| INTRAWARE INC ITEM 1A RISK FACTORS You should carefully consider the risks described below before making a decision to invest in our common stock |
| The risks and uncertainties described below are not the only ones facing Intraware |
| Additional risks and uncertainties presently unknown to us, or that we do not currently believe are important to an investor, may also harm our business operations |
| If any of the events, contingencies, circumstances or conditions described in the following risks actually occur, our business, financial condition and results of operations could be seriously harmed |
| If that occurs, the trading price of our common stock could decline, and you may lose part or all of your investment |
| We have a history of losses and negative cash flow, and we have yet to achieve sustained profitability or positive cash flow |
| We have incurred significant losses since we were formed in 1996, and have yet to achieve sustained profitability or positive cash flow |
| As of February 28, 2006, we had an accumulated deficit of approximately dlra158 million |
| Also, with the exception of our quarters ended November 30, 2002, and August 31, 2005, we have not achieved positive cash flow from operations since our formation in 1996 |
| We expect to report an overall cash usage from operations for our 2007 fiscal year |
| Our operating history makes it difficult to evaluate whether or when we will be able to achieve sustained profitability or positive cash flow in the future |
| The market for our SubscribeNet electronic software and license delivery and management service is immature and volatile |
| The market for hosted digital delivery services is relatively unproven, and it is uncertain whether these services will achieve and sustain high levels of demand and market acceptance |
| Our success will depend to a substantial extent on the willingness of companies, large and small, to increase their use of hosted digital delivery services |
| If companies do not increase their use of hosted digital delivery services, our operating results will be hurt |
| In addition, in this unproven market, we have limited insight into trends that may develop and affect our business |
| We may make errors in predicting and reacting to relevant business trends, which could harm our business |
| We market our SubscribeNet electronic software and license delivery and management service principally to software companies |
| However, many software companies have invested substantial personnel and financial resources in developing their own electronic software and/or license delivery systems, and therefore may be unwilling to migrate to and pay for an outsourced service |
| In addition, some software companies have adopted automatic update, or "e phone home, "e technology for delivering software updates, whereby an end-userapstas computer automatically contacts the software companyapstas server to check whether updates are available and, if so, downloads and installs those updates |
| This method for delivering software updates could be viewed by our potential and existing customers as an alternative to our digital delivery technology, and therefore any increased adoption of this automatic update technology could hurt our business and results of operations |
| Further, some companies may be reluctant to use either our SubscribeNet delivery services because they are concerned about the security capabilities of these services |
| Provisions of our charter documents could make it more difficult for a third party to acquire us, even if the offer may be considered beneficial by our stockholders, which could depress the trading price of our common stock |
| Our charter documents contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous |
| These provisions among other things: * establish a classified board of directors so that not all members of our board are elected at one time; * require super-majority voting to amend some provisions in our amended and restated certificate of incorporation and bylaws; * authorize the issuance of "e blank check "e preferred stock that our board could issue to increase the number of outstanding shares and to discourage a takeover attempt; * prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders; * provide that the board of directors is expressly authorized to make, alter or repeal our bylaws; and * establish advance notice requirements for nominations for election to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings |
| In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control of our company |
| Section 203 imposes certain restrictions on merger, business combinations and other transactions between us and holders of 15 percent or more of our common stock |
| The loss of one or more of our key customers could cause our revenue growth to slow or cause our revenues to decline |
| A substantial portion of the revenues from our SubscribeNet service comes from a relatively small number of customers |
| Our contracts with most of these customers are subject to renewal or cancellation annually |
| If any of these customers elected to cancel their agreements with us, our revenue growth would likely slow and our revenues could decline |
| Mergers and acquisitions in the technology sector could harm us by causing cancellation of customer contracts where our customers are acquired, or by strengthening our competitors |
| In recent years, there has been an increase in mergers and acquisitions among technology companies |
| This trend poses risks for us |
| First, our customers are technology companies, and any acquisitions of our customers could lead to cancellation of our contracts with those customers by the acquiring companies |
| Second, our competitors also are technology companies |
| Any acquisitions of other companies by our competitors, or acquisitions of our competitors by other companies, are likely to result in larger and stronger companies competing against us |
| Either of these types of events could reduce our revenue through loss of existing customers, or reduce our margins through increased price competition |
| Competition from other electronic delivery and licensing providers, and potential customers &apos development of their own electronic delivery and/or licensing systems, could limit our revenue growth and reduce our gross margins |
| The market for selling electronic delivery and licensing services is highly competitive |
| Some of our competitors have longer operating histories, greater financial, technical, marketing and other resources, broader product and service offerings, better name recognition, and a larger installed base of customers than we do |
| Some of our competitors also have well-established relationships with our potential customers and with third-party information technology or consulting firms that help market our competitors &apos services |
| We expect competition to intensify as current competitors expand and improve their service offerings and new competitors enter the market |
| In addition, our current and potential customers are primarily information technology companies with strong software development expertise |
| When considering their alternatives for implementing a system for electronic delivery of software or license keys, these companies sometimes elect to develop such systems in-house |
| While we believe our competitive position is strong against both external competitors and in-house development, we have at times experienced reduced prices, reduced gross margins and lost sales as a result of such competitive factors |
| Such competition is likely to intensify, which could limit the growth of our revenues or gross margins |
| Our sales and marketing services arrangement with Software Spectrum, Inc |
| terminated on January 3, 2006 |
| As a result, we will no longer recognize alliance and reimbursement revenues after January 3, 2006 |
| Until January 3, 2006, we provided sales and marketing services to Software Spectrum to assist in its resale and marketing of Sun Java Enterprise System and Sun One software licenses and maintenance, under a Sales Alliance Agreement between us and Software Spectrum |
| Under that agreement, Software Spectrum shared with us a portion of its gross profit from resales of licenses and maintenance for that Sun software, and paid us a SubscribeNet service fee for electronic delivery of that Sun software |
| This agreement accounted for substantially all of our alliance and reimbursement revenues, a significant portion of our online services and technology revenues, and more than 10prca of our total revenues in our 2006 fiscal year |
| Effective January 3, 2006, we terminated our Sales Alliances Agreement with Software Spectrum We have signed a two-year SubscribeNet service agreement with FusionStorm to provide ESDM services for their SunOne product sales, which we expect will partially offset the decline in our online services and technology revenues |
| The company does not expect to offer sales and marketing services in the future to other customers as part of the SubscribeNet offering |
| We will no longer recognize any alliance and reimbursement revenues after January 3, 2006 |
| Although our subscription-based sales model for our SubscribeNet service limits the volatility of our online services and technology revenue, other factors may cause our operating results, and therefore our stock price, to fluctuate |
| Our SubscribeNet service fees, which comprise most of our online services and technology revenues, are recognized ratably over contract terms of generally one year, thereby limiting the quarter-to-quarter volatility of those revenues |
| Nevertheless, certain factors may cause our online services and technology revenues to fluctuate |
| In addition to the other risk factors described in this section, factors that could cause such fluctuation include: * Deferral of SubscribeNet revenue recognition due to delays by customers in implementing the SubscribeNet service, due to new sales involving extensive implementations, or due to contract modifications adding significant future deliverables; * Lengthening of the sales cycle for our SubscribeNet service due to macroeconomic or other factors; * Actual events, circumstances, outcomes, and amounts differing from judgments, assumptions, and estimates used in determining the values of certain assets (including the amounts of related valuation allowances), liabilities and other items reflected in our consolidated financial statements or unaudited interim consolidated financial statements; and * Changes in accounting rules, such as recording expenses for employee stock option grants |
| * Consequently, operating results for a particular future period are difficult to predict, and prior results are not necessarily indicative of results to be expected in future periods |
| Any of these factors could materially adversely affect our results of operations and stock price |
| The technological and functional requirements we must meet to stay competitive are subject to rapid change |
| If we are unable to quickly adapt to these changes and meet the demands of our current and potential customers, we will likely lose sales and market share and our revenue growth will be limited |
| We market primarily to software publishers, who generally demand that a service like ours meet high technological and functional standards |
| To remain competitive in this market and meet the demands of current and prospective customers, we must continually adapt and upgrade our technology and functionality |
| We are a small company with limited resources available for enhancing and expanding our services |
| If we do not respond quickly enough to changing industry standards or the demands of customers and potential customers, we will likely lose sales and market share to competitors and our growth prospects will be limited |
| In addition, we could incur substantial costs to modify our services or infrastructure in order to adapt to changing standards and demands |
| If we incur such costs and our sales fail to increase commensurately, we may not be able to achieve sustained profitability and positive operating cash flow |
| Defects in our SubscribeNet service could diminish demand for the service and subject us to substantial liability |
| Our service is complex, and may have errors or defects that users identify after they begin using it, which could harm our reputation and our business |
| Internet-based services frequently contain undetected errors when first introduced or when new versions or enhancements are released |
| Despite taking precautions to avoid errors, we have from time to time found defects in our service and new errors in our existing service may be detected in the future |
| Because our customers use our service for important aspects of their business, any errors, defects or other performance problems with our service could hurt our reputation and may damage our customers &apos businesses |
| If that occurs, customers could elect not to renew their agreements with us, could be eligible for credits under our service level agreements, and could delay or withhold payment to us |
| We also could lose future sales, or customers may make warranty claims against us, which could result in an increase in our provision for doubtful accounts, an increase in collection cycles for accounts receivable, or the expense and risk of litigation |
| Interruptions or delays in service from our third-party Web hosting facilities, or in our relationships with third party hardware and software vendors, could impair the delivery of our service and harm our business |
| We provide our service through computer hardware that is currently located in a third-party Web hosting facilities in Santa Clara, California operated by SAVVIS Communications, and in Ireland operated by Data Electronics |
| We do not control the operation of these facilities, and they are subject to damage or interruption from earthquakes, floods, fires, power loss, telecommunications failures and similar events |
| While physical security measures are in place, they are also subject to break-ins, sabotage, intentional acts of vandalism and similar misconduct |
| Despite precautions taken at the facilities, the occurrence of a natural disaster, a decision to close a facility without adequate notice, or other unanticipated problems at a facility could result in lengthy interruptions in our service |
| In addition, the failure by either facility to provide our required data communications capacity could result in interruptions in our service |
| We have an agreement with SBC E-Services, an affiliate of SBC Communications, Inc, to provide access to a geographically remote disaster recovery facility that would provide us access to hardware, software and Internet connectivity in the event the SAVVIS facility becomes unavailable |
| Even with this disaster recovery arrangement, however, our service would be interrupted during the transition |
| Any damage to, or failure of, our systems could result in interruptions in our service |
| Interruptions in our service may reduce our revenue, cause us to issue credits or pay penalties, cause customers to terminate their subscriptions and adversely affect our renewal rates |
| Our business will be harmed if our customers and potential customers believe our service is unreliable |
| In addition, to a significant degree, we rely on various third-party software applications and hardware to deliver our service |
| If we experience disruptions in those vendor relationships and those software and hardware components become unavailable to us, or unavailable on commercially reasonable terms, our service could be interrupted and/or damaged, causing harm to our customer relationships, our reputation, and our overall business |
| Viruses may hinder acceptance of Internet-based digital delivery, which could in turn limit our revenue growth |
| The proliferation of software viruses is a key risk that could inhibit acceptance by information technology professionals of Web-based delivery of digital goods |
| Any well-publicized transmission of a computer virus by us or another company using digital delivery could deter information technology professionals from using-and deter software providers from outsourcing-digital delivery, thereby adversely affecting our business |
| Our SubscribeNet service enables our customers to upload their software products directly onto our systems for downloading by their end-users |
| Our systems automatically scan our customers &apos software products for known computer viruses on an ongoing basis while they are on our systems |
| However, it is possible that, in spite of those periodic virus scans, our system could transmit the virus to one or more end-users |
| Any such virus transmission could result in disputes, litigation and negative publicity that could adversely affect our business and our stock price |
| If our security measures are breached and unauthorized access is obtained to a customerapstas data, our service may be perceived as not being secure and customers may curtail or stop using our service |
| Our service involves the storage and transmission of customers &apos proprietary information, and security breaches could expose us to a risk of loss of this information, litigation and possible liability |
| If our security measures are breached as a result of third-party action, employee error, malfeasance or otherwise, and, as a result, someone obtains unauthorized access to one of our customers &apos data, our reputation will be damaged, our business may suffer and we could incur significant liability |
| Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures |
| If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose sales and customers |
| Additional government regulations may harm demand for our services and increase our costs of doing business |
| Our business has benefited from the tax laws of states in which purchases of software licenses are not taxable if the software is received only electronically |
| Some such states are considering whether to change their laws to broaden the taxability of transactions fulfilled over the Internet |
| Any new imposition of taxes on sales of software licenses, where the software is received electronically, could substantially harm demand for our services and thereby materially adversely affect our business, operating results and financial condition |
| We also have benefited from implementing our services in Ireland, which offers tax advantages to software companies distributing software from Ireland to other European countries |
| Any regulatory change in Ireland or elsewhere that diminishes those advantages could harm our business |
| Other changes in government regulations, in areas such as privacy and export compliance, could also require us to implement changes in our services or operations that increase our cost of doing business and thereby hurt our financial performance |
| Claims by third parties for intellectual property infringement could force us to stop selling our services, force us to pay royalties, and force us to indemnify our customers |
| Our business involves a high risk that we will be the target of intellectual property infringement claims |
| These claims could take a number of forms, including: * Claims by other technology companies alleging that current or future components of our digital delivery service or related services infringe their intellectual property rights; * Claims by our customers &apos competitors alleging that our customers &apos software, which we store and electronically deliver for our customers, infringes those competitors &apos intellectual property rights (our customers would typically be required to defend and indemnify us against such claims, but the claims could nevertheless disrupt our business); * Claims that our use of the name Intraware violates the rights of other entities that are using the same name |
| We are aware that certain other companies are using the name "e Intraware "e as a company name or as a trademark or service mark |
| While we have received no notice of any claims of trademark infringement from any of those companies, we cannot assure you that these companies may not claim superior rights to "e Intraware "e or to other marks we use; or * Claims by our customers that we delivered their software to unauthorized third parties, thereby infringing our customers &apos intellectual property rights |
| Industry consolidation is increasing the risk that we will become a target of the types of claims described in the first two bullets above |
| Consolidation among companies providing digital delivery, licensing, e-commerce and related technologies is resulting in more direct competition among the surviving companies in that segment, heightening the risk of intellectual property infringement claims among those companies, including us |
| Similarly, consolidation in the enterprise software industry heightens the risk of intellectual property infringement claims among the companies remaining in that industry, including most of our customers |
| These intellectual property claims could be made for patent, copyright or trademark infringement or for misappropriation of trade secrets |
| They could be made directly against us, or indirectly through our contractual indemnification obligations to our customers and channel partners |
| Any claims could result in costly litigation and be time-consuming to defend, divert managementapstas attention and resources, or cause delays in releasing new or upgrading existing services |
| Royalty or licensing agreements, if required, may be available only on onerous terms, if at all |
| Although we carry general liability insurance, our insurance may not cover all potential claims or may not be adequate to protect us from all liability that may be imposed |
| We believe we own the rights in, or have the rights required to use, our SubscribeNet technology |
| However, there can be no assurance that this technology does not infringe the rights of third parties |
| In addition, we take steps to verify that end-users who download our customers &apos software through our SubscribeNet service are entitled to deploy and use that software |
| However, there can be no assurance that this verification procedure will help us defend against claims by, or protect us against liability to, our customers whose software is downloaded |
| If our export compliance system fails to prevent unauthorized exports of our customers &apos software, we could be sanctioned by the US government |
| Through our SubscribeNet service, we globally distribute software containing encryption technology and other technologies restricted by US laws and regulations from exportation to certain countries, certain types of recipients, and certain specific end-users |
| Our SubscribeNet solution incorporates automated procedures to help ensure that the software we deliver electronically is not downloaded in violation of US export laws and regulations |
| However, these procedures may not prevent unauthorized exports of restricted software in every case |
| If an unauthorized export of software occurs through the SubscribeNet service and the US government determines that we violated the US export laws or regulations, we could be sanctioned under those laws or regulations |
| Sanctions include fines, suspension or revocation of export privileges, and imprisonment |
| If our key personnel left the company, our product development, sales, and corporate management could suffer |
| Our future success depends upon the continued service of our executive officers and other key technology, sales, marketing and support personnel |
| None of our officers or key employees is bound by an employment agreement for any specific term |
| If we lost the services of one or more of our key employees, or if one or more of our executive officers or key employees decided to join a competitor or otherwise compete directly or indirectly with us, this could have a significant adverse effect on our business |
| The adoption of Statement 123R by the Financial Accounting Standards Board ( "e FASB "e ) will cause, and changes to existing accounting pronouncements or taxation rules or practices, may cause adverse revenue fluctuations and/or affect our reported results of operations and how we conduct our business |
| In December 2004, the FASB adopted Statement 123R, "e Share-Based Payment, "e which will require us to measure compensation costs for all employee stock-based compensation (including stock options and our employee stock purchase plan) at fair value and take a compensation charge equal to that value |
| This new accounting pronouncement will likely have a material effect on our reported financial results |
| In addition, any future accounting pronouncements, taxation rules, and new interpretations of existing accounting pronouncements or taxation rules, could also have a significant effect on our reported results, including our reporting of transactions completed before the effective date of the change |
| Financial and securities laws, especially the Sarbanes-Oxley Act of 2002, require that we evaluate our internal control structure |
| While we believe we currently have adequate internal controls in place, this exercise has no precedent available by which to measure the adequacy of our compliance, and in addition it may cause our operating expenses to increase |
| The Sarbanes-Oxley Act of 2002, the California Disclosure Act and newly proposed or enacted rules and regulations of the SEC and the National Association of Securities Dealers impose new duties on us and our executives, directors, attorneys and independent registered public accounting firms |
| In order to comply with the Sarbanes-Oxley Act and such new rules and regulations, we are evaluating our internal control over financial reporting to allow management to report on, and our independent registered public accounting firm to attest to, our internal control over financial reporting |
| We are performing the system and process evaluation and testing (and any necessary remediation) required in an effort to comply with the management certification and independent registered public accounting firm attestation requirements of Section 404 of the Sarbanes-Oxley Act |
| As a result, we are incurring additional expenses and diversion of managementapstas time, and we may be required to hire additional personnel and engage additional outside legal, accounting and advisory services |
| Any of these developments could materially increase our operating expenses and accordingly reduce our net income or increase our net losses |
| While we anticipate being able to fully implement the requirements relating to internal control over financial reporting and all other aspects of Section 404 in a timely fashion, we cannot be certain as to the outcome of our testing and resulting remediation actions or the impact of the same on our operations since there is no precedent available by which to measure compliance adequacy |
| If we are unable to implement the requirements of Section 404 in a timely manner or with adequate compliance, we may be subject to sanctions or investigation by regulatory authorities, such as the SEC or The Nasdaq Stock Market, and our reputation may be harmed |
| Any such action could adversely affect our financial results and the price of our common stock |
| Moreover, our management, including our CEO and CFO, does not expect that our disclosure controls or our internal controls over our financial reporting will eliminate all risk of error or fraud |
| A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met |
| Our disclosure controls or procedures can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the control |
| Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected |
| We may raise additional capital to fund acquisitions, product development or general operations |
| Any such capital financing would dilute our shareholders &apos investments |
| We may raise additional capital in the future through private or public offerings of stock, or through other means |
| The purposes of any such financing would be to increase our cash reserves for potential use in acquiring other businesses, product development activities, funding our operations and generally strengthening our balance sheet |
| Any such additional financing would likely dilute the investments of our current shareholders |
| If we acquire any companies or technologies in the future, they could prove difficult to integrate, disrupt our business, dilute stockholder value and adversely affect our operating results |
| We may acquire or make investments in complementary companies, services and technologies in the future |
| We are considerably smaller now than we were when we made our past acquisitions, and therefore any new acquisitions or investments could be more disruptive to our organization than in the past |
| Acquisitions and investments involve numerous risks, including: * difficulties in integrating operations, technologies, services and personnel; * diversion of financial and managerial resources from existing operations; * risk of entering new markets; * potential write-offs of acquired assets; * potential loss of key employees; * inability to generate sufficient revenue to offset acquisition or investment costs; and * delays in customer purchases due to uncertainty |
| In addition, if we finance acquisitions by issuing convertible debt or equity securities, our existing stockholders may be diluted which could affect the market price of our stock |
| As a result, if we fail to properly evaluate and execute acquisitions or investments, our business and prospects may be seriously harmed |
| Our current strategy includes the use of strategic marketing relationships, which may prove unsuccessful |
| We currently have marketing relationships in place with Hewlett Packard and Zomax, and are in the process of negotiating an alliance with Digital River, Inc |
| ( "e Digital River "e ) under which Intraware and Digital River will market one anotherapstas products and Digital River will obtain a seat on our Board of Directors |
| It is possible, however, that we will not successfully complete our negotiations with Digital River, or that our relationships with Digital River, Hewlett Packard and/or Zomax will prove less beneficial than we currently expect |
| If that happens, our business could suffer |