10-Q 1 d52485_10q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) |X| Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2002 or |_| Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from __________________ to _____________________ COMMISSION FILE NUMBER: 000-3156 AVANTGO, INC. (Exact name of Registrant as specified in its charter) DELAWARE 94-3275789 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 25881 Industrial Blvd. Hayward, CA 94545 (Address of principal executive offices) (510) 259-4000 (Registrant's telephone number, including area code) 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 |X| No |_| As of November 4, 2002 there were 35,714,155 shares of the Registrant's Common Stock outstanding. AVANTGO, INC. Form 10-Q INDEX PART I. FINANCIAL INFORMATION PAGE ---- ITEM 1. Condensed Consolidated Financial Statements (Unaudited) Condensed Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001 3 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and September 30, 2001 4 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and September 30, 2001 5 Notes to Condensed Consolidated Financial Statements 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 27 ITEM 4. Controls and Procedures 27 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 27 ITEM 6. Exhibits and Reports on Form 8-K 28 Signatures 29 -2- PART I. FINANCIAL INFORMATION ITEM 1. Condensed Consolidated Financial Statements CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share data) (Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements. -3- CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements. -4- CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements. -5- NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2002 (Unaudited) NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION The Company AvantGo, Inc. (the "Company") was incorporated on June 30, 1997 in Delaware. The Company provides software and services that enable and enhance the use of Internet-based content and corporate portals to mobile devices, including personal digital assistants and Internet-enabled phones. The Company licenses its AvantGo M-Business ServerTM products and AvantGo(R) mobile applications products to help its customers provide their employees, customers, suppliers and business affiliates with easy access to business information. The AvantGo Mobile Internet ServiceTM allows individuals to access Internet-based content and applications and gives content providers and other businesses a new medium for reaching and interacting with new and existing customers, increasing customer acquisition and retention. Basis of Presentation The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles 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 footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month period ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The balance sheet at December 31, 2001 has been derived from the audited 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, 2001. Certain reclassifications have been made to the financial statements for the three months and nine months ended September 30, 2001 to conform to the presentation of the financial statements for the three months and nine months ended September 30, 2002. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported results of operations during the reporting period. Actual results could differ from those estimates. Recent Accounting Pronouncements In July 2001, the FASB issued Statements of Financial Accounting Standards No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other Intangible Assets (SFAS 142). SFAS 141 eliminates the pooling-of-interests method of accounting for business combinations except for qualifying business combinations that were initiated prior to July 1, 2001. SFAS 141 further clarifies the criteria to recognize intangible assets separately from goodwill. The requirements of SFAS 141 are effective for any business combination accounted for by the purchase method that is completed after September 30, 2001. Under SFAS 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives (but with no maximum life). The amortization provisions of Statement 142 apply to goodwill and intangible assets acquired after June 30, 2001. SFAS 142 will have no affect on the Company's financial statements in that all goodwill and intangible assets have been written off due to impairment during 2001. Had the provisions of SFAS 142 been in effect during the three and nine months ended September 30, 2001, the Company's -6- net loss and net loss per share would have been $21.2 million and $0.63 per share, and $45.3 million and $1.41 per share, respectively. During August 2001, the Financial Accounting Standards Board also issued Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). SFAS 144 is effective for fiscal years beginning after December 15, 2001 and supercedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30 relating to the disposal of a segment of business. The adoption of SFAS 144 did not have a material impact on the Company's consolidated financial position, results of operations or cash flows. NOTE 2. CONCENTRATION OF CREDIT RISK The following table sets forth the percentages of revenues from our major customer for the three and nine months ended September 30, 2002 and 2001: Three Months Ended Nine Months Ended September 30, September 30, 2002 2001 2002 2001 ---- ---- ---- ---- Customer A 25% 23% 23% 19% NOTE 3. NET LOSS PER SHARE Basic and diluted net loss per share information for all periods is presented under the requirement of FASB Statement No. 128, "Earnings per Share" ("FASB 128"). Basic earnings per share has been computed using the weighted-average number of shares of common stock outstanding during the period, less shares that may be repurchased, and excludes any dilutive effects of options, warrants and convertible securities. Shares subject to repurchase will be included in the computation of earnings per share when our option to repurchase these shares lapses. Diluted net loss per share reflects the potential dilution of securities by adding other common stock equivalents, including stock options, shares subject to repurchase, warrants and convertible preferred stock, to the weighted average number of common shares outstanding for a period, if dilutive. All potentially dilutive securities have been excluded from the computation, as their effect would be anti-dilutive. The calculation of basic and diluted net loss per share is as follows:

NOTE 4. COMPREHENSIVE LOSS Statement of Financial Accounting Standard (SFAS) No. 130 "Reporting for Comprehensive Income", established standards of reporting and display of comprehensive income and its components of net income and "Other Comprehensive Income". "Other Comprehensive Income" refers to revenues, expenses and gains and losses that are not included in net income but rather are recorded directly in stockholders' equity. The components of -7- comprehensive loss for the three and nine months ended September 30, 2002 and 2001 were as follows (in thousands):

NOTE 5. BUSINESS SEGMENT INFORMATION The Company operates in a single operating segment, providing software and services that enable and enhance the use of Internet-based content and corporate applications to mobile devices, including personal digital assistants and Internet-enabled phones. Geographic Information The Company operates in North America and Europe. Approximately 19% and 15% of revenues were derived from outside North America in the three and nine months ended September 30, 2002, respectively. Approximately 16% of revenues were derived from outside North American in both the three and nine months ended September 30, 2001. Less than 10% of net loss was derived from outside North America in the three and nine months ended September 30, 2002 as well as the three and nine months ended September 30, 2001. During the three and nine months ended September 30, 2002 and 2001, no more than 10% of revenues were derived from any specific country. At September 30, 2002 and 2001, less than 10% of the Company's assets were located outside North America. NOTE 6. AMORTIZATION OF DEFERRED STOCK-BASED COMPENSATION During the quarter ended September 30, 2002, and in connection with a reduction in force, the Company recorded an adjustment to reverse compensation expense for the cancellation of stock option awards that had not yet been earned. This resulted in a net $1.8 million and $526,000 credit included in amortization of goodwill, other intangible assets, and deferred stock-based compensation for the three and nine month periods ended September 30, 2002, respectively. As of September 30, 2002, all of the affected employees had been notified and the majority of these terminations were completed. NOTE 7. RESTRUCTURING AND OTHER IMPAIRMENT CHARGES In April 2001, management approved, and the Company formally adopted and began to implement a restructuring program in an effort to reduce operating expenses. The Company incurred a charge of approximately $2.8 million in the second quarter of 2001 relating to the restructuring. During the third quarter of 2001, the Company reported additional charges of approximately $9.8 million, which included approximately $406,000 related to adjustments to facility exit costs as a result of a rapidly deteriorating real estate market. In the fourth quarter of 2001, management approved and the Company implemented a further restructuring program that resulted in aggregate charges of $2.5 million, which included approximately $1.2 million related to adjustments to facility exit costs as a result of continuing deterioration in the real estate market. In the second quarter of 2002, the Company recorded adjustments to the estimates of facility exit costs resulting in a charge to restructuring expense of $322,000. In July 2002, management approved and the Company formally adopted and began to implement another restructuring program in an effort to reduce operating expenses that resulted in aggregate charges of $4.1 million. These charges included $1.2 million related to revised estimates on the excess space at the Hayward facility, and $207,000 related to revised estimates on the excess space at the Chicago facility as a result of continuing deterioration in the real estate market. The Company also recorded a charge of $479,000 related to excess equipment and software, and other charges related to the reduction in force. Restructuring charges also included $2.2 million related to employee termination costs associated with the elimination of 78 positions, most of which -8- occurred in the United States and affected employees at all levels of the Company. As of September 30, 2002, all of the affected employees had been notified and the majority of these terminations were completed. The following table sets forth the restructuring activity during the three months ended September 30, 2002 (in thousands):

The following table sets forth the restructuring activity during the nine months ended September 30, 2002 (in thousands):

The following table sets forth the restructuring activity during the three months ended September 30, 2001 (in thousands):

-9- The following table sets forth the restructuring activity during the nine months ended September 30, 2001 (in thousands):

At September 30, 2002, the current portion of the restructuring liability of $2,281,000 is included in accrued liabilities; the non-current portion of $3,655,000 is included in accrued restructuring charges. NOTE 8. LEGAL PROCEEDINGS In October 2001, a purported shareholder class action lawsuit was filed in the United States District Court for the Southern District of New York against the Company, certain of the Company's officers and directors (the "Individual Defendants"), and the underwriters of the Company's initial public offering. The suit is a class action filed on behalf of purchasers of the Company's common stock during the period from September 27, 2000 to December 6, 2000. The complaint alleges that the underwriter defendants agreed to allocate stock in the Company's initial public offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases of stock in the aftermarket at pre-determined prices. Plaintiffs allege that the prospectus for the Company's initial public offering was false and misleading in violation of the securities laws because it did not disclose these arrangements. The complaint seeks unspecified damages on behalf of the purported class. Over 300 companies involved in an initial public offering have been named as defendants in nearly identical lawsuits filed by some of the same plaintiffs' law firms. A consolidated amended complaint has been filed. A motion to dismiss addressing issues common to the companies and individuals who have been sued in these actions was filed on July 15, 2002. The Court has not yet ruled on this motion. On October 9, 2002, the Court dismissed the Individual Defendants from the case without prejudice based upon Stipulations of Dismissal filed by the plaintiffs and the Individual Defendants. The Company believes it has meritorious defenses, and it intends to defend the action vigorously; however, due to inherent uncertainties in litigation, management cannot predict accurately the ultimate outcome of the litigation. An adverse judgment in a large monetary amount could have a material adverse impact on the financial position, and consequently the business and results of operations. NOTE 9. RELATED PARTY On July 8, 2002, the Company entered into a consulting agreement with one of its directors. The director provided consulting services to the Company with respect to the development of the Company's business plan and restructuring activities. The consulting engagement was completed and the Company incurred related expenses in the amount of approximately $50,000 during the three months ended September 30, 2002. -10- ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS This document contains certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. These forward-looking statements involve risks and uncertainties, including, but not limited to, those identified in the section of this Form 10-Q entitled "Risk Factors," which may cause actual results to differ materially from those discussed in such forward-looking statements. When used in this document, the words "believes," "expects," "anticipates," "intends," "plans," "future," "may," "will," "should," "estimates," "potential," or "continue" and similar expressions, are intended to identify certain of these forward-looking statements. However, these words are not the exclusive means of identifying such statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. The cautionary statements made in this document should be read as being applicable to all related forward-looking statements wherever they appear in this document. Factors that could cause or contribute to such differences include those discussed below, as well as those contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission for year ended December 31, 2001. We undertake no obligation to release publicly the results of any revision to these forward-looking statements that may be made to reflect events or circumstances occurring subsequent to the filing of this Form 10-Q with the SEC. Readers are urged to review and consider carefully the various disclosures made by us in this report and in our other reports filed with the SEC that attempt to advise interested parties of the risk factors that may affect our business. As used in this report on Form 10-Q, unless the context otherwise requires, the terms "we," "us" or "the Company" and "AvantGo" refer to AvantGo, Inc., a Delaware corporation and, unless the context otherwise requires, its wholly-owned subsidiaries. OVERVIEW We were incorporated in June 1997 as a Delaware corporation under the name Bombardier Software, Inc. and changed our name to AvantGo, Inc. in January 1998. In September 1998, we launched our AvantGo Enterprise products, today called AvantGo M-Business Server products. In May 1999, we introduced our AvantGo Mobile Internet Service. In May 2000, we purchased Globalware Computing and began integrating its Pylon software products and consulting services into our mobile offerings. In October 2000, we completed our initial public offering. In July 2001, September 2001, March 2002 and April 2002, respectively, we launched AvantGo Mobile Sales(TM), AvantGo Mobile Delivery(TM)., AvantGo Mobile Pharma(TM) and AvantGo Mobile Inspection(TM) - mobile business applications that interoperate with our AvantGo M-Business Server products. We provide mobile enterprise software and services that enable and enhance the use of Internet-based content and corporate applications on handheld devices and Internet-enabled phones. We designed our AvantGo M-Business Server products and mobile business applications to automate business processes and improve the exchange of information between companies and their employees and customers, resulting in improved business efficiencies and more effective customer interactions. We license our AvantGo M-Business Server products and mobile business applications to help companies provide their employees, customers, suppliers and business affiliates with easy access to business information. We host our AvantGo Mobile Internet Service to enable our Media and M-Business customers to deliver their content and applications to our over 7.0 million registered AvantGo Mobile Internet Service users. Our AvantGo Mobile Internet Service also allows consumers to access and interact with over 2,000 sources of Internet-based content and corporate applications optimized for delivery to handheld devices and Internet-enabled phones. In July 2002, we announced that we will heighten our focus on applications and solutions targeted to field force professionals. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure or contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to uncollectible accounts and restructuring. We base our estimates on historical experience and on various other -11- assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about amounts and timing of revenue costs and expenses, the carrying values of assets and the recorded amount of liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. Revenue Recognition We generally license our enterprise software under non-cancelable license agreements and provide services including training, consulting and maintenance. Maintenance consists of product support services and unspecified product updates. We sell placement service contracts which provide customers with priority visibility on our website, and also sell advertising on the device delivered through the AvantGo Mobile Internet service, a service that is free to consumers. We recognize license revenues when a non-cancelable license agreement has been signed, the software product has been shipped, there are no uncertainties surrounding product acceptance, the fees are fixed or determinable, collectability is probable, and vendor-specific objective evidence exists to allocate the total fee to elements of the arrangement using the residual method. In instances where no vendor-specific objective evidence exists and the only undelivered element is maintenance, we recognize revenues ratably over the term of the agreement. Our agreements with our customers and resellers generally do not contain product return rights. We recognize revenues from maintenance, which consist of fees for ongoing support and product updates, ratably over the term of the agreement, which is typically one year. For sales made through distributors, resellers and original equipment manufacturers, we recognize revenue at the time these partners report to us that they have sold the software to the end user and all revenue recognition criteria have been met. Consulting revenues are primarily related to implementation services performed on a time-and-materials basis under separate service arrangements. We generate training revenues from classes offered both on-site and at customer locations. We recognize revenues from time-and-materials consulting engagements and training services as we perform the services. Occasionally we enter into short-term fixed price consulting contracts. Under these arrangements, we recognize revenues as work progresses using the percentage-of-completion method, which relies on estimates of total expected contract revenue and costs. We follow this method since reasonably dependable estimates of the revenue and costs applicable to various stages of a contract can be made. When reasonably dependable estimates of the revenue and costs are not available, we use the completed contract method of revenue recognition. Recognized revenues are subject to revisions as the contract progresses to completion. We make revisions in recognized revenues in the period in which the facts that give rise to the revision become known to us. We recognize revenues from placement agreements ratably over the service period, which in most instances is between three months and one year. We recognize advertising revenues based upon the lesser of the ratio of impressions delivered over the total guaranteed impressions or the straight-line basis over the term of the advertising agreement. We also earn revenues from advertising barter transactions. We recognize revenues and costs from advertising barter transactions during the period in which the placement or advertising is delivered. We record barter transactions at the fair value of the goods or services provided or received, whichever is more readily determinable in the circumstances. In determining the value of the services provided, we use historical pricing of comparable cash transactions. Allowance for Doubtful Accounts We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Restructuring We have recorded restructuring charges, some of which are based on estimates regarding the sublease of -12- excess space at several of our facilities. If actual market conditions are less favorable than those projected by management, and we are unable to sublease the excess space as soon as estimated, or for the estimated rate, then additional restructuring charges may be required in the future. OUR BUSINESS We generate our primary sources of revenues through our license agreements and our services agreements. We recognize license revenues for our AvantGo M-Business Server products, which are typically based on fixed-fee agreements, when we have executed an agreement with a customer, delivery and acceptance have occurred, the fee is fixed or determinable, and we deem the collection of the related receivable to be probable. Historically, our services revenues have consisted primarily of consulting revenues and technical support fees. We recognize revenues from consulting services on a monthly basis as the services are performed. We recognize technical support fees ratably on a monthly basis over the course of the support period, typically twelve months. Our services revenues also include amounts derived from the operation of our AvantGo Mobile Internet Service, generated through placement, subscription and advertising revenues, and revenue sharing arrangements. We recognize placement and advertising revenues ratably over the period of time in which placement or advertising is provided. The cost of license fees consists primarily of royalties paid to other software vendors whose products are included in our enterprise software products, as well as costs incurred to manufacture, package and distribute our enterprise software products and related documentation. Cost of services includes cost of professional services, customer service and support and costs related to running our AvantGo Mobile Internet Service. Cost of professional services and technical support consists primarily of the cost of personnel. Costs related to our AvantGo Mobile Internet Service consist of the cost of personnel, hardware, co-location facilities and Internet connectivity charges. Because the cost of services is greater than cost of license fees, cost of revenues as a percentage of total revenues may fluctuate based on the mix of products and services sold. We classify our costs and expenses into three general operational categories: product development, sales and marketing, and general and administrative. In addition, our operating expenses include amortization of goodwill, intangible assets, and deferred stock-based compensation. For the three and nine months ended September 30, 2002 only amortization of deferred stock-based compensation was recorded, as all goodwill and intangible assets were written off in 2001. We classify all charges to the product development, sales and marketing, and general and administrative categories based on the nature of the expenses. Each of these three categories includes commonly recurring expenses such as salaries, employee benefits, travel and entertainment costs, and allocated communication, rent and depreciation costs. We allocate these expenses to each of the functional areas that derive a benefit from such expenses based upon their respective headcount. The sales and marketing category of costs and expenses also includes sales commissions and expenses related to public relations and advertising, trade shows and marketing collateral materials. The general and administrative category of operating expenses also includes administrative and professional services fees. In connection with the granting of stock options to, and restricted stock purchases by, our employees, we recorded deferred stock compensation totaling approximately $22.9 million as of September 30, 2002. This amount represents the difference between the exercise and the deemed fair value of our common stock for financial accounting purposes on the date these stock options were granted. This amount is included as a component of stockholders' equity and is being amortized by charges to operations over the vesting period of the options using a graded method. The amortization of the remaining deferred stock compensation will result in additional charges to operations through 2004. During the quarter ended September 30, 2002, and in connection with our reduction in force, we recorded an adjustment to reverse compensation expense for the cancellation of stock option awards that had not yet been earned. This resulted in a net $1.8 million and a $526,000 credit included in amortization of goodwill, other intangible assets, and deferred stock-based compensation for the three and nine months ended September 30, 2002, respectively. As of September 30, 2002, all of the affected employees had been notified, and the majority of these terminations were completed. We have incurred significant losses and negative cash flows from operations since our inception. As of September 30, 2002, we had an accumulated deficit of $133.7 million. We had 118 full-time employees as of September 30, 2002. -13- RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 The following table sets forth certain financial data, derived from our unaudited statements of operations, as a percentage of total revenues for the periods indicated. The operating results for the three and nine months ended September 30, 2002 and 2001 are not necessarily indicative of the results that may be expected for any future period.

Comparisons of Three and Nine Months Ended September 30, 2002 and 2001 Revenues Total revenues were approximately $4.5 million and $4.9 million for the three months ended September 30, 2002 and 2001, representing a decrease in the third quarter of 2002 of approximately $400,000, or 8%, from the comparable quarter of the prior year. Total revenues were approximately $14.6 million and $18.7 million for the nine months ended September 30, 2002 and 2001, representing a decrease of approximately $4.1 million, or 22% from the comparable period of the prior year. The decline in revenues period over period was primarily attributable to an overall downturn in the economy, one of the results of which has been reduced capital spending on technology, including mobile enterprise software and professional services, as well as longer sales cycles. Consequently, sales of licenses and associated services, and sales of advertising have been negatively impacted. The decline in revenues reflects a decreased volume of licenses and services sold, rather than a decrease in prices. License Fees. License fee revenues decreased approximately $400,000, or 14%, from approximately $2.8 million for the three months ended September 30, 2001 to approximately $2.4 million for the three months ended September 30, 2002. License fee revenues decreased approximately $2.7 million, or 25%, from approximately $10.9 million for the nine months ended September 30, 2001 to approximately $8.2 million for the nine months ended September 30, 2002. The decline in license fee revenues was primarily attributable to the circumstances described in the immediately preceding paragraph. Services. Services revenue decreased approximately $56,000, or 3%, from approximately $2.1 million for the three months ended September 30, 2001 to approximately $2.0 million for the three months ended September 30, -14- 2002. Services revenue decreased approximately $1.3 million, or 18%, from $7.7 million for the nine months ended September 30, 2001 to approximately $6.4 million for the nine months ended September 30, 2002. The decline in services revenue was due to decreased consulting services performed, as a result of fewer license sales to new customers. We also earn revenues from advertising barter transactions. We recognize revenues and costs from advertising barter transactions during the period in which we deliver the advertising or distribution product. We record barter transactions at the fair value of the goods or services provided or received, whichever is more readily determinable in the circumstances. In determining the value of the goods or services provided, we use historical pricing of comparable cash transactions. Revenues earned from barter transactions were $0 and $45,000 for the three months ended September 30, 2002 and 2001. Revenues earned from barter transactions were $0 and $173,000 for the nine months ended September 30, 2002 and 2001, respectively. We do not expect barter revenue to be a significant portion of revenue in the future. We have seen a rapid and increasingly severe downturn in the United States economy that has continued through the first three quarters of 2002. Although we expect this economic downturn to continue into the fourth quarter of 2002, we cannot be certain as to the severity or duration of this downturn. We have also seen a downturn in our European business in 2002. If the economic conditions in the United States and Europe fail to improve or if wider or global economic slowdowns occur, the demand for our products and services may be reduced. In addition to reducing our customers' and prospective customers' budgets for our products and services, these economic slowdowns may also adversely affect our customers' ability to pay for our products and services. Accordingly, these economic slowdowns may have a material adverse impact on our business, operating results and financial condition. Costs and Expenses Cost of License Fees. Our cost of license fees decreased approximately $277,000, or 82%, from approximately $336,000 for the three months ended September 30, 2001 to approximately $59,000 for the three months ended September 30, 2002. Cost of license fees decreased approximately $221,000, or 53%, from approximately $418,000 for the nine months ended September 30, 2001 to approximately $197,000 for the nine months ended September 30, 2002. These decreases were primarily attributable to decreased royalty expenses incurred as a result of a decline in reselling other software developers' products in conjunction with ours during the three and nine months ended September 30, 2002. We expect the cost of license fees to vary according to the sales mix of our products and those of other software developers' products. Cost of Services. Our cost of services decreased approximately $200,000, or 14%, from approximately $1.2 million for the three months ended September 30, 2001 to approximately $1.0 million for the three months ended September 30, 2002. Cost of services decreased approximately $900,000, or 20%, from approximately $4.2 million for the nine months ended September 30, 2001 to approximately $3.3 million for the nine months ended September 30, 2002. These decreases were primarily attributable to a reduction in headcount as a result of the restructuring program that we implemented during 2002. Product Development. Product development expenses decreased approximately $1.5 million, or 48%, from approximately $3.1 million for the three months ended September 30, 2001 to approximately $1.6 million for the three months ended September 30, 2002. Product development expenses decreased approximately $4.8 million, or 44%, from approximately $10.9 million for the nine months ended September 30, 2001 to approximately $6.1 million for the nine months ended September 30, 2002. These decreases were primarily attributable to a reduction in headcount as a result of the restructuring program that we implemented during 2002. To date, all software and development costs have been expensed in the period incurred. Sales and Marketing. Our sales and marketing expenses include those related to compensation, public relations, advertising, trade shows and marketing materials. Sales and marketing expenses decreased approximately $3.1 million, or 44%, from approximately $6.9 million for the three months ended September 30, 2001 to approximately $3.8 million for the three months ended September 30, 2002. Sales and marketing expenses decreased approximately $9.6 million, or 40%, from approximately $23.7 million for the nine months ended September 30, 2001 to approximately $14.1 million for the nine months ended September 30, 2002. These decreases were primarily attributable to a reduction in headcount as a result of the restructuring program that we implemented -15- during 2002, as well as a reduction in the level of advertising expenditures relating to our AvantGo Mobile Internet service. General and Administrative. General and administrative expenses consist primarily of salaries, recruiting and related costs for general corporate functions including executive, accounting and administrative personnel, and other miscellaneous general corporate expenses. Our general and administrative expenses decreased approximately $800,000, or 37%, from approximately $2.2 million for the three months ended September 30, 2001 to approximately $1.4 million for the three months ended September 30, 2002. General and administrative expenses decreased approximately $3.2 million, or 46%, from approximately $6.9 million for the nine months ended September 30, 2001 to approximately $3.7 million for the nine months ended September 30, 2002. This decrease was due primarily to a decrease in the number of executive, finance and administrative employees as a result of the restructuring program that we implemented during 2002. Amortization of goodwill, other intangible assets and deferred stock compensation. Until we determined that goodwill and other intangible assets were impaired and were written off in September 2001, we had been amortizing the amount of goodwill and acquired workforce that we purchased in connection with our acquisition of Globalware, using the straight-line method. We are also amortizing the amount that equals the difference between the exercise price of stock options granted to our employees and consultants and the deemed fair values of our common stock, in the case of option grants to employees, and on values based on the Black-Scholes formula for valuing options, in the case of grants to non-employees, in each case on the date of the grants over vesting periods using a graded vesting method. We recognized $0 of amortization of goodwill and other intangible assets during the three months ended September 30, 2002 and 2001. We recognized $0 for the nine months ended September 30, 2002 and approximately $2.6 million during the nine months ended September 30, 2001. We recognized approximately $406,000 and $1.2 million of amortization of deferred stock compensation during the three months ended September 30, 2002 and 2001. We recognized approximately $1.7 million of deferred stock compensation for the nine months ended September 30, 2002 and approximately $5.5 million of deferred stock compensation for the nine months ended September 30, 2001. During the three months ended September 30, 2002, and in connection with our reduction in force, we recorded an adjustment to reverse compensation expense for the cancellation of stock option awards that had not yet been earned in the amount of $2.2 million. This resulted in a net $1.8 million and $526,000 credit included in amortization of goodwill, other intangible assets, and deferred stock-based compensation for the three and nine month periods ended September 30, 2002, respectively. We anticipate that the amortization of the remaining deferred stock compensation will result in additional charges through 2004. Because goodwill and other intangible assets were determined to be impaired and were written off in September 2001, there will be no further amortization of goodwill or intangible assets. Write-off of core technology. During the third quarter of 2001, due to an overall decline in information technology spending, and anticipated increased pressure from competitors, we concluded that core technology would not be recoverable. An impairment assessment, test and measurement resulted in the recording of a write-off of core technology of $2.0 million related to the acquisition of Globalware in May 2000. Restructuring and other impairment charges. During the third quarter of 2002, management approved and we formally adopted and began to implement another restructuring program in an effort to reduce operating expenses that resulted in aggregate charges of $4.1 million. These charges included $1.2 million related to revised estimates on the excess space at the Hayward facility, and $207,000 related to revised estimates on the excess space at the Chicago facility, due to the continuing deterioration in the real estate market, and $479,000 related to excess equipment and software, and other charges related to the reduction in force. Restructuring charges also included $2.2 million related to employee termination costs associated with the elimination of 78 positions, most of which occurred in the United States and affected employees at all levels. See Note 7 to the Condensed Consolidated Financial Statements, "Restructuring and Other Impairment Charges," for further information regarding these activities. Interest and Other Income, Net. Net interest and other income decreased approximately $343,000, or 52%, from approximately $654,000 for the three months ended September 30, 2001 to approximately $311,000 for the three -16- months ended September 30, 2002. Net interest and other income decreased approximately $1.0 million, or 43%, from approximately $2.2 million for the nine months ended September 30, 2001 to approximately $1.2 million for the nine months ended September 30, 2002. This decrease was primarily due to a decrease in net interest earned as a result of decreased cash balances and lower interest rates. Liquidity and Capital Resources Since inception, we have funded our operations primarily through the sale of equity securities, through which we have raised net proceeds of $124.5 million through September 30, 2002. As of September 30, 2002, we had $32.2 million of cash and cash equivalents, a decrease from $43.1 million of cash and cash equivalents held as of December 31, 2001. As of September 30, 2002, our working capital was approximately $26.5 million compared to approximately $38.2 million on December 31, 2001. Net cash used in operating activities totaled $10.1 million for the nine months ended September 30, 2002, as compared with $21.7 million for the comparable period in 2001. During the nine months ended September 30, 2002, we received a payment of $6 million from our largest customer, McKesson Corporation. This was the final scheduled payment on a three-year contract which will expire in March 2003. During the comparable period in 2001, we received a scheduled payment of $5 million from McKesson Corporation. The principal use of cash was to fund our losses from operations. Net cash provided by financing activities totaled $3,000 during the nine months ended September 30, 2002, as compared with $330,000 for the comparable period in 2001. Since our inception, our investing activities have consisted primarily of purchases of fixed assets, principally computer hardware and software, and leasehold improvements. Capital expenditures totaled $344,000 in the nine months ended September 30, 2002, as compared with $2.3 million for the comparable period in 2001. The decrease was primarily due to the reduction of expenditures related to leasehold improvements for our Hayward office and the reduction of expenditures for computer hardware. During the nine months ended September 30, 2001, we converted all of our investments to cash and cash equivalents, which provided $16.4 million of net cash from investing activities. We have restructured our business to more closely align expenses with near-term revenue. In conjunction with this restructuring, we reduced our workforce by approximately 40% during the third quarter of 2002. We believe that our current cash and cash equivalents will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. However, we may need to raise additional funds in order to support more rapid expansion, develop new or enhanced services and products, respond to competitive pressures, acquire complementary businesses or technologies or take advantage of unanticipated opportunities. Our future liquidity and capital requirements will depend upon numerous factors, including costs and timing of expansion of research and development efforts and the success of such efforts, the success of our existing and new service offerings and competing technological and market developments. The factors described earlier in this paragraph will impact our future capital requirements and the adequacy of our available funds. If additional funds are raised through the issuance of equity securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution in net book value per share or such equity securities may have rights, preferences or privileges senior to those of our stockholders. If additional funds are needed, we cannot assure that additional financing will be available on terms favorable to us, if at all. We lease our facilities under non-cancelable operating leases. Future minimum payments under operating leases, net of any contracted third-party sub-lease rental income at September 30, 2002 are as follows (in thousands): -17- Less Sub- Net Future Operating Lease Rental Minimum Leases Income Payments ------ ------ -------- 2002 $ 710 $ (36) $ 674 2003 2,390 (50) 2,340 2004 2,484 (65) 2,419 2005 2,410 (52) 2,358 2006 2,290 -- 2,290 2007 1,769 -- 1,769 ------- ----- ------- Total $12,053 $(203) $11,850 ======= ===== ======= Included in the table above is the restructuring liability of $4.8 million associated with charges related to excess office space. RISK FACTORS We may be unable to fund our future operating and capital requirements and, therefore, may be unable to execute on our business strategy. Since our inception, we have never been profitable. From inception through September 30, 2002, we had an accumulated deficit of $133.7 million. Because we are not currently generating sufficient cash to fund our operations, we may be forced to rely on external financing to meet future operating and capital requirements. Any projections of future cash needs and cash flows are subject to substantial uncertainty. Our operating and capital requirements depend upon several factors, including the rate of market acceptance of our products and services, our ability to expand our customer base and increase revenues, our level of expenditures for product development, marketing and sales, general administration and purchases of equipment, and other factors. If our operating and capital requirements vary materially from those currently planned, we may require additional financing sooner than anticipated. We cannot assure that financing will be available in amounts or on terms acceptable to us, if at all. Further, if we issue equity securities, stockholders may experience additional dilution, or the new equity securities may have rights, preferences or privileges senior to those of existing holders of our common stock. Debt financing, if available, may involve restrictive covenants, which could restrict our operations or finances. If we cannot raise funds, if needed, on acceptable terms, we may not be able to continue our operations, grow market share, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements. This in turn, could materially and adversely impact our business, operating results and financial condition. If we fail to meet the continued listing requirements of the Nasdaq Stock Market, our stock could be delisted. Our stock is currently listed on the Nasdaq Small Cap Market. Our stock moved from the Nasdaq National Market to the Nasdaq Small Cap Market on September, 12, 2002, because it was no longer in compliance with the listing requirements of the National Market. The Nasdaq Stock Market's Marketplace Rules impose certain minimum financial requirements on us for the continued listing of our stock on the Nasdaq Small Cap Market. One such requirement is a minimum bid price on our stock of $1.00 per share, which must be maintained over a certain period of time prescribed by Nasdaq. Our stock price is currently below the minimums set forth by those rules. We expect to have until June 2, 2003, for our stock price to remain above $1.00 for 10 consecutive days, or our stock could be delisted. Our stock price may continue to be volatile and an active trading market for our common stock may never develop or be sustained. The stock markets, particularly the Nasdaq Small Cap Market on which our common stock is listed, have experienced significant price and volume fluctuations, and the market prices of companies focused on the Internet and wireless communications have been highly volatile. The market price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in response to factors including: o actual or anticipated variations in our quarterly operating results; o announcements of new product or service offerings by us or our competitors; -18- o changes in the handheld and wireless device industries; o technological innovations; o competitive developments; o departure of key personnel; o securities class action litigation, or other civil litigation, brought against us by third parties, regardless of outcome; o changes in financial estimates by securities analysts; o the potential for delisting by Nasdaq; o the potential for a reverse stock split; and o changes in interest rates and other general economic conditions. The slowdown in the adoption of mobile devices and mobile applications has harmed and could continue to harm our revenues. The emergence of markets for our software is critically dependent upon the rapid expansion of the market for mobile devices, including personal digital assistants, handheld computers, smart phones, pagers and other mobile devices. This market has suffered recent setbacks due to the decline in general economic conditions, particularly in the technology sector. Moreover, the economic slowdown has caused prospective customers to reduce their budgets for information technology projects, such as mobile application deployments. This economic slowdown has reduced the rate of growth in the adoption of mobile devices, and associated products and services. Sustained economic slowdown could continue to reduce demand for our software and services. A significant portion of our enterprise revenues comes from a small number of customers, and any decrease in revenues from these customers could harm our operating results. We currently derive a significant portion of our enterprise software revenues from a small number of major customers. For example, McKesson Corporation, our largest customer, represented 25% of our total revenues for the third quarter of 2002. We expect that McKesson Corporation will continue to represent a significant portion of our revenues through March 2003. Any disruption or termination of our commercial relationship with McKesson Corporation would harm our revenues and results of operations. If we adopt additional economic incentives to retain our current employees or attract new employees, stockholder equity could be diluted. The purchase price of many outstanding stock options held by our employees is above the current fair market value of our common stock. To adequately motivate and retain our employees, and to attract new employees, we may need to provide additional economic incentives. For example, our board of directors may seek to increase the stock pool in our existing 2000 Stock Incentive Plan or adopt a new equity incentive plan, such as the new 2001 Stock Incentive Plan, to retain current employees and attract new employees. If we issue additional stock options or additional stock grants to current or new employees, our existing stockholders will suffer dilution. We depend on our M-Business Server software products as a primary source of our revenues, and we do not know if businesses will adopt these products and related services or continue to make investments in technology products such as ours. Our mobile enterprise software, which consists of our AvantGo M-Business Server, and our mobile enterprise applications, including AvantGo Mobile Sales, AvantGo Mobile Delivery, AvantGo Mobile Pharma and AvantGo Mobile Inspection, as well as AvantGo Pylon products, has accounted for 56% of our revenues in the nine months ended September 30, 2002, 56% of our revenues in 2001, and 56% of our revenues in 2000. We expect that a significant portion of our revenues will depend upon the continued and growing market acceptance of our enterprise software products. The lifecycle of our products is particularly difficult to estimate because of growing competition and the changing marketplace. Our enterprise software may not achieve acceptance among businesses and other organizations. A decline in the demand for our enterprise software or our failure to successfully develop, introduce -19- or market new or enhanced products in a timely manner would have a negative impact on sales of our enterprise products, jeopardizing our most important source of revenues. The sales cycle for our products is lengthy. Due to the recent economic downturn, our current and prospective customers may elect to delay or postpone investments in technology such as ours, which would harm our enterprise sales efforts and cause our business to suffer. Increasing competition could harm our ability to maintain or increase sales of our products or reduce the prices we can charge for our products. We face intense competition, and we expect this competition to grow in the future. Our competitors include both start-up companies designing software and services similar to ours and established companies seeking to capitalize on the mobile market. Competition in our industry is primarily on the basis of product functionality, compatibility with other hardware and software, and price. Our enterprise software and services compete primarily with offerings from the following types of companies: o server synchronization software providers, including Palm, Inc., PUMATECH, Inc., Extended Systems and Oracle Corporation; o handheld application development environment providers, including PUMATECH, Inc., IBM Corporation and Microsoft Corporation; o application service providers, including Aether Systems, Inc.; o mobile personal information management application providers, including Synchrologic and Extended Systems; o mobile sales force automation application providers, including Siebel Systems; o mobile pharmaceutical application providers, including Dendrite; and o mobile delivery application providers, including Aether Systems, Inc. Our AvantGo Mobile Internet Service competes with the service offerings from the following types of companies: o value-added wireless service providers, such as Palm, Inc.'s Palm.Net and GoAmerica, Inc.; and o wireless Internet portals, such as InfoSpace, Inc. and Oracle Corporation's Portal to Go. As the mobile device and wireless markets mature, we expect competition to intensify. This competition presents us with several risks. Many of our existing and potential competitors have substantially greater financial, technical, marketing and distribution resources than we do. Several of these competitors have greater name recognition and more established relationships with our target customers. Our competitors may be able to use these advantages to adopt more aggressive pricing policies and products that compete with our enterprise software and offer more attractive terms to customers. As a result, we may lose customers or may be required to limit the amount we can charge customers for our products. In addition, current and potential competitors may establish cooperative relationships among themselves or with third parties to compete more effectively with us. Further, existing and potential competitors may develop enhancements to or future generations of competitive products that will have better performance features than our products. Any of these factors, if they occur, would likely cause our revenues to fall. We do not maintain redundant facilities for our servers, and system failures resulting from earthquakes, power outages or other causes, or accidental or intentional security breaches could disrupt our operations, cause us to incur significant expenses, expose us to liability and harm our reputation. Our operations depend upon our ability to maintain and protect our computer systems, which are located at our offices in Hayward, California and at facilities owned by Level 3 Communications in Sunnyvale, California. We currently do not have redundant facilities. Our systems therefore are vulnerable to damage from vendor shutdowns, break-ins, unauthorized access, vandalism, fire, floods, earthquakes, power loss, telecommunications failures, terrorist acts such as that occurring on September 11, 2001 and similar events. -20- The potential impact on us and our general infrastructure of being located near major earthquake faults is unknown, but operating results could be materially adversely affected in the event of a major earthquake. In addition, California has experienced power shortages in the past, which resulted in brief power outages, or "blackouts", in parts of the state. Any such blackouts in the future could cause disruptions to our operations, especially our AvantGo Mobile Internet Service, which during a blackout could become inaccessible to our users. Additionally, these blackouts could disrupt the operations of our distributors, resellers and customers. Although we maintain insurance against break-in, unauthorized access, vandalism, fires, floods, earthquakes and general business interruptions, the amount of coverage may not be adequate in any particular case, and will not likely compensate us for all the damages caused by these or similar events. We may be unable to prevent computer programmers or hackers from penetrating our network security from time to time. A breach of our security could seriously damage our reputation, which would harm our business. In addition, because a hacker who penetrates our network security could misappropriate proprietary information or cause interruptions in our services, we might be required to expend significant resources to protect against, or to alleviate, problems caused by hackers. We might also face liability to persons harmed by misappropriation of secure information if it is determined that we did not exercise sufficient care to protect our systems. Our future success will depend on our ability to anticipate and keep pace with technological change, and if we experience delays in developing and introducing software compatible with new products and technologies, our business will suffer. The market for mobile enterprise software is becoming highly competitive and is characterized by evolving industry standards, rapid technological change and frequent product introductions. To remain competitive, we must continuously develop new products and services and adapt our software to function on new devices and operating systems designed and marketed by other companies. The development of software and services like ours can be difficult, time-consuming and costly, and we could lose market share if we encounter delays in the development and introduction of our future software products. Additionally, our business could be seriously harmed if: o competitors develop new technologies and products which provide comparable functionality at reduced prices to our customers and potential customers; o we fail to anticipate technological trends or evolving industry standards or to adapt our software and services to these new trends and standards; o other companies develop products that render our software obsolete or less desirable to consumers; or o technical, legal, financial or other obstacles prevent us from improving our software and services to adapt to changing market conditions. Because our quarterly operating results are volatile and difficult to predict, period-to-period comparisons of our operating results are not necessarily meaningful, and you should not rely on them as indications of future performance. Because our licensing, professional services and AvantGo Mobile Internet Service revenues can vary substantially from month to month and are difficult to predict, and we expect to continue to rely on these revenues, our future quarterly revenues and operating results may fluctuate substantially. As a result of these factors, we believe that quarter-to-quarter or other periodic comparisons of our revenue and operating results are not necessarily meaningful, and that these comparisons may not be accurate indicators of future performance. Our prospects must be considered in light of the risks, expenses and difficulties encountered by companies at an early stage of development, particularly companies in new and rapidly evolving markets, such as mobile software and Internet technologies. Examples of the factors that could cause our quarterly results to vary include: o failure to close key enterprise agreements as contemplated; o termination of important contracts, including those with McKesson Corporation; and o long sales cycles for our products. Because our staffing and operating expenses are based on anticipated revenue levels and because a high percentage of our costs are fixed, small variations in the timing of the recognition of specific revenue could cause -21- significant variations in operating results from quarter to quarter. If we are unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall, any significant revenue shortfall would likely have an immediate negative effect on our business. It is likely that in some future quarter or quarters our operating results will be below public expectations. If this occurs, we would expect to experience an immediate and significant decline in the market price of our common stock. The emergence of a dominant platform for mobile devices could reduce our customer base and revenues. The marketplace for mobile devices is currently characterized by a number of competing operating systems and standards for handheld devices and cellular telephones. Currently, our customers and potential customers often use a variety of mobile devices with multiple connectivity options. One of the primary benefits of our products is their ability to operate across a wide variety of platforms. If a dominant platform for mobile devices emerges, the demand for interoperable software may decline and the need for our software may diminish. We depend on our ability to market successfully the functionality of our software. Even if the market for mobile devices continues to expand, our success will depend, among other things, on whether businesses and consumers adopt our products and services for obtaining Web-based information and applications on mobile devices. We have expended considerable resources on sales and marketing of our products and services. As revenues increase, we expect that these expenses will continue to increase. If our sales and marketing efforts are inadequate and we are unable to build our visibility and brand name, our enterprise revenues will fall and consumer use of our AvantGo Mobile Internet Service will fail to develop further, jeopardizing our ability to generate revenue from the sale of advertising and distribution products. If we fail to either maintain our existing relationships or enter into new key relationships with leading hardware and software manufacturers, our brand awareness and the use of our products and services will suffer. The success of our product and service offerings depends, in large part, on our ability to develop and maintain relationships with leading hardware and software manufacturers, such as Palm, Inc., Microsoft Corporation and Research in Motion Ltd., that bundle or offer our software with their product offerings. We depend on these relationships to: o distribute our products to purchasers of mobile devices; o increase usage of our AvantGo Mobile Internet Service; o build brand awareness through product marketing; and o cooperatively market our products and services. All of our agreements with these companies are non-exclusive and have broad rights of termination. In addition, these agreements do not require these companies to bundle our software with all of their product offerings. Some of these manufacturers have products or services that compete with AvantGo's mobile software. Any of these manufacturers may choose either to promote its competing product or service or promote the services of one or more of our other competitors, which could limit the growth of our business. Our success depends on strong performance by equipment manufacturers and software companies with whom we have key relationships. Because we depend on equipment manufacturers like Palm, Inc. and Research in Motion Ltd., and software companies like Microsoft Corporation to help promote the benefits and adoption of mobile technology, as well as in some instances distribute our software, the sales growth of our products and services is dependent in part upon their success. If the products that these companies sell, or the operating systems upon which these products are based, were to lose popularity, or if any of these equipment manufacturers or software companies cease to distribute our software in significant volumes, or if they change operating systems to which we cannot adapt, our business would suffer. The use of our AvantGo Mobile Internet Service may be reduced if we are unable to maintain and expand our agreements with content providers and e-businesses. -22- Existing users of our content providers and e-businesses that deliver content to our website account for a significant portion of the traffic to our AvantGo Mobile Internet Service. To expand our AvantGo Mobile Internet Service, we must maintain quality relationships with these content providers and e-businesses. If we fail to continue to provide valuable content and services, mobile device users may be less likely to actively use our service and to engage in commercial transactions using our service, which, in turn, would harm our business. All of our agreements with content providers and e-businesses survive for a short period of time and are non-exclusive. These companies may choose not to renew their agreements with us or may terminate their agreements at any time. If any of these agreements terminate, we will experience a decline in the number of websites that are optimized for use with mobile devices, and our competitive position could suffer. Further, while we intend to pursue additional relationships with content providers and e-businesses, we may not experience sustained increases in user traffic from these affiliations. Our future results could be harmed by risks associated with our operations in Europe and other international markets. We sell our products in the United States and abroad. We manage our European sales and marketing operations through our U.K. subsidiary, AvantGo Europe, Ltd. Revenues from international sales represented 15% of our revenues in the nine months ended September 30, 2002. Our business therefore is subject to the risks associated with doing business internationally. The costs of developing overseas revenues may exceed those revenues. Accordingly, our future results could be harmed by a variety of factors, including: o changes in foreign currency exchange rates; o inflation; o the adoption of incompatible platforms or standards; o trade protection measures and import or export licensing requirements; o potentially negative consequences from changes in tax laws; and o weak economic conditions in foreign markets. Our success depends on retaining and recruiting key personnel. Our future success depends to a significant extent on the continued services of our senior management and other key personnel. We have no employment agreements that prevent any of our key personnel from terminating their employment at any time. We do not maintain key person life insurance on any of our officers. Despite recent reductions in workforce, we will continue to recruit key personnel. We may be unable to retain our key employees or to attract, assimilate or retain other highly qualified employees in the future. The mobile computer industry is a complex industry that requires a unique knowledge base, and the loss of technical knowledge and industry expertise among our key personnel, or our failure to obtain necessary additional expertise, could result in delays in software development, loss of sales and a diversion of management resources, which could harm our business. Our software may contain defects or errors, which would delay shipments of our products, harm our reputation and increase our costs. Our software is complex as it must operate across a broad variety of operating systems, devices and connectivity options and meet the stringent requirements of our customers. We must develop our products and services quickly to keep pace with the rapidly changing software and telecommunications markets. Despite testing by our customers and us, software as complex as ours is likely to contain undetected errors or defects, especially when first introduced or when new versions are released. Our software may not be free from errors or defects after delivery to customers has begun, which could result in the rejection of our software or services, damage to our reputation, lost revenues, diverted development resources and increased service and support costs, any of which could harm our business. Computer viruses have been reported to impact handheld device operating systems. Viruses and publicity about them may adversely impact adoption of mobile technology and sales of our products and services. In particular, the -23- unavailability of anti-virus protection that our users deem to be adequate to combat these viruses could have a material adverse effect on our business. We incorporate software licensed from third parties into our products, and our loss of these licenses could disrupt our sales. We currently license software from a variety of third parties. If we were found to be in breach of any of our license agreements, or, in any event, upon termination of such agreements, we would have to discontinue the use of the licensed software, cease the use and sale of products containing this software, and incur expenses to develop or obtain licenses to other technology. We may be unable to develop alternative technologies or to obtain a license to use the software formerly licensed to us on commercially reasonable terms. Although we are generally indemnified against claims that technology licensed to us infringes the intellectual property rights of others, such indemnification is not always available for all types of intellectual property, and in some cases the scope of such indemnification is limited. Even if we receive broad indemnification, third party indemnitors may not have the financial resources to fully indemnify us in the event of infringement, resulting in substantial exposure to us. We cannot be assured that infringement claims arising from the incorporation of this technology will not be asserted or prosecuted against us. These claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources in addition to potential redevelopment costs and delays, all of which could materially adversely affect our business, operating results and financial condition. We were named in a securities class action lawsuit that could materially harm our business and financial condition and result in a decline in our stock price. AvantGo, certain of our officers and directors, and the underwriters of our initial public offering are parties to a class action lawsuit alleging a violation of securities laws. This pending litigation, and any subsequent litigation against us or our affiliates or employees, regardless of the outcome, may result in substantial costs and expenses and significant diversion of management, which could materially adversely affect our business. Due to inherent uncertainties in litigation, we cannot predict accurately the ultimate outcome of the litigation. An adverse judgment in a large monetary amount could have a material adverse impact on our financial position, and consequently our business and results of operations. Such an event would likely cause our stock price to decline substantially. Increasing government regulation could cause demand for our products and services to grow more slowly or to decline. We are subject not only to government regulations applicable to businesses generally, but also to laws and regulations directly applicable to the Internet. Demand for our software in certain countries, and our ability to meet this demand, is subject to export controls on hardware and on the encryption software incorporated into our products. In addition, state, federal and foreign governments may adopt laws and regulations governing any of the following issues: o user privacy; o taxation of electronic commerce; o the online distribution of specific material or content; and o the characteristics and quality of online products and services. One or more states or the federal government could enact regulations aimed at companies like us, which provide software that facilitates e-commerce and the distribution of content over the Internet. The likelihood of the enactment of regulations in these areas will increase as the Internet becomes more pervasive and extends to more people's daily lives. Any legislation, regulation or taxation of, or concerning, electronic commerce could dampen the growth of the Internet and decrease its acceptance as a communications and commercial medium. If a reduction in growth occurs as a result of these events, demand for our products and services could decline significantly. We may be subject to liability for transmitting information, and our insurance coverage may be inadequate to fully cover us against this liability. -24- We could be exposed to liability with respect to third-party information that our users access with our software. Even if these claims do not result in liability to us, they would likely divert management's attention and resources and we could incur significant costs in investigating and defending against these claims. Although we carry general liability insurance, our insurance may not cover potential claims of this type or may be inadequate to cover all costs incurred in defense of potential claims or to indemnify us for all liability that may be imposed. We rely on intellectual property rights, and we may not be able to obtain patent or other protection for our technology, products or services. We rely on a combination of patent, copyright, trademark and trade secret laws, confidentiality procedures and contractual provisions to protect our proprietary technology, products and services. We also believe that factors such as the technological and creative skills of our personnel, new product developments, frequent product enhancements and name recognition are essential to establishing and maintaining a technology leadership position. We seek to protect our proprietary software and written materials under trade secret, patent and copyright laws, which afford only limited protection. We do not know which, if any of these or other applications will ever be issued or, if issued, whether they will contain claims with the scope that we seek, or whether they will survive legal challenges that may be brought. Any such legal challenges, whether or not successful, may be expensive to defend. Furthermore, others may develop technologies that are similar or superior to our technology or design around any patents which may issue. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our software or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries do not ensure that our means of protecting our proprietary rights in the United States or abroad will be adequate. We have entered into source code escrow agreements with a limited number of our customers and business affiliates requiring release of our source code in certain limited circumstances. These agreements generally provide that each party to the agreement will have a limited, non-exclusive right to use our code should one of these circumstances occur, such as if we cease to do business or if we fail to meet our contractual obligations. This may increase the likelihood of misappropriation by third parties. If we are unable to adequately protect our intellectual property, it could materially affect our financial performance. In addition, potential competitors may be able to develop non-infringing technologies or services similar to ours. We may be sued by third parties for infringement of their proprietary rights, and litigation or threatened litigation could require us to incur significant litigation or licensing expenses, prevent us from selling our software or require us to make expensive modifications to our software to avoid infringement. The wireless communications, handheld computers and software industries are characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement or other violations of intellectual property rights. As the number of participants in our market increases, the likelihood of an intellectual property claim against us could increase. We expect that we may increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any claim made against us, regardless of merit, could be time-consuming to defend, result in costly litigation, divert management's attention and resources or cause product release delays. In addition, this kind of claim, if successful, could require us to discontinue the use of infringing software code or processes, to cease the use and sale of infringing products, to incur significant litigation costs and expenses and to develop non-infringing technology or to obtain licenses to the alleged infringing technology under which we might be required to pay expensive royalties. We may be unable to develop alternative technologies or to obtain a license to use software formerly used by us or, if a license were obtainable, the terms might not be commercially acceptable to us. In the event of a successful claim of product infringement against us and our failure or inability to obtain a license or develop or acquire non-infringing technology, our business would suffer. Future sales of our common stock may cause our stock price to decline. Sales of significant amounts of our common stock in the public market or the perception that sales of significant amounts of common stock will occur could adversely affect the market price of our common stock or our future ability to raise capital through an offering of our equity securities. -25- Acquisitions we consummate in the future may disrupt our business and cause our existing stockholders to suffer dilution. As part of our business strategy, we may acquire or make additional investments in businesses, products and technologies that complement ours. We may experience difficulties integrating the operations of companies we might acquire, into ours. As a result, we may divert management attention to the integration that would otherwise be available for the ongoing development of our core business. Acquisitions have inherent risks, including: o risks related to the strategic utility of technology acquired; o difficulties assimilating acquired operations, technologies or products; o unanticipated costs; and o adverse effects on relationships with customers, suppliers and employees. If we fail to successfully integrate any businesses, products, technologies or personnel that we acquire, that would harm our business. We cannot guarantee that we will not need to write off any of our investments or that our investments will yield a significant return, if any. We may issue equity securities to finance acquisitions, which would dilute our current stockholders' investment, or we may incur significant indebtedness, which could harm our business. Provisions in our charter documents and Delaware law could prevent or delay a change in control, which could reduce the market price of our common stock. Provisions of our certificate of incorporation and bylaws, and of Delaware law, could limit the price that investors might be willing to pay in the future for shares of our common stock and may have the effect of delaying or preventing a change of control or changes in our management. These provisions: o allow the board of directors to issue preferred stock without any vote or further action by the stockholders; o eliminate the right of stockholders to act by written consent without a meeting; o eliminate cumulative voting in the election of directors; and o divide our board of directors into three classes, with each class serving a staggered three-year term. Provisions of Delaware law may discourage, delay or prevent someone from acquiring or merging with us. These provisions prevent us from engaging, under limited circumstances, in a merger or sale of more than 10% of our assets, with a stockholder who owns 15% or more of our outstanding voting stock, as well as affiliates and associates of the stockholder, for three years following the date that the stockholder became an owner of 15% or more of our outstanding voting stock unless: o the transaction is approved by the board of directors before the date the interested stockholder attained that status; o upon the closing of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced; or o on or after such date, the business combination is approved by the board and authorized at an annual or special meeting of stockholders by at least two-thirds of the outstanding voting stock that is not owned by the interested stockholder. -26- ITEM 3. Quantitative and Qualitative Disclosures About Market Risk We are exposed to the impact of interest rate changes and change in the market values of our investments. Interest Rate Risk. We are exposed to the impact of short-term changes in interest rates. Our exposure primarily relates to our investment portfolio. We invest our excess cash in high quality corporate and municipal debt instruments. Investments in both fixed rate and floating rate interest earning instruments carries a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted by a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. As a result, changes in interest rates may cause us to suffer losses in principal if forced to sell securities that have declined in market value or may cause our future investment income to fall short of expectations. Our investment portfolio is designated as available-for-sale, and accordingly is presented at fair value in the consolidated balance sheet. We protect and preserve our invested funds with investment policies and procedures that limit default, market and reinvestment risk. We have not utilized derivative financial instruments in our investment portfolio. As of September 30, 2002, we had unrestricted cash and cash equivalents of $32.2 million. Cash and cash equivalents consist of cash and highly liquid short-term investments with original maturities of three months or less at the date of purchase. Our interest income is sensitive to changes in the general level of U.S. interest rates, particularly since the majority of our investments are in short-term instruments. Due to the nature of our cash and cash equivalents, we have concluded that there is no material market risk exposure. At September 30, 2002, our cash and cash equivalents consisted primarily of demand deposits, money market funds, U.S. government obligations and corporate debt securities held by three major financial institutions in the United States. We had no short-term investments at September 30, 2002. Foreign Currency Exchange Risk. We develop products in the United States for sale in North America and Europe. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since our sales are currently priced in U.S. dollars and translated to local currency amounts, a strengthening of the dollar could make our products less competitive in foreign markets. We have one foreign subsidiary whose expenses are incurred in its local currency. As exchange rates vary, its expenses, when translated, may vary from expectations and adversely impact overall expected profitability. Our operating results include $126,000 of unrealized other income due to exchange rate fluctuations in the third quarter of 2002. ITEM 4. Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. An evaluation has been performed under the supervision and with the participation of our management, including the CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures within 90 days prior to the filing of this report. Based on that evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of September 30, 2002. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to September 30, 2002. PART II OTHER INFORMATION ITEM 1. Legal Proceedings In October 2001, a purported shareholder class action lawsuit was filed in the United States District Court for the Southern District of New York against us, certain of our officers and directors (the "Individual Defendants"), and -27- the underwriters of our initial public offering. The suit is a class action filed on behalf of purchasers of our common stock during the period from September 27, 2000 to December 6, 2000. The complaint alleges that the underwriter defendants agreed to allocate stock in our initial public offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases of stock in the aftermarket at pre-determined prices. Plaintiffs allege that the prospectus for our initial public offering was false and misleading in violation of the securities laws because it did not disclose these arrangements. The complaint seeks unspecified damages on behalf of the purported class. Over 300 companies involved in an initial public offering have been named as defendants in nearly identical lawsuits filed by some of the same plaintiffs' law firms. A consolidated amended complaint has been filed. A motion to dismiss addressing issues common to the companies and individuals who have been sued in these actions was filed on July 15, 2002. The Court has not yet ruled on this motion. On October 9, 2002, the Court dismissed the Individual Defendants from the case without prejudice based upon Stipulations of Dismissal filed by the plaintiffs and the Individual Defendants. We believe we have meritorious defenses, and we intend to defend the action vigorously. ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits. Exhibit No Description ---------- ----------- 10.42 Letter Agreement with Lesko Associates, dated July 18, 2002 10.43 Separation Agreement and General Release with Mike Aufricht, dated September 4, 2002 10.44 Separation Agreement and General Release with Felix Lin, dated September 28, 2002 10.45 Separation Agreement and General Release with David Moore, dated September 3, 2002 10.46 Separation Agreement and General Release with Richard Owen, dated September 30, 2002 10.47 Separation Agreement and General Release with Paul Kanneman, dated August 19, 2002 10.48 Offer Letter to David B. Pratt from Jim T. Richardson dated September 25, 2002 99.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C Section 1350 as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K. Current report on Form 8-K filed on August 14, 2002, under Item 9 thereof. -28- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AVANTGO, INC. Date: November 13, 2002 By: /s/ David B. Cooper, Jr. ------------------------------ David B. Cooper, Jr. Chief Financial Officer (Principal financial and chief accounting officer) -29- CERTIFICATIONS I, David Pratt, certify that: 1. I have reviewed this quarterly report on Form 10-Q of AvantGo, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entitles, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 /s/ David Pratt --------------- David Pratt Interim Chief Executive Officer -30- CERTIFICATIONS I, David B. Cooper, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of AvantGo, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entitles, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 13, 2002 /s/ David B. Cooper, Jr. ------------------------ David B. Cooper, Jr. Chief Financial Officer -31-

AVANTGO INC 10-Q