 
Revenues
  $ 6,100     $ 8,262  
Cost of revenues, including amortization expense of $132 and $89 for the three months ended March 31, 2005 and 2006, respectively
    1,457       1,962  
                 
Gross profit
    4,643       6,300  
Operating expenses:
               
Sales and marketing
    3,354       4,005  
Research and development
    596       739  
General and administrative
    1,228       1,927  
Amortization of intangible assets
    394       261  
                 
Total operating expenses
    5,572       6,932  
                 
Loss from operations
    (929 )     (632 )
Other income (expense):
               
Interest and other income
    25       503  
Interest expense
    (47 )     (21 )
                 
Total other income (expense)
    (22 )     482  
                 
Loss before provision for income taxes
    (951 )     (150 )
Provision for income taxes
          (32 )
                 
Net loss
    (951 )     (182 )
Accretion on preferred stock
    (508 )      
                 
Net loss attributable to common stockholders
  $ (1,459 )   $ (182 )
                 
Net loss attributable to common stockholders per share:
               
Basic and Diluted
  $ (0.35 )   $ (0.01 )
Weighted average shares used in computing per share amounts:
               
Basic and Diluted
    4,168,621       14,965,271  
 
See accompanying notes.


3


 

Vocus, Inc. and Subsidiaries
 
 
                 
    Three Months Ended March 31,  
    2005     2006  
    (Unaudited)
 
    (Dollars in thousands)  
 
Cash flows from operating activities:
               
Net loss
  $ (951 )   $ (182 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization of property and equipment
    119       275  
Amortization of intangible assets
    526       350  
Stock-based compensation
    4       378  
Provision for doubtful accounts
    (6 )     8  
Changes in operating assets and liabilities:
               
Accounts receivable
    292       1,263  
Prepaid royalty fees
    (108 )     2  
Other current assets
    62       (183 )
Other assets
    11       (17 )
Accounts payable
    663       50  
Accrued compensation
    (412 )     (324 )
Accrued expenses
    (172 )     (95 )
Deferred revenue
    312       643  
Other liabilities
    7       5  
                 
Net cash provided by operating activities
    347       2,173  
                 
Cash flows from investing activities:
               
Purchases of short-term investments
          (2,000 )
Software development and information database costs
    (795 )     (10 )
Purchases of property and equipment
    (522 )     (122 )
                 
Net cash used in investing activities
    (1,317 )     (2,132 )
                 
Cash flows from financing activities:
               
Proceeds from exercise of stock options
    96       161  
Proceeds from borrowings under revolving line of credit
    825        
Proceeds from notes payable
    368        
Payments on notes payable and capital lease obligations
    (37 )     (123 )
                 
Net cash provided by financing activities
    1,252       38  
Effect of exchange rate changes on cash and cash equivalents
    (4 )     3  
                 
Net increase in cash and cash equivalents
    278       82  
Cash and cash equivalents, beginning of period
    7,554       40,027  
                 
Cash and cash equivalents, end of period
  $ 7,832     $ 40,109  
                 
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $ 42     $ 15  
 
See accompanying notes.


4


 

 
Vocus, Inc. and Subsidiaries
 
 
1.   Business Description
 
 
Vocus, Inc. (Vocus or the Company) is a leading provider of on-demand software for corporate communications and public relations. The Company’s principal operations are located in Lanham, Maryland.
 
2.   Summary of Significant Accounting Policies
 
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. The consolidated balance sheet at December 31, 2005 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2005.
 
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
 
The Company considers all highly liquid investments purchased with an original maturity date of three months or less to be cash equivalents. Cash equivalents are recorded at cost, which approximates fair value.
 
 
Management determines the appropriate classification of short-term investments at the time of purchase and evaluates such determination as of each balance sheet date. Available-for-sale securities are stated at fair value based on quoted market rates. The net unrealized gains and losses on available-for-sale securities are reported as a component of comprehensive income (loss), net of tax. As of March 31, 2006, the net unrealized gains on available-for-sale securities were not material. The Company owns no investments that are considered to be trading or held-to-maturity securities.
 
The Company regularly monitors and evaluates the fair value of its investments to identify other than temporary declines in value. Management believes no such declines in value existed at March 31, 2006.
 
 
The Company derives its revenues principally from subscription arrangements permitting customers to access and utilize the Company’s on-demand software and from providing related professional services. The Company recognizes revenue when there is persuasive evidence of an arrangement, the service has been provided to the


5


 

 
Vocus, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 

customer, the collection of the fee is probable and the amount of the fee to be paid by the customer is fixed or determinable.
 
Subscription agreements generally contain multiple service elements and deliverables. These elements include access to the Company’s on-demand software and often specify initial services including implementation and training. Subscription agreements do not provide customers the right to take possession of the software at any time.
 
The Company considers all elements in its multiple element subscription arrangements as a single unit of accounting and recognizes all associated fees over the subscription period. In applying the guidance in Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables (EITF 00-21), the Company determined that it does not have objective and reliable evidence of the fair value of the subscription fees after delivery of specified initial services. The Company therefore accounts for its subscription arrangements and its related service fees as a single unit of accounting. As a result, all revenue from multiple element subscription arrangements is recognized ratably over the term of the subscription. The subscription term commences on the later of the start date specified in the subscription arrangement or the date access to the software is provided to the customer.
 
The Company recognizes revenue from professional services sold separately from subscription arrangements as the services are performed. The Company also has entered into a royalty agreement with a reseller of its application service. The Company recognizes this revenue over the term of the end-user subscription upon obtaining persuasive evidence, which includes monthly notification from the reseller, that the service has been sold and delivered.
 
In connection with the acquisitions of Gnossos Software, Inc. (Gnossos) and Public Affair Technologies (PAT), the Company acquired corporate communications and government relations software. The Company does not enter into new licenses for the Gnossos and PAT software, but continues to provide maintenance and support under contracts generally with a term of one year. Revenue is recognized ratably over the service period.
 
 
Deferred revenue consists of billings to customers in advance of revenue recognition. Deferred revenue to be recognized in the succeeding 12-month period is included in current deferred revenue with the remaining amounts included in non-current deferred revenue.
 
 
Sales commissions, including commissions related to deferred revenue, are expensed when a subscription agreement is executed by the customer.
 
 
Prior to January 1, 2006, the Company accounted for its stock-based compensation using the intrinsic value method of accounting under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25). The Company’s stock-based compensation awards have generally been granted with an exercise price equal to the estimated fair value of the underlying common stock on the grant date, and accordingly, any stock-based compensation related to stock option grants has not been material. The Company applied the disclosure provisions under Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation and related interpretations (SFAS No. 123) as if the fair value method had been applied in measuring compensation expense. As a result, stock-based compensation expense, based upon the fair value method, was included as a pro forma disclosure in the notes to the Company’s financial statements.


6


 

 
Vocus, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 

 
The following illustrates the effect on the Company’s net loss attributable to common stockholders as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation during the three months ended March 31, 2005 (dollars in thousands, except per share data):
 
         
    March 31, 2005  
 
Net loss attributable to common stockholders, as reported
  $ (1,459 )
Stock-based compensation, as reported
    4  
Pro forma stock-based compensation
    (25 )
         
Pro forma net loss attributable to common stockholders
  $ (1,480 )
         
Basic and Diluted net loss attributable to common stockholders per share:
       
As reported
  $ (0.35 )
Pro forma
  $ (0.36 )
 
On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standard No. 123(R), Share-Based Payment (SFAS No. 123R), using the modified-prospective transition method for the unvested portion of stock-based compensation awards granted after the Company became a public entity. Because the Company did not complete its initial public offering until December 2005, the Company has applied the prospective method to the unvested portion of stock-based compensation awards granted prior to June 15, 2005, the date the Company first filed a registration statement with the Securities and Exchange Commission (SEC). Accordingly, the Company has not restated its financial results for prior periods. Under the prospective method, the Company will continue to account for stock-based compensation awards granted before June 15, 2005 using the intrinsic value method as prescribed by APB No. 25. Under the modified prospective method, stock-based compensation expense for all stock-based compensation awards granted after June 15, 2005, but not vested as of December 31, 2005, is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. The Company recognizes compensation expense for stock-based compensation awards on a straight-line basis over the requisite service period of the award.
 
 
Income taxes are provided utilizing the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax-credit carryforwards, and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amount of assets and liabilities and their tax bases. Deferred tax assets are reduced by the valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
 
The Company incurred losses for all periods presented. A valuation allowance has been recorded to completely offset the carrying value of the Company’s net deferred tax asset because of the inability to predict future taxable income. For the three months ended March 31, 2006, the Company recorded an income tax provision of $32,000 to reflect the increase in the valuation allowance for Alternative Minimum Tax (AMT) credits related to estimated 2006 AMT payments.
 
 
Basic net loss attributable to common stockholders per share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net


7


 

 
Vocus, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 

loss attributable to common stockholders per share includes the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
 
The following summarizes the potential outstanding common stock of the Company as of the end of each period:
 
                 
    Three Months Ended March 31,  
    2005     2006  
 
Options to purchase common stock
    1,270,052       2,306,109  
Warrants to purchase common stock
    361,446       361,446  
Shares of common stock into which outstanding preferred stock is convertible
    5,826,668        
                 
Total options, warrants and preferred stock convertible into common stock
    7,458,166       2,667,555  
                 
 
If the Company’s outstanding common stock equivalents were exercised or converted into common stock, the result would be anti-dilutive and, accordingly, basic and diluted net loss attributable to common stockholders per share are identical for all periods presented in the accompanying consolidated statements of operations.
 
 
Comprehensive loss includes the Company’s net loss as well as other changes in stockholders’ equity that result from transactions and economic events other than those with stockholders. Other comprehensive income or loss includes foreign currency translation adjustments and unrealized gains and losses on short-term investments classified as available-for-sale securities. There were no material differences between net loss and comprehensive net loss for the three months ended March 31, 2005 and 2006.
 
3.   Initial Public Offering of Common Stock and Reverse Stock Split
 
  Initial Public Offering of Common Stock
 
In December 2005, the Company completed the sale of 5,000,000 shares of common stock, at a public offering price of $9.00 per share. A total of $45,000,000 in gross proceeds was raised in the initial public offering. After deducting the underwriters’ commissions and offering expenses of $4,979,000, net proceeds of the offering were $40,021,000. All of the outstanding shares of the Company’s redeemable convertible preferred stock were converted into shares of common stock, on a one-for-one basis, at the closing of the offering. In addition, warrants to acquire shares of Series B redeemable convertible preferred stock were converted, on a one-for-one basis, into warrants to acquire common stock.
 
  Reverse Stock Split
 
In October 2005, the Company effected a 3-for-1 reverse stock split. Accordingly, all share and per share amounts have been retroactively adjusted to give effect to this event.
 
4.   Stock-Based Compensation
 
The Company’s 1999 Stock Option Plan and the 2005 Stock Award Plan (the “Plans”) provide for the grant of stock options, restricted stock, stock appreciation rights and other equity awards to employees, consultants, officers and directors. The 2005 Stock Award Plan was adopted by the Board of Directors and stockholders in November 2005 in conjunction with the Company’s initial public offering. Under the 2005 Stock Award Plan, 2,600,000 shares have been reserved for future issuance, subject to annual increases. The Plans are administered by the


8


 

 
Vocus, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 

Compensation Committee of the Board of Directors, which has the authority, among other things, to determine which individuals receive awards pursuant to the Plans, and the terms of the awards. At March 31, 2006, only grants of stock options have been made under the Plans. Options granted under the Plans have a 10-year term and generally vest annually over a three or four-year period. At March 31, 2006, 1,318,750 shares were available for future grants. All shares available for future grant are restricted to the 2005 Stock Award Plan.
 
On January 1, 2006, the Company adopted the provisions of SFAS No. 123R requiring the recognition of compensation expense based upon the fair value of its stock-based compensation awards. The following table sets forth the incremental stock-based compensation expense related to the adoption of SFAS No. 123R that is recorded in the consolidated statement of operations for the three months ended March 31, 2006 (in thousands):
 
         
    March 31, 2006  
 
Cost of revenues
  $ 19  
Sales and marketing
    71  
Research and development
    53  
General and administration
    232  
         
Total
  $ 375  
         
 
The effect of adopting SFAS No. 123R was an increase to net loss of $295,000 or $0.02 per basic and diluted share.
 
During 2004, the Company granted certain options with an estimated fair value of the underlying stock that was greater than the exercise price, resulting in deferred compensation. Stock-based compensation from these awards for the three months ended March 31, 2005 and 2006 was $4,000 and $3,000, respectively. Upon the adoption of SFAS No. 123R, the related deferred compensation of $19,000 was reclassified to additional paid-in-capital.
 
In accordance with SFAS No. 123R, the Company used the Black-Scholes option pricing model to measure the fair value of its option awards granted after June 15, 2005. The Black-Scholes model requires the input of highly subjective assumptions including volatility, expected term, risk-free interest rate and dividend yield. In 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB No. 107) which provides supplemental implementation guidance for SFAS No. 123R. The Company recently became a public entity, and therefore has a limited history of volatility. Accordingly, the expected volatility is based on the historical volatilities of similar entities’ common stock over the most recent period commensurate with the estimated expected term of the awards. The expected term of an award is based on the “simplified” method allowed by SAB No. 107, whereby the expected term is equal to the midpoint between the vesting date and the end of the contractual term of the award. The risk-free interest rate is based on the rate on U.S. Treasury securities with maturities consistent with the estimated expected term of the awards. The Company has not paid dividends and does not anticipate paying a cash dividend in the foreseeable future and accordingly, uses an expected dividend yield of zero.
 
The following weighted-average assumptions were used in calculating stock-based compensation for options granted during the three months ended March 31, 2006:
 
         
Stock price volatility
    55 %
Expected term (years)
    6.3  
Risk-free interest rate
    4.6 %
Dividend yield
    0 %
 
The weighted-average grant date fair value of options granted during the three months ended March 31, 2006 was $7.16.


9


 

 
Vocus, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 

 
Stock-based compensation expense recognized is based on the estimated portion of the awards that are expected to vest. The Company applies estimated forfeiture rates based on analyses of historical data, including termination patterns and other factors.
 
Stock option activity for the three months ended March 31, 2006 is as follows:
 
                                         
                      Weighted-
       
                Weighted-Average
    Average
    Aggregate Intrinsic
 
    Number of
    Range of
    Exercise Price Per
    Contractual
    Value as of
 
    Options     Exercise Prices     Share     Term     March 31, 2006  
                            (in thousands)  
 
Balance outstanding at December 31, 2005
    2,468,351       $0.30 – $ 9.00     $ 5.92                  
Granted
    11,000       $12.42     $ 12.42                  
Exercised
    (162,494 )     $0.30 – $ 4.77     $ 0.99                  
Forfeited or cancelled
    (10,748 )     $2.46 – $12.42     $ 7.64                  
                                         
Balance outstanding at March 31, 2006
    2,306,109       $0.30 – $12.42     $ 6.29       8.3     $ 19,734  
                                         
Expected to vest at March 31, 2006
    2,176,853       $0.30 – $12.42     $ 6.21       8.3     $ 18,807  
                                         
Exercisable at March 31, 2006
    603,304       $0.30 – $ 9.00     $ 1.89       5.4     $ 7,819  
                                         
 
The following details the outstanding options at March 31, 2006:
 
                                         
    Options Outstanding     Options Exercisable  
                Weighted-
          Weighted-
 
          Weighted-Average
    Average
          Average
 
Range of
  Outstanding as of
    Remaining
    Exercise
    Exercisable as of
    Exercise
 
Exercise Price
  March 31, 2006     Contractual Life     Price     March 31, 2006     Price  
 
$0.30 – $1.24
    274,160       3.8     $ 0.30       274,160     $ 0.30  
$1.25 – $2.48
    312,801       6.2     $ 2.46       224,961     $ 2.46  
$2.49 – $4.97
    418,908       8.8     $ 4.71       98,875     $ 4.72  
$4.98 – $6.21
    13,162       9.1     $ 6.03       3,121     $ 6.03  
$6.22 – $7.45
    5,828       9.3     $ 7.05           $  
$7.46 – $9.94
    1,270,750       9.7     $ 9.00       2,187     $ 9.00  
$9.95 – $12.42
    10,500       9.9     $ 12.42           $  
                                         
      2,306,109       8.3     $ 6.29       603,304     $ 1.89  
                                         
 
The aggregate intrinsic value represents the difference between the exercise price of the underlying awards and the quoted closing price of the Company’s common stock at March 31, 2006 multiplied by the number of shares that would have been received by the option holders had all option holders exercised their options on March 31, 2006. During the three months ended March 31, 2006, the aggregate intrinsic value of options exercised was $2,252,000.
 
Cash proceeds from the exercise of stock options were $161,000 for the three months ended March 31, 2006. The Company did not realize a tax benefit from these exercises as substantially all stock options exercised were incentive stock options. Additionally, the Company has recorded a valuation allowance to completely offset its net deferred tax asset.
 
As of March 31, 2006, there was $5,454,000 of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under the Plans. This cost is expected to be recognized over a weighted


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Vocus, Inc. and Subsidiaries
 
Notes to Consolidated Financial Statements — (Continued)
 

average period of 3.7 years. Substantially all options that vested during the three months ended March 31, 2006 were granted prior to June 15, 2005, the date the Company filed a registration statement with the SEC to sell its common stock in a public offering. The Company valued these options using the intrinsic value method for purposes of recording stock-based compensation expense in its financial statements. For pro forma disclosure purposes, the Company valued these options using the minimum value method. The fair value of these options that vested during the three months ended March 31, 2006 was $29,000.
 
5.   Commitments and Contingencies
 
The Company from time to time is subject to lawsuits, investigations and claims arising out of the ordinary course of business, including those related to commercial transactions, contracts, government regulation and employment matters. In the opinion of management, all such matters, if any, are either without merit or are of such kind, or involve such amounts that would not have a material effect on the financial position or results of operations of the Company if disposed of unfavorably.


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that appear elsewhere in this report and in our annual report on Form 10-K for the year ended December 31, 2005. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, particularly in “Risk Factors” in Item 1A of Part II.
 
 
We are a leading provider of on-demand software for corporate communications and public relations. Our on-demand software suite helps organizations of all sizes manage local and global relationships and communications with journalists, analysts, public officials and other key audiences. We deliver our on-demand software over the Internet using a secure, scalable application and system architecture, which allows our customers to eliminate expensive up-front hardware and software costs and to quickly deploy and implement our on-demand software.
 
We sell access to our on-demand software primarily through our direct sales channel, and to a lesser extent through third-party distributors. As of March 31, 2006, we had 1,447 active customers of all sizes across a wide variety of industries, including financial and insurance, technology, healthcare and pharmaceutical and retail and consumer products, as well as government agencies, not-for-profit organizations and educational institutions. We define active customers as unique customer accounts that have an active subscription and have not been suspended for non-payment.
 
We plan to continue the expansion of our customer base by expanding our direct and indirect distribution channels, expanding our international market penetration and selectively pursuing strategic acquisitions. As a result, we plan to hire additional personnel, particularly in sales and professional services, expand our domestic and international selling and marketing activities, increase the number of locations around the world where we conduct business and develop our operational and financial systems to manage a growing business. We also intend to identify and acquire companies which would either expand our solution’s functionality, provide access to new customers or markets, or both.
 
 
We derive all of our revenues from subscription agreements and related services. Our subscription agreements contain multiple service elements and deliverables, which include use of our on-demand software, hosting services, content and content updates, implementation and training services and customer support. The typical term of our subscription agreements is one year, but increasingly our customers are selecting subscriptions with multi-year terms. We generally invoice our customers in advance of their annual subscription, with payment terms that require our customers pay us within 30 days of invoice. Our subscription agreements are non-cancelable, though customers typically have the right to terminate their agreements for cause if we materially breach our obligations under the agreement.
 
Professional services revenue consists primarily of data migration, training and configuration services sold separately after the initial subscription agreement. Typically, our professional service engagements are billed on a fixed fee basis with payment terms requiring our customers to pay us within 30 days of invoice. Revenues from professional services sold separately from subscription agreements have not been material to our business. During the three months ended March 31, 2006, professional services sold separately accounted for less than 5% of our revenues.
 
Historically, we have increased the price of our subscriptions for many of our renewal customers in order to absorb the increasing costs of providing ongoing hosting services, content and customer support to our existing customer base. Since 2003, these price increases have typically ranged from 5% to 10% per annum.


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Cost of Revenues.  Cost of revenues consists primarily of compensation for training and support personnel, hosting infrastructure, amortization of content and purchased technology, depreciation associated with computer equipment and software and allocated overhead. We allocate overhead expenses such as employee benefits, computer supplies, depreciation for computer equipment and office supplies based on headcount. As a result, indirect overhead expenses are included in cost of revenues and each operating expense category.
 
We believe content is an integral part of our solution and provides our customers with access to broad, current and relevant information critical to their PR efforts. We expect to continue to make investments in both our own content as well as content acquired from third parties and to continue to enhance our News On-Demand service. We expect that in 2006, cost of revenues will increase in absolute dollars and remain constant or decrease slightly as a percentage of revenues, as we incur expenses to expand our content offerings and our capacity to support new customers.
 
Sales and Marketing.  Sales and marketing expenses are our largest operating expense, accounting for 49% of our revenues for the three months ended March 31, 2006. Sales and marketing expenses consist primarily of compensation for our sales and marketing personnel, sales commissions and incentives, marketing programs, including lead generation, events and other brand building expenses and allocated overhead. We expense our sales commissions at the time a subscription agreement is executed by the customer, and we recognize substantially all of our revenues ratably over the term of the corresponding subscription agreement. Accordingly, we generally experience a delay between the recognition of revenues and the corresponding increase in sales and marketing expenses.
 
As our revenues increase, we plan to continue to invest heavily in sales and marketing by increasing the number of direct sales personnel in order to add new customers and increase sales to our existing customers. We also plan to expand our marketing activities in order to build brand awareness and generate additional leads for our growing sales personnel. We expect that in 2006, sales and marketing expenses will increase in absolute dollars but will decrease as a percentage of revenues.
 
Research and Development.  Research and development expenses consist primarily of compensation for our software application development personnel and allocated overhead. We have historically focused our research and development efforts on increasing the functionality and enhancing the ease of use of our on-demand software. Because of our hosted, on-demand model, we are able to provide all of our customers with a single, shared version of our most recent application. As a result, we do not have to maintain legacy versions of our software, which enables us to have relatively low research and development expenses as compared to traditional enterprise software business models. We expect that in 2006, research and development expenses will increase in absolute dollars as we upgrade and extend our service offerings and develop new technologies, but will remain relatively consistent as a percentage of revenues.
 
General and Administrative.  General and administrative expenses consist of compensation and related expenses for executive, finance, accounting, administrative and management information systems personnel, professional fees, other corporate expenses and allocated overhead. We expect that in 2006, general and administrative expenses will increase in absolute dollars and increase slightly as a percentage of revenues, as we incur additional costs associated with being a public company.
 
Amortization of Intangible Assets.  Amortized intangible assets consist of customer relationships and covenants not to compete from business combinations.
 
 
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.


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We believe that of our significant accounting policies, which are described in Note 2 to the consolidated financial statements and in our annual report on Form 10-K for the year ended December 31, 2005, the following accounting policies include a greater degree of judgement and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations. Effective January 1, 2006, the Company adopted SFAS No. 123R as described below.
 
Revenue Recognition.  We recognize revenues in accordance with SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” as amended by Staff Accounting Bulletin No. 104, “Revenue Recognition.” We recognize revenues from subscription agreements for our on-demand software and related services when there is persuasive evidence of an arrangement, the service has been provided to the customer, the collection of the fee is probable and the amount of the fee to be paid by the customer is fixed or determinable. Amounts that have been invoiced are recorded in accounts receivable and deferred revenue.
 
Our subscription agreements generally contain multiple service elements and deliverables. These elements include access to our software and often specify initial services including implementation and training. Our subscription agreements do not provide customers the right to take possession of the software at any time.
 
Our revenue recognition policy considers all elements in our multiple element subscription agreements as a single unit of accounting, and accordingly, we recognize all associated fees over the subscription period, which is typically one year. We recognize our revenue over the subscription period because the subscription is the last element delivered to the customer and the predominant element of our agreements. In applying the guidance in Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, or EITF 00-21, we determined that we do not have objective and reliable evidence of the fair value of the subscription to our on-demand software after delivery of specified initial services. When we sell this subscription separately from professional services the price charged varies widely, and therefore we cannot objectively and reliably determine the subscription’s fair value. As a result, subscription revenues are recognized ratably over the subscription period. Professional services sold separately from a subscription arrangement are recognized as the services are performed.
 
Stock-Based Compensation.  Prior to January 1, 2006, we accounted for stock-based compensation using the intrinsic value method of accounting under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25). Our stock-based compensation awards have generally been granted with an exercise price equal to the estimated fair value of the underlying common stock on the grant date, and accordingly, any stock-based compensation related to stock option grants has not been material. We applied the disclosure provisions under Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation and related interpretations (SFAS No. 123) as if the fair value method had been applied in measuring compensation expense. As a result, stock-based compensation expense, based upon the fair value method, was included as a pro forma disclosure in the notes to our financial statements for the unvested portion of the stock-based compensation awards granted after we became a public entity.
 
On January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standard No. 123(R), Share-Based Payment (SFAS No. 123R), using the modified-prospective transition method. Because we did not complete our initial public offering until December 2005, we have applied the prospective method to the unvested portion of stock-based compensation awards granted prior to June 15, 2005, the date we first filed a registration statement with the Securities and Exchange Commission (SEC). Accordingly, we have not restated our financial results for prior periods. Under the prospective method, we will continue to account for stock-based compensation awards granted before June 15, 2005 using the intrinsic value method as prescribed by APB No. 25. Under the modified prospective method, stock-based compensation expense for all stock-based compensation awards granted after June 15, 2005, but not vested as of December 31, 2005, is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R. We recognize compensation expense for stock-based compensation awards on a straight-line basis over the requisite service period of the award.


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In accordance with SFAS No. 123R, we used the Black-Scholes option pricing model to measure the fair value of our option awards granted after June 15, 2005. The Black-Scholes model requires the input of highly subjective assumptions including volatility, expected term, risk-free interest rate and dividend yield. In 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB No. 107) which provides supplemental implementation guidance for SFAS No. 123R. We recently became a public entity, and therefore have a limited history of volatility. Accordingly, our expected volatility is based on the historical volatilities of similar entities’ common stock over the most recent period commensurate with the estimated expected term of the awards. The expected term of an award is based on the “simplified” method allowed by SAB No. 107, whereby the expected term is equal to the midpoint between the vesting date and the end of the contractual term of the award. The risk-free interest rate is based on the rate on U.S. Treasury securities with maturities consistent with the estimated expected term of the awards. We have not paid and do not anticipate paying a cash dividend in the foreseeable future and accordingly, use an expected dividend yield of zero. Changes in these assumptions can affect the estimated fair value of options granted and the related compensation expense which may significantly impact our results of operations in future periods.
 
Stock-based compensation expense recognized is based on the estimated portion of the awards that are expected to vest. We apply estimated forfeiture rates based on analyses of historical data, including termination patterns and other factors.
 
As of March 31, 2006, there was $5,454,000 of total unrecognized compensation cost related to nonvested stock-based compensation awards granted under our equity Plans. That cost is expected to be recognized over a weighted-average period of 3.7 years.
 
Results of Operations
 
The following tables set forth selected unaudited consolidated statements of operations data for each of the periods indicated as a percentage of total revenues for the periods indicated.
 
                 
    Three Months Ended March 31,  
    2005     2006  
 
Revenues
    100 %     100 %
Cost of revenues
    24 %     24 %
                 
Gross profit
    76 %     76 %
Operating expenses:
               
Sales and marketing
    55 %     49 %
Research and development
    10 %     9 %
General and administrative
    20 %     23 %
Amortization of intangible assets
    6 %     3 %
                 
Total operating expenses
    91 %     84 %
Loss from operations
    (15 )%     (8 )%
Interest and other income (expense), net
          6 %
                 
Loss before provision for income taxes
    (15 )%     (2 )%
Provision for income taxes
           
                 
Net loss
    (15 )%     (2 )%
                 
 
The following table sets forth our total deferred revenue and net cash provided by operating activities for each of the periods indicated and number of active customers as of the last day of each of the periods indicated.
 
                 
    Three Months Ended March 31,  
    2005     2006  
 
Total deferred revenue (in thousands at period end)
  $ 16,353     $ 21,346  
Net cash provided by operating activities (in thousands)
  $ 347     $ 2,173  
Active customers
    1,174       1,447  


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Three Months Ended March 31, 2006 and 2005
 
Revenues.  Revenues for the three months ended March 31, 2006 were $8.3 million, an increase of $2.2 million, or 35%, over revenues of $6.1 million for the comparable period in 2005. The increase in revenues was primarily due to the increase in the number of total active customers to 1,447 as of March 31, 2006 from 1,174 as of March 31, 2005, and to a lesser extent an increase in prices charged for subscriptions from our renewal customers. The increase in total active customers was the result of the continued increased market acceptance of our on-demand software for public relations. We estimate that the increase in prices charged for subscriptions from our renewal customers represented $258,000 of the total increase in revenues over the comparable period. Total deferred revenue as of March 31, 2006 was $21.3 million, representing an increase of $5.0 million, or 31%, over total deferred revenue of $16.4 million as of March 31, 2005.
 
Cost of Revenues.  Cost of revenues for the three months ended March 31, 2006 was $2.0 million, an increase of $505,000, or 35%, over cost of revenues of $1.5 million for the comparable period in 2005. The increase in cost of revenues was primarily due to an increase of $566,000 in employee related costs, including $459,000 from personnel for the maintenance of our information database, $72,000 from amortization of our internally developed software and information database used in our subscription services and $19,000 in stock-based compensation reflecting the adoption of SFAS No. 123R, offset by a decrease of $209,000 in third-party license and royalty fees. We launched our information database in August 2005, resulting in a reduction of license and royalty fees paid to third-party providers. We had 75 full-time employee equivalents in our professional and other support services groups at March 31, 2006 compared to 26 full-time employee equivalents at March 31, 2005.
 
Sales and Marketing Expenses.  Sales and marketing expenses for the three months ended 2006 were $4.0 million, an increase of $651,000, or 19%, over sales and marketing expenses of $3.4 million for the comparable period in 2005. The increase was primarily due to an increase of $570,000 in employee related costs, including $144,000 in sales commissions and $71,000 in stock-based compensation reflecting the adoption of SFAS No. 123R. Our sales and marketing headcount increased by 28% as we hired additional sales personnel to focus on adding new customers and increasing revenues from existing customers. We had 100 full-time sales and marketing employee equivalents at March 31, 2006 compared to 78 full-time employee equivalents at March 31, 2005.
 
Research and Development Expenses.  Research and development expenses for the three months ended March 31, 2006 were $739,000, an increase of $143,000, or 24%, over research and development expenses of $596,000 for the comparable period in 2005. The increase in research and development expenses was primarily due to an increase of $114,000 in employee related costs and an increase of $53,000 in stock-based compensation reflecting the adoption of SFAS No. 123R. For the three months ended March 31, 2006 and 2005, we capitalized $10,000 and $87,000, respectively, of employee related costs for internally developed software used in our subscription services. We had 23 full-time employee equivalents in our research and development group at March 31, 2006 and 2005.
 
General and Administrative Expenses.  General and administrative expenses for the three months ended March 31, 2006 were $1.9 million, an increase of $699,000, or 57%, over general and administrative expenses of $1.2 million for the comparable period in 2005. The increase in general and administrative expenses was primarily due to $216,000 in public company operating costs and professional fees, $87,000 in employee related costs, $71,000 in depreciation expense and $232,000 in stock-based compensation reflecting the adoption of SFAS No. 123R. Our general and administrative headcount increased by 11% as we hired additional personnel to support our growth. We had 21 full-time employee equivalents in our general and administrative group at March 31, 2006 compared to 19 full-time employee equivalents at March 31, 2005.
 
Amortization of Intangible Assets.  Amortization of intangible assets for the three months ended March 31, 2006 was $261,000, a decrease of $133,000, or 34%, over amortization of intangible assets of $394,000 for the comparable period in 2005. Customer relationships acquired in the purchase of PAT were fully amortized in January 2006 resulting in the decrease in amortization.
 
Other Income (Expense).  Other income for the three months ended March 31, 2006 was $482,000 compared to other expense of $22,000 for the comparable period in 2005. The increase in other income (expense) was $504,000. We invested proceeds from our initial public offering in December 2005 in cash equivalents and short-


16


 

term investments, and we repaid in full our outstanding borrowings under our revolving line of credit which was terminated. The higher balances of cash and short-term investments resulted in increased interest income of $465,000. The repayment of the outstanding borrowings under our revolving line of credit resulted in decreased interest expense of $33,000.
 
Provision for Income Taxes.  The provision for income taxes for the three months ended March 31, 2006 was $32,000 compared to no provision for income taxes for the comparable period in 2005. The provision for income taxes in 2006 reflects an increase in the valuation allowance for estimated Alternative Minimum Tax (AMT) payments for 2006. We have incurred losses for all periods presented and have recorded a valuation allowance to offset net deferred tax assets including credits for AMT payments.
 
 
At March 31, 2006, our principal sources of liquidity were cash and cash equivalents, short-term investments and net accounts receivable totaling $48.3 million, compared to $47.4 million at December 31, 2005.
 
Our deferred revenue at March 31, 2006 and December 31, 2005 was $21.3 million and $20.7 million, respectively, which reflects growth in the invoiced amounts due from our customers. Amounts that have been invoiced are recorded in accounts receivable and deferred revenue, which are then recognized as revenue ratably over the term of the subscription arrangement.
 
Net cash provided by operating activities was $2.2 million during the three months ended March 31, 2006 and $347,000 during the comparable period in 2005. The increase of $1.8 million resulted principally from a lower net loss for the three months ended March 31, 2006, non-cash stock-based compensation and increased collections from customers.
 
Net cash used in investing activities was $2.1 million during the three months ended March 31, 2006. Net cash used in investing activities consisted primarily of cash invested in short-term marketable securities.
 
As of December 31, 2005, we had net operating loss carryforwards of $22.6 million available to reduce future taxable income. In the future, we may utilize our net operating loss carryforwards and would begin making cash tax payments at that time. In addition, the limitations on utilizing net operating loss carryforwards and other minimum state taxes may also increase our overall tax obligations. We expect that if we generate taxable income and/or we are not allowed to use net operating loss carryforwards for state tax purposes, our cash generated from operations will be adequate to meet our income tax obligations.
 
As of March 31, 2006, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Other than our operating leases for office space and computer equipment, we do not engage in off-balance sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.
 
Item 3.   Quantitative and Qualitative Disclosures about Market Risk
 
For quantitative and qualitative disclosures about market risk, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our annual report on Form 10-K for the year ended December 31, 2005. Our exposures to market risk have not changed materially since December 31, 2005.
 
Item 4.   Controls and Procedures
 
 
Our management carried out an evaluation required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the supervision and with the participation of our President and Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act (“Disclosure Controls and


17


 

Procedures”). A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. Based on the evaluation, our CEO and CFO concluded that as of March 31, 2006, our Disclosure Controls and Procedures are effective at the reasonable assurance level.
 
 
We have implemented a new accounting software system during the three months ended March 31, 2006. This new system provides expanded functionality and capabilities and when fully utilized, we may achieve additional benefits from the system which could impact our control environment in the future. To date, there have been no material changes in the internal controls over financial reporting.
 
 
Item 1.   Legal Proceedings
 
We are not currently subject to any material legal proceedings. From time to time, however, we are named as a defendant in legal actions arising from our normal business activities. Although we cannot accurately predict the amount of our liability, if any, that could arise with respect to legal actions currently pending against us, we do not expect that any such liability will have a material adverse effect on our financial positions, operating results or cash flows.
 
Item 1A.   Risk Factors
 
We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. This discussion highlights some of the risks which may affect future operating results. These are the risks and uncertainties we believe are most important for you to consider. Additional risks and uncertainties not presently known to us, which we currently deem immaterial or which are similar to those faced by other companies in our industry or business in general, may also impair our business operations. If any of the following risks or uncertainties actually occurs, our business, financial condition and operating results would likely suffer. The following discussion of risks and uncertainties does not reflect any material changes from the risk factors as previously disclosed in our annual report on Form 10-K for the year ended December 31, 2005.
 
Risks Related to Our Business and Industry
 
 
The market for software designed specifically for corporate communications and public relations is relatively new and emerging, making our business and future prospects difficult to evaluate. Many companies have invested substantial personnel and financial resources in their PR departments, and may be reluctant or unwilling to migrate to software designed to address the corporate communications and public relations market. Widespread market acceptance of our solutions is critical to the success of our business. You must consider our business and future prospects in light of the challenges, risks and difficulties we encounter in the new and rapidly evolving market of corporate communications and public relations software. These challenges, risks and difficulties include the following:
 
  •  generating sufficient revenue to achieve and maintain profitability;
 
  •  managing growth in our operations;
 
  •  managing the risks associated with developing new modules;


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  •  attracting and retaining customers; and
 
  •  attracting and retaining key personnel.
 
We may not be able to successfully address any of these challenges, risks and difficulties, including the other risks related to our business and industry described below. Failure to adequately do so could adversely affect our business, results of operations or financial condition.
 
 
Although our predecessor company was founded in 1988, we did not begin offering our on-demand software until 1999. We derive, and expect to continue to derive for the foreseeable future, all of our revenue from providing on-demand software and related ancillary services. The market for on-demand software is at an early stage of development, and it is uncertain whether on-demand solutions such as ours 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 software in general and for on-demand corporate communications and public relations software in particular. If businesses do not perceive the benefits of on-demand software, then the market 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.
 
 
Our solutions are sold pursuant to annual or multi-year subscription agreements and our customers have no obligation to renew these agreements. As a result, we are not able to consistently and accurately predict future renewal rates. Our customers’ renewal rates may decline or fluctuate or our customers may renew for fewer modules or seats as a result of a number of factors, including their level of satisfaction with our solutions, their ability to continue their operations due to budgetary or other concerns, and the availability and pricing of competing products. Additionally, we may lose our customers due to the high turnover rate in the PR departments of small and mid-sized organizations. If large numbers of existing customers do not renew these agreements, or renew these agreements on terms less favorable to us, and if we cannot replace or supplement those non-renewals with new subscription agreements generating the same or greater level of revenue, our business, financial condition and results of operations will be adversely affected.
 
 
We recognize revenue from our customers over the term of their subscription agreements with us. The majority of our quarterly revenue usually represents deferred revenue from subscription agreements entered into during previous quarters. As a result, a decline in new or renewed subscription agreements in any one quarter will not necessarily be fully reflected in the revenue for the corresponding quarter but will negatively affect our revenue in future quarters. Additionally, the effect of significant downturns in sales and market acceptance of our solutions may not be fully reflected in our results of operations until future periods. Our business model also makes it difficult for us to reflect any rapid increase in our customer base and the resulting effect of this increase in our revenue in any one period because revenue from new customers will be recognized over the applicable subscription agreement term.
 
 
The success of our strategy is dependent, in part, on the success of our efforts to sell additional modules to our existing customers and to increase the number of users per customer. These customers might choose not to expand


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their use of or make additional purchases of our solutions. If we fail to generate additional business from our current customers, our revenue could grow at a slower rate or decrease.
 
 
We have developed our own content that our customers began using in place of a significant portion of the third-party content that had been included in the information database that we make available to our customers through our on-demand software. In August 2005, we began providing this internally-developed content to our customers. If this new information database does not attain market acceptance, current customers may not renew their subscription agreements with us, and it may be more difficult for us to acquire new customers. We may be required to continue to license information from third parties, and such information may not continue to be available from third parties on commercially reasonable terms, if at all.
 
 
We have incurred operating losses in the past and we may incur operating losses in the future. Our recent operating losses were $3.6 million for 2003, $2.7 million for 2004 and $4.9 million for 2005. We have not been profitable since we began offering our on-demand software, and we may not become profitable. In addition, we expect our operating expenses to increase in the future as we expand our operations, and if our operating expenses exceed our expectations, our financial performance could be adversely affected. If our revenue does not grow to offset these increased expenses, we may not become profitable. You should not consider recent quarterly revenue growth as indicative of our future performance. In fact, in future quarters we may not have any revenue growth, or our revenue could decline.
 
 
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 customers and attract new customers;
 
  •  changes in the volume and mix of subscriptions sold in a particular quarter;
 
  •  seasonality of our business cycle, given that our subscription volumes are normally lowest in the first quarter and highest in the fourth quarter;
 
  •  our policy of expensing sales commissions at the time our customers are invoiced for a subscription agreement, while the majority of our revenue is recognized ratably over future periods;
 
  •  the timing and success of new product introductions or upgrades by us or our competitors;
 
  •  changes in our pricing policies or those of our competitors;
 
  •  the amount and timing of expenditures related to expanding our operations;
 
  •  changes in the payment terms for our products and services; and
 
  •  the purchasing and budgeting cycles of our customers.
 
Because our on-demand software is sold pursuant to annual or multi-year subscription agreements, and we recognize revenue from these subscriptions 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


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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.
 
 
The corporate communications and public relations market is fragmented, competitive and rapidly evolving, and there are limited barriers to entry to some segments of this market. We expect the intensity of competition to increase in the future as existing competitors develop their capabilities and as new companies enter our market. 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 maintain our pricing rates and add and retain customers, and our business, financial condition and results of operations will be seriously harmed. We face competition from:
 
  •  PR solution providers offering products specifically designed for PR;
 
  •  generic desktop software and other commercially available software not specifically designed for PR;
 
  •  outsourced PR service providers; and
 
  •  custom-developed solutions.
 
Many of our current and potential competitors have longer operating histories, a larger presence in the general PR market, 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, our competitors may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or customer 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 customer, that customer may be unwilling to switch vendors due to existing time and financial commitments with our competitors.
 
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 enter the on-demand software market with competing products as the on-demand software market develops and matures. Many of these potential competitors have established or may establish business, financial or strategic relationships among themselves or with existing or potential customers, alliance partners or other third parties or may combine and consolidate to become more formidable competitors with better resources. It is possible that these new competitors could rapidly acquire significant market share.
 
 
The market for our on-demand software is characterized by changes in client requirements, changes in protocols and evolving industry standards. If we are unable to enhance or develop new features for our existing solutions or develop acceptable new solutions that keep pace with these changes, our on-demand software may become obsolete, less marketable and less competitive and our business will be harmed. The success of any enhancements, new modules and on-demand software depends on several factors, including timely completion, introduction and market acceptance of the modules. Failure to produce acceptable new modules and enhancements may significantly impair our revenue growth and reputation.
 
 
All of our solutions reside on hardware that we own or lease and operate that is currently located in a third-party facility maintained and operated in Sterling, Virginia. We do not maintain long-term supply contracts with our third-party facility provider, and the provider does not guarantee that our customers’ access to our solutions will be


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uninterrupted, error-free or secure. Our operations depend on our third-party facility provider’s 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. In the event that our third-party facility arrangement is terminated, or there is a lapse of service or damage to such facility, we could experience interruptions in our service as well as delays and additional expense in arranging new facilities and services.
 
Our disaster recovery computer hardware and systems located at our headquarters in Lanham, Maryland, 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 at our third-party facility. In the event of a disaster in which our third-party facility was irreparably damaged or destroyed, we could experience lengthy interruptions in our service. Moreover, our disaster recovery computer hardware and systems are located within the same geographic region as our third-party facility and may be equally or more affected by any disaster affecting our third-party facility. Any or all of these events could cause our customers to lose access to our software. In addition, the failure by our third- party facility to meet our capacity requirements could result in interruptions in our service or impede our ability to scale our operations.
 
We architect the system infrastructure and procure and own or lease the computer hardware used for our services. 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 service. Any interruptions or delays in our service, 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 customers and our reputation. Also, in the event of damage or interruption, our insurance policies may not adequately compensate us for any losses that we may incur. These factors in turn could reduce our revenue, subject us to liability, cause us to issue credits or cause customers to fail to renew their subscriptions, any of which could adversely affect our business, financial condition and results of operations.
 
 
Prospective customers, especially large enterprise customers, may require heavily customized features and functions unique to their business processes. If prospective customers require customized features or functions that we do not offer, and that would be difficult for them to implement themselves, then the market for our solutions will be more limited and our business could suffer.
 
 
One of our business strategies is to continue to selectively acquire companies which would either expand our solution’s functionality, provide access to new customers or markets, or both. We also may enter into business relationships with other organizations in order to expand our service offerings, which could involve preferred or exclusive licenses, additional channels of distribution or discount pricing or investments in other organizations. An acquisition, investment or business relationship may result in unforeseen operating difficulties and expenditures. In particular, we may encounter difficulties assimilating or integrating the acquired organizations, technologies, products, personnel or operations of the acquired organizations, particularly if the key personnel of the acquired company choose not to work for us, and we may have difficulty retaining the customers of any acquired business due to changes in management and ownership. Acquisitions may also disrupt our ongoing business, divert our resources and require significant management attention that would otherwise be available for ongoing development of our business. We also may experience lower rates of renewal from customers obtained through acquisitions than our typical renewal rates. Moreover, we cannot assure you that the anticipated benefits of any acquisition, investment or business relationship would be realized or that we would not be exposed to unknown liabilities. In connection with one or more of these transactions, we may:
 
  •  issue additional equity securities that would dilute the ownership of our stockholders;


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  •  use cash that we may need in the future to operate our business;
 
  •  incur debt on terms unfavorable to us or that we are unable to repay;
 
  •  incur large charges or substantial liabilities;
 
  •  encounter difficulties retaining key employees of an acquired company or integrating diverse business cultures; and
 
  •  become subject to adverse tax consequences, substantial depreciation or deferred compensation charges.
 
To date, we have completed several acquisitions. For example, in January 2003 we acquired substantially all of the assets of Public Affairs Technology, Inc., and in November 2004 we acquired substantially all of the assets of Gnossos Software, Inc. In both of these transactions, the consideration we paid included both cash and shares of our common stock. The issuance of shares of our common stock diluted the ownership of our existing stockholders, and the cash consideration paid reduced the cash available to us for other purposes.
 
 
Increasing our customer base and achieving broader market acceptance of our solutions will depend to a significant extent on our ability to expand our sales and marketing operations. We plan to continue to expand our direct sales force and engage additional third-party channel partners, both domestically and internationally. This expansion will require us to invest significant financial and other resources. Our business will be seriously harmed if our efforts do not generate a corresponding significant increase in revenue. We may not achieve anticipated revenue growth from expanding our direct sales force if we are unable to hire and develop talented direct sales personnel, if our new direct sales personnel are unable to achieve desired productivity levels in a reasonable period of time or if we are unable to retain our existing direct sales personnel. We also may not achieve anticipated revenue growth from our third-party channel partners if we are unable to attract and retain additional motivated third-party channel partners, if any existing or future third-party 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.
 
 
We believe that developing and maintaining awareness of our brand in a cost-effective manner is critical to achieving widespread acceptance of our existing and future services and is an important element in attracting new customers. Successful promotion of our brand will depend largely on the effectiveness of our marketing efforts and on our ability to provide reliable and useful solutions. Brand promotion activities may not yield increased revenue, and even if they do, any increased revenue may not offset the expenses we incurred in building our brand. If we fail to successfully promote and maintain our brand, or incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, we may fail to attract new customers or retain our existing customers to the extent necessary to realize a sufficient return on our brand-building efforts, and our business could suffer.
 
 
The information in our databases may not be complete or may contain inaccuracies that our customers regard as significant. Our ability to collect and report data may be interrupted by a number of factors, including our inability to access the Internet, the failure of our network or software systems or failure by our third-party facility to meet our capacity requirements. In addition, computer viruses and intentional or unintentional acts of our employees may harm our systems causing us to lose data we maintain and supply to our customers or data that our customers input and maintain on our systems, and the transmission of computer viruses could expose us to litigation. Our subscription agreements generally give our customers the right to terminate their agreements for cause if we materially breach our obligations. Any failures in the services that we supply or the loss of any of our customers’ data that we cannot rectify in a certain time period may give our customers the right to terminate their agreements with us and could subject us to liability. As a result, we may also be required to spend substantial


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amounts to defend lawsuits and pay any resulting damage awards. In addition to potential liability, if we supply inaccurate data or experience interruptions in our ability to supply data, our reputation could be harmed and we could lose customers.
 
Although we maintain general liability insurance, including coverage for errors and omissions, this coverage may be inadequate, or may not be available in the future on acceptable terms, or at all. In addition, we cannot assure you that this policy will cover any claim against us for loss of data or other indirect or consequential damages and defending a suit, regardless of its merit, could be costly and divert management’s attention.
 
 
Our software may contain undetected errors or defects that may result in product failures or otherwise cause our solutions to fail to perform in accordance with customer expectations. Because our customers use our solutions for important aspects of their business, any errors or defects in, or other performance problems with, our solutions could hurt our reputation and may damage our customers’ businesses. If that occurs, we could lose future sales or our existing customers could elect to not renew. 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 solutions fail to perform or contain a technical defect, a customer may assert a claim against us for substantial damages, whether or not we are responsible for our solutions’ 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 arbitration/dispute resolution 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 claim successfully brought against us could cause our business to suffer.
 
The success of our 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 business depends upon the continued and widespread adoption of the Internet as a primary medium for commerce, communication and business applications. Our business growth would be impeded if the performance or perception of the Internet was harmed by security problems such as “viruses,” “worms” and other malicious programs, reliability issues arising from outages and damage to Internet infrastructure, delays in development or adoption of new standards and protocols to handle increased demands of Internet activity, increased costs, decreased accessibility and quality of service or increased government regulation and taxation of Internet activity.
 
Federal, state or foreign government bodies or agencies have in the past adopted, and may in the future adopt, laws or regulations affecting data privacy, the use of the Internet as a commercial medium and the use of email 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 email. 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.
 
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.


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If we are unable to protect our intellectual property, our competitors could use our intellectual property to market products similar to our products, which could decrease demand for our solutions. We rely on a combination of copyright, trademark and trade secret laws, as well as licensing agreements, third-party nondisclosure agreements and other contractual provisions and technical measures, to protect our intellectual property rights. These protections may not be adequate to prevent our competitors from copying our solutions or otherwise infringing on our intellectual property rights. Existing copyright laws afford only limited protection for our intellectual property rights and may not protect such rights in the event competitors independently develop solutions similar or superior to ours. In addition, the laws of some countries in which our solutions are or may be licensed do not protect our solutions and intellectual property rights to the same extent as do the laws of the United States.
 
To protect our trade secrets and other proprietary information, we require employees, consultants, advisors and collaborators to enter into confidentiality agreements. These agreements may not provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information.
 
 
The software and Internet industries are characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. Third-parties may assert patent and other intellectual property infringement claims against us in the form of lawsuits, letters, or other forms of communication. If a third-party successfully asserts a claim that we are infringing their proprietary rights, royalty or licensing agreements might not be available on terms we find acceptable or at all. As currently pending patent applications are not publicly available, we cannot anticipate all such claims or know with certainty whether our technology infringes the intellectual property rights of third-parties. We expect that the number of infringement claims in our market will increase as the number of solutions and competitors in our industry grows. These claims, whether or not successful, could:
 
  •  divert management’s attention;
 
  •  result in costly and time-consuming litigation;
 
  •  require us to enter into royalty or licensing agreements, which may not be available on acceptable terms, or at all; or
 
  •  require us to redesign our solutions to avoid infringement.
 
As a result, any third-party intellectual property claims against us could increase our expenses and adversely affect our business. In addition, many of our customer agreements require us to indemnify our customers for third-party intellectual property infringement claims, which would increase the cost to us resulting from an adverse ruling in any such claim. Even if we have not infringed any third-parties’ intellectual property rights, we cannot be sure our legal defenses will be successful, and even if we are successful in defending against such claims, our legal defense could require significant financial resources and management’s time, which could adversely affect our business.
 
 
Rapid growth in our headcount and operations may place a significant strain on our management, administrative, operational and financial infrastructure. We anticipate that additional growth will be required to address increases in our customer base, as well as expansion into new geographic areas.
 
Our success will depend in part upon the ability of our senior management to manage growth effectively. To do so, we must continue to hire, train and manage new employees as needed. To date, we have not experienced any


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significant problems as a result of the rapid growth in our headcount, other than occasional office space constraints. However, our anticipated future growth may place greater strains on our resources. For instance, if our new hires perform poorly, or if we are unsuccessful in hiring, training, managing and integrating these new employees as needed, or if we are not successful in retaining our existing employees, our business may be harmed. To manage the expected growth of our operations and personnel, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. The additional headcount and capital investments we expect to add will increase our cost base, which will make it more difficult for us to offset any future revenue shortfalls by offsetting expense reductions in the short term. If we fail to successfully manage our growth, we will be unable to execute our business plan.
 
 
Our success depends largely upon the continued services of our executive officers and other key personnel, particularly Richard Rudman, our Chief Executive Officer, President and Chairman and Robert Lentz, our Chief Technology Officer. We are also substantially dependent on the continued service of our existing development personnel because of the complexity of our service and technologies. We do not have employment agreements with any of our development personnel that require them to remain our employees nor do the employment agreements we have with our executive officers require them to remain our employees and, therefore, they could terminate their employment with us at any time without penalty. Although we currently maintain key man life insurance policies on Messrs. Rudman and Lentz, this insurance would not adequately compensate us for the loss of their services, and we may not maintain these policies. The loss of one or more of our key employees could seriously harm our business.
 
 
To execute our business strategy, we must attract and retain highly qualified personnel. Competition for these personnel is intense, especially for senior sales executives and engineers with high levels of experience in designing and developing software. We may not be successful in attracting and retaining qualified personnel. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. Many of the companies with which we compete for experienced personnel have greater resources than us. In addition, in making employment decisions, particularly in the Internet and high-technology industries, job candidates often consider the value of the stock options they are to receive in connection with their employment. Significant volatility in the price of our stock may, therefore, adversely affect our ability to attract or retain key employees. Furthermore, changes to accounting principles generally accepted in the United States relating to the expensing of stock options may discourage us from granting the size or type of stock options awards that job candidates require to join our company, and may result in our paying additional cash compensation to job candidates to offset reduced stock option grants. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects could be severely harmed.
 
 
We have small but growing international operations and our business strategy includes expanding these operations. Conducting international operations subjects us to new risks that we have not generally faced in the United States. These include:
 
  •  fluctuations in currency exchange rates;
 
  •  unexpected changes in foreign regulatory requirements;
 
  •  difficulties in managing and staffing international operations;


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  •  potentially adverse tax consequences, including the complexities of foreign value added tax systems and restrictions on the repatriation of earnings; and
 
  •  the burdens of complying with a wide variety of foreign laws and different legal standards.
 
The occurrence of any one of these risks could negatively affect our international operations and, consequently, our results of operations generally. In addition, the Internet may not be used as widely in international markets in which we expand our international operations and, as a result, we may not be successful in offering our solutions internationally.
 
 
We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to develop new software or enhance our existing solutions, enhance our operating infrastructure and acquire complementary businesses and technologies. Accordingly, we may need to engage in equity or debt financings to secure additional funds. If we raise additional funds through issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior 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 and to pursue business opportunities, including potential acquisitions. In addition, we may not be able to obtain additional financing on terms favorable to us, if at all. If we are unable to obtain adequate financing or financing on terms satisfactory to us, when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly limited.
 
 
Generally accepted accounting principles in the United States are subject to interpretation by the Financial Accounting Standards Board, or FASB, the American Institute of Certified Public Accountants, the SEC and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change.
 
For example, FASB now requires companies to expense the fair value of employee stock options. Such stock option expensing requires us, beginning in 2006, to value our employee stock option grants pursuant to a fair value-based model, and then amortize that value against our reported earnings over the vesting period in effect for those options. We have previously accounted for stock-based awards to employees in accordance with the intrinsic value method. The intrinsic value method generally results in recording less expense than the fair value method for stock-based awards. This change in accounting treatment will materially and adversely affect our reported results of operations. We discuss more fully the adoption of new rules for accounting for stock-based awards in Note 2 to the notes to the consolidated financial statements included elsewhere in this report.
 
 
Many new laws, regulations and standards, notably those adopted in connection with the Sarbanes-Oxley Act of 2002, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices and have created uncertainty for public companies. These new laws, regulations and standards are subject to interpretations due to their lack of specificity, and as a result, their application in practice may evolve over time as new guidance is provided by varying regulatory bodies. This may cause continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. Our implementation of these reforms and enhanced new disclosures may result in increased general and administrative expenses and a significant diversion of management’s time and attention from revenue-generating activities. Any unanticipated difficulties in implementing these reforms could result in material delays in complying with these new laws, regulations and standards or significantly increase our operating costs.


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Risks Related to our Common Stock and the Securities Markets
 
 
The trading market for our common stock relies in part on the research and reports that industry or financial analysts publish about us or our business. We do not control these analysts. There are many large, well-established publicly traded companies active in our industry and market, which may mean it will be less likely that we receive widespread analyst coverage. Furthermore, if one or more of the analysts who do cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of us, we could lose visibility in the market, which may cause our stock price to decline.
 
 
The market price of our common stock could fluctuate significantly as a result of:
 
  •  quarterly variations in our operating results;
 
  •  seasonality of our business cycle;
 
  •  interest rate changes;
 
  •  changes in the market’s expectations about our operating results;
 
  •  our operating results failing to meet the expectation of securities analysts or investors in a particular period;
 
  •  changes in financial estimates and recommendations by securities analysts concerning our company or the on-demand software industry in general;
 
  •  operating and stock price performance of other companies that investors deem comparable to us;
 
  •  news reports relating to trends in our markets;
 
  •  changes in laws and regulations affecting our business;
 
  •  material announcements by us or our competitors;
 
  •  sales of substantial amounts of common stock by our directors, executive officers or significant stockholders or the perception that such sales could occur; and
 
  •  general economic and political conditions such as recessions and acts of war or terrorism.
 
 
As of March 31, 2006, our executive officers, directors, current 5% or greater stockholders and affiliated entities together beneficially owned approximately 60% of our outstanding common stock. These stockholders, acting together, have control over most matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions. Corporate action might be taken even if other stockholders oppose them. This concentration of ownership might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.


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Our amended and restated certificate of incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:
 
  •  establish a classified board of directors so that not all members of our board of directors are elected at one time;
 
  •  provide that directors may only be removed “for cause” and only with the approval of 662/3 percent of our stockholders;
 
  •  require super-majority voting to amend our bylaws or specified provisions in our amended and restated certificate of incorporation;
 
  •  authorize the issuance of “blank check” preferred stock that our board of directors could issue to increase the number of outstanding shares and to discourage a takeover attempt;
 
  •  limit the ability of our stockholders to call special meetings of stockholders;
 
  •  prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
 
  •  provide that the board of directors is expressly authorized to adopt, amend, or repeal our bylaws; and
 
  •  establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
 
In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control of our company.
 
 
In connection with our initial public offering, we, along with our officers, directors and certain stockholders, agreed, subject to limited exceptions, not to sell or transfer any shares of common stock for 180 days after December 6, 2005 without Thomas Weisel Partners LLC’s consent. However, Thomas Weisel Partners LLC may release these shares from these restrictions at any time. In evaluating whether to grant such a request, Thomas Weisel Partners LLC may consider a number of factors with a view toward maintaining an orderly market for, and minimizing volatility in the market price of, our common stock. These factors include, among others, the number of shares involved, recent trading volume and prices of the stock, the length of time before the lock-up expires and the reasons for, and the timing of, the request. We cannot predict what effect, if any, market sales of shares held by any stockholder or the availability of these shares for future sale will have on the market price of our common stock.
 
A total of approximately 9,019,094 shares of common stock may be sold in the public market by existing stockholders on or about 181 days after December 6, 2005, subject to applicable volume and other limitations imposed under federal securities law. Sales of substantial amounts of our common stock in the public market or the perception that such sales could occur, could adversely affect the market price of our common stock and could materially impair our future ability to raise capital through offerings of our common stock.


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Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
 
Sale of Unregistered Securities
 
None.
 
 
In connection with our initial public offering of our common stock, the SEC declared our Registration Statement on Form S-1 (No. 333-125834), filed under the Securities Act of 1933, effective on December 6, 2005. On December 12, 2005, we closed the sale of 5,000,000 shares of our common stock registered under the Registration Statement. On January 6, 2006, certain selling stockholders sold 750,000 shares of our common stock pursuant to the exercise in full of the underwriters’ over-allotment option. Thomas Weisel Partners LLC, RBC Capital Markets, Wachovia Securities and William Blair & Company served as the managing underwriters.
 
The initial public offering price was $9.00 per share. The aggregate sale price for all of the shares sold by us was $45.0 million, resulting in net proceeds to us of approximately $40.0 million after payment of underwriting discounts and commissions and legal, accounting and other fees incurred in connection with the offering of approximately $5.0 million. The aggregate sales price for all of the shares sold by the selling stockholders was approximately $6.8 million. We did not receive any of the proceeds from the sale of shares of common stock by the selling stockholders.
 
In December 2005, we used approximately $6.8 million from the net proceeds received from our initial public offering to repay certain indebtedness. We have invested the remainder of the proceeds from the initial public offering in short-term, interest-bearing, investment-grade securities and money market funds. We anticipate that we will use the remaining proceeds to fund working capital and general corporate purposes, which may include the expansion of our content and service offerings and potential acquisitions of complimentary businesses, products and technologies. We cannot specify with certainty all of the particular uses for the proceeds. The amounts we actually expend for these purposes may vary significantly and will depend on a number of factors. Accordingly, our management will retain broad discretion in the allocation of the proceeds.
 
Item 5.   Other Information
 
On March 2, 2006, we filed a report on Form 8-K reporting the termination of certain material agreements in January 2006. The information contained in that report is hereby incorporated by this reference.
 
Item 6.   Exhibits
 
         
Exhibit
   
Number
 
Exhibit
 
3.1
  Fifth Amended and Restated Certificate of Incorporation. (1)
3.2
  Amended and Restated Bylaws. (1)
10.1
  OEM License Agreement between the Registrant and Moreover Technologies, Inc., dated March 23, 2006, as amended by that amendment between the Registrant and Moreover Technologies, Inc., dated March 27, 2006. (2)
31.1
  Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.*
31.2
  Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Act of 1934, as amended.*
32.1
  Certification of Chairman and 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.*
 
 
Filed herewith
 
(1) Incorporated by reference to an exhibit to the Registration Statement on Form S-8 of Vocus, Inc. (Registration No. 333-132206) filed with the Securities and Exchange Commission on March 3, 2006.
 
(2) Incorporated by reference to an exhibit to the Current Report of Form 8-K of Vocus, Inc. with the Securities and Exchange Commission on March 29, 2006.


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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
VOCUS, INC.
 
  By: 
/s/  Richard Rudman
Richard Rudman
Chief Executive Officer, President and Chairman
 
  By: 
/s/  Stephen Vintz
Stephen Vintz
Chief Financial Officer, Treasurer and Secretary
 
Date: May 12, 2006


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Exhibit
   
Number
 
Exhibit
 
  3 .1   Fifth Amended and Restated Certificate of Incorporation.(1)
  3 .2   Amended and Restated Bylaws.(1)
  10 .1   OEM License Agreement between the Registrant and Moreover Technologies, Inc., dated March 23, 2006, as amended by that amendment between the Registrant and Moreover Technologies, Inc., dated March 27, 2006.(2)
  31 .1   Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.*
  31 .2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Act of 1934, as amended.*
  32 .1   Certification of Chairman and 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.*
 
 
Filed herewith
 
(1) Incorporated by reference to an exhibit to the Registration Statement on Form S-8 of Vocus, Inc. (Registration No. 333-132206) filed with the Securities and Exchange Commission on March 3, 2006.
 
(2) Incorporated by reference to an exhibit to the Current Report of Form 8-K of Vocus, Inc. with the Securities and Exchange Commission on March 29, 2006.


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