| IPASS INC Item 1A Risk Factors Set forth below and elsewhere in this report are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this report |
| Risks Relating to Our Business If we are unable to meet the challenges posed by broadband access, our ability to grow our business will be impaired |
| We have generated substantially all of our usage revenues to date from the sale of enterprise connectivity services using narrowband technologies such as modem dial-up |
| In particular, in 2005, we derived dlra138dtta1 million, or 82prca of our total revenues from our traditional dial-up business |
| In some countries, including the United States, the use of narrowband as a primary means of enterprise connectivity has declined and is expected to continue to decline at an accelerated rate over time as broadband access technologies, such as cable modem, DSL, Wi-Fi and other wireless technologies, including 3G, become more broadly used |
| In 2005, our revenue derived from the use of narrowband connectivity decreased 8prca as compared to 2004 |
| A substantial portion of the growth of our business will depend in part upon our ability to expand the broadband elements of our virtual network |
| Such an expansion may not result in additional revenues to us |
| Key challenges in expanding the broadband elements of our virtual network include: The broadband access market is at an early stage of development |
| Although we derive revenues from wired and wireless broadband “hotspots”, such as particular airports, hotels and convention centers, the broadband access market, particularly for wireless access, is at an early stage of development and demand at levels we anticipate may not develop |
| In particular, the market for enterprise connectivity services through broadband is characterized by evolving industry standards and specifications and there is currently no uniform standard for wireless access |
| We have developed and made available Wi-Fi specifications that are directed at enabling Wi-Fi access points to become ready for use by enterprise customers |
| If this specification is not widely adopted, market acceptance of our wireless broadband services may be significantly reduced or delayed and our business could be harmed |
| Furthermore, although the use of wireless frequencies generally does not require a license in the United States and abroad, if Wi-Fi frequencies become subject to licensing requirements, or are otherwise restricted, this would substantially impair the growth of wireless access |
| Some large telecommunications providers and other stakeholders that pay large sums of money to license other portions of the wireless spectrum may seek to have the Wi-Fi spectrum become subject to licensing restrictions |
| The broadband service provider market is highly fragmented |
| Due to the early stage of development of the broadband access market, there are currently many wired and wireless broadband service providers that provide coverage in only one or a small number of hotspots |
| We have entered into contractual relationships 13 _________________________________________________________________ [70]Table of Contents with numerous broadband service providers |
| These contracts generally have an initial term of two years or less |
| As this process is in an early stage, we must continue to develop relationships with many providers on terms commercially acceptable to us in order to provide adequate coverage for our customers’ mobile workers and to expand our broadband coverage |
| We may also be required to develop additional technologies in order to integrate new broadband services into our service offering |
| If we are unable to develop these relationships or technologies, our ability to grow our business could be impaired |
| In addition, if broadband service providers consolidate, our negotiating leverage with providers may decrease, resulting in increased rates for access, which could harm our operating results |
| If demand for broadband access does not materially increase, or if demand increases but we do not meet the challenges outlined above, our ability to grow our business may suffer |
| Our customers require a high degree of reliability in our services, and if we cannot meet their expectations, demand for our services will decline |
| Any failure to provide reliable network access, uninterrupted operation of our network and software infrastructure, or a satisfactory experience for our customers and their mobile workers, whether or not caused by our own failure, could reduce demand for our services |
| In 2002, we experienced three outages affecting our clearinghouse system, which handles invoicing to our customers and network service providers, resulting in five days of outages and eight days of work to confirm data integrity in response to the outages |
| Although these problems did not affect the ability of mobile workers to access our services or impact our revenues, one of these outages caused a delay in our invoicing of approximately one week |
| If additional outages occur, or if we experience other hardware or software problems, our business could be harmed |
| We face strong competition in our market, which could make it difficult for us to succeed |
| Some of our competitors have substantially greater resources, larger customer bases, longer operating histories or greater name recognition than we have |
| Also, with the recent introduction of our policy management services, we face additional competition from companies that provide security and policy-based services and software |
| In addition, we face the following challenges from our competitors: Many of our competitors can compete on price |
| Because many of our facilities-based competitors own and operate physical networks, there may be little incremental cost for them to provide additional telephone or Internet connections |
| As a result, they may offer dial-up remote access services at little additional cost, and may be willing to discount or subsidize remote access services to capture other sources of revenue |
| In contrast, we have traditionally purchased network access from facilities-based network service providers to enable our dial-up remote access service |
| In either case, we may lose business or be forced to lower our prices to compete, which could reduce our revenues |
| Many of our competitors offer additional services that we do not, which enables them to compete favorably against us |
| Some of our competitors provide services that we do not, such as local exchange and long distance services, voicemail and digital subscriber line, or DSL, services |
| Potential customers that desire these services on a bundled basis may choose to obtain remote access and policy management services from the competitor that provides these additional services |
| Our potential customers may have other business relationships with our competitors and consider those relationships when deciding between our services and those of our competitors |
| Many of our competitors are large facilities-based carriers that purchase substantial amounts of products and services, or provide other services or goods unrelated to remote access services |
| As a result, if a potential customer is also a supplier to one of our large competitors, or purchases unrelated services or goods from our competitor, the potential customer may be motivated to purchase its remote access services from our competitor in order to maintain or enhance its business relationship with that competitor |
| 14 _________________________________________________________________ [71]Table of Contents The telecommunications industry has experienced a dramatic decline, which may cause consolidation among network service providers and impair our ability to provide reliable, redundant service coverage and negotiate favorable network access terms |
| The telecommunications industry has experienced dramatic technological change and increased competition that have led to significant declines in network access pricing |
| In addition, the revenues of network service providers have declined as a result of the general economic slowdown |
| As a result, network service providers have experienced operating difficulties in the last several years, resulting in poor operating results and a number of these providers declaring bankruptcy |
| As these conditions have continued, some of these service providers have consolidated and are working to consolidate or otherwise cease operations, which would reduce the number of network service providers from which we are able to obtain network access |
| As this occurs, while we expect that we will still be able to maintain operations and provide enterprise connectivity services with a small number of network service providers, we would potentially not be able to provide sufficient redundant access points in some geographic areas, which could diminish our ability to provide broad, reliable, redundant coverage |
| Further, our ability to negotiate favorable access rates from network service providers could be impaired, which could increase our network access expenses and harm our operating results |
| If our security measures are breached and unauthorized access is obtained to a customer’s internal network, our virtual network may be perceived as not being secure and enterprises may curtail or stop using our services |
| It is imperative for our customers that access to their mission critical data is secure |
| A key component of our ability to attract and retain customers is the security measures that we have engineered into our network for the authentication of the end user’s credentials; on a going forward basis, we expect an additional key component in this regard to be our policy management services |
| These measures are designed to protect against unauthorized access to our customers’ networks |
| Because techniques used to obtain unauthorized access or to sabotage networks 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 against unauthorized access or sabotage |
| If an actual or perceived breach of network security occurs, regardless of whether the breach is attributable to our services, the market perception of the effectiveness of our security measures could be harmed |
| To date, we have not experienced any significant security breaches to our network |
| If enterprise connectivity demand does not continue to expand, we may experience a shortfall in revenues or earnings or otherwise fail to meet public market expectations |
| The growth of our business is dependent, in part, upon the increased use of enterprise connectivity services and our ability to capture a higher proportion of this market |
| If the demand for enterprise connectivity services does not continue to grow, then we may not be able to grow our business, maintain profitability or meet public market expectations |
| Increased usage of enterprise connectivity services depends on numerous factors, including: • the willingness of enterprises to make additional information technology expenditures; • the availability of security products necessary to ensure data privacy over the public networks; • the quality, cost and functionality of these services and competing services; • the increased adoption of wired and wireless broadband access methods; and • the proliferation of electronic devices and related applications |
| If we are unable to meet the challenges related to the market acceptance and provision of our policy management services, our ability to grow the business may be harmed |
| We expect that the growth of our business may depend in part upon whether our policy management services will achieve and sustain expected levels of demand and market acceptance |
| If enterprises do not 15 _________________________________________________________________ [72]Table of Contents perceive the benefits of our policy management services, then the market for these services may not develop at all, or it may develop more slowly than we expect, either of which could significantly and adversely affect our growth |
| In addition, if demand for our policy management services does not materialize as expected, our ability to recover our investment in Safe3w, Inc |
| and Mobile Automation, Inc |
| In addition, because of our limited operating history relating to policy management services, we cannot predict our revenue and operating results from the provision of these services |
| Key challenges that we face related to our provision of these services include the risk that we may encounter unexpected technical and other difficulties in developing our policy management services which could delay or prevent the development of these services or certain features of these services; the risk that the rate of adoption by enterprises of network security software or integrated secure connectivity solutions will not be as we anticipate, which if slow would reduce or eliminate the purchase of these services; and the risk that security breaches may occur, notwithstanding the use of our policy management services, by hackers that develop new methods of avoiding security software |
| If we do not adequately address these challenges, our growth and operating results may be negatively impacted |
| Our long sales and service deployment cycles require us to incur substantial sales costs that may not result in related revenues |
| Our business is characterized by a long sales cycle between the time a potential customer is contacted and a customer contract is signed |
| In addition, the downturn in the economy from early 2001 to 2003 and the resulting reduction in corporate spending on Internet infrastructure further lengthened the average sales cycle for our services |
| Furthermore, once a customer contract is signed, there is typically an extended period before the customer’s end users actually begin to use our services, which is when we begin to realize revenues |
| As a result, we may invest a significant amount of time and effort in attempting to secure a customer which may not result in any revenues |
| Even if we enter into a contract, we will have incurred substantial sales-related expenses well before we recognize any related revenues |
| If the expenses associated with sales increase, we are not successful in our sales efforts, or we are unable to generate associated offsetting revenues in a timely manner, our operating results will be harmed |
| There are approximately 24 countries in which we provide dial-up access only through Equant |
| The loss of Equant as a dial-up network service provider would substantially diminish our ability to deliver global network access |
| In approximately 24 countries, our sole dial-up network service provider is Equant |
| Network usage from access within these countries accounted for less than 2prca of our revenues for the years ended December 31, 2005, 2004 and 2003 |
| If we lose access to Equant’s network and are unable to replace this access in some or all of these countries, our revenues would decline |
| In addition, our ability to market our services as being global would be impaired, which could cause us to lose customers |
| Our agreement with Equant expires in February 2007, but Equant may terminate the agreement earlier if we materially breach the contract and fail to cure the breach, or if we become insolvent |
| In addition, Equant has no obligation to continue to provide us with access to its network after February 2007 |
| If Equant were to cease operations or terminate its arrangements with us, we would be required to enter into arrangements with other dial-up network service providers, which may not be available |
| This process could be costly and time consuming, and we may not be able to enter into these arrangements on terms acceptable to us |
| If our channel partners do not successfully market our services to their customers or corporate end users, then our revenues and business may be adversely affected |
| We sell our services directly through our sales force and indirectly through our channel partners, which include network service providers, systems integrators and value added resellers |
| Our business depends on the efforts and the success of these channel partners in marketing our services to their customers |
| Our own ability to promote our services directly to their customers is often limited |
| Many of our channel partners may offer services to their customers that may be similar to, or competitive with, our services |
| Therefore, these channel 16 _________________________________________________________________ [73]Table of Contents partners may be reluctant to promote our services |
| If our channel partners fail to market our services effectively, our ability to grow our revenue would be reduced and our business will be impaired |
| If we fail to address evolving standards and technological changes in the enterprise connectivity and policy management services industry, our business could be harmed |
| The market for enterprise connectivity and policy management services is characterized by evolving industry standards and specifications and rapid technological change, including new access methods, devices, applications and operating systems |
| In developing and introducing our services, we have made, and will continue to make, assumptions with respect to which features, security standards, performance criteria, access methods, devices, applications and operating systems will be required or desired by enterprises and their mobile workers |
| If we implement technological changes or specifications that are different from those required or desired, or if we are unable to successfully integrate required or desired technological changes or specifications into our wired or wireless services, market acceptance of our services may be significantly reduced or delayed and our business could be harmed |
| Our software is complex and may contain errors that could damage our reputation and decrease usage of our services |
| Our software may contain errors that interrupt network access or have other unintended consequences |
| If network access is disrupted due to a software error, or if any other unintended negative results occur, such as the loss of billing information, a security breach or unauthorized access to our virtual network, our reputation could be harmed and our business may suffer |
| Although we generally attempt by contract to limit our exposure to incidental and consequential damages, if these contract provisions are not enforced or enforceable for any reason, or if liabilities arise that are not effectively limited, our operating results could be harmed |
| Because much of our business is international, we encounter additional risks, which may reduce our profitability |
| We generate a substantial portion of our revenues from business conducted internationally |
| Revenues from customers domiciled outside of the United States were 45prca of our revenues for 2005, of which approximately 29prca and 12prca were generated in our EMEA (Europe, Middle East and Africa) and Asia Pacific regions, respectively |
| In 2004, revenues from customers domiciled outside of the United States were 41prca of our total revenues, of which approximately 24prca and 13prca were generated in our EMEA and Asia Pacific regions, respectively |
| Although we currently bill for our services in US dollars, our international operations subject our business to specific risks |
| These risks include: • longer payment cycles for foreign customers, including delays due to currency controls and fluctuations; • the impact of changes in foreign currency exchange rates on the attractiveness of our pricing; • high taxes in some foreign jurisdictions; • difficulty in complying with Internet-related regulations in foreign jurisdictions; • difficulty in staffing and managing foreign operations; and • difficulty in enforcing intellectual property rights and weaker laws protecting these rights |
| Any of these factors could negatively impact our business |
| Completed or future acquisitions or investments could dilute the ownership of our existing stockholders, cause us to incur significant expenses or harm our operating results |
| Integrating any newly acquired businesses, technologies or services may be expensive and time-consuming |
| For example, we completed the acquisitions of Safe3w, Inc |
| in September 2004, Mobile Automation, Inc |
| in October 2004 and GoRemote Internet Communications, Inc |
| in February 2006 |
| To 17 _________________________________________________________________ [74]Table of Contents finance any acquisitions, it may be necessary for us to raise additional funds through public or private financings |
| Additional funds may not be available on terms that are favorable to us and, in the case of equity financings, would result in dilution to our stockholders |
| In the case of completed or future acquisitions, we may be unable to operate any acquired businesses profitably or otherwise implement our strategy successfully |
| If we are unable to integrate any newly acquired entities, such as GoRemote Internet Communications, Inc, or technologies effectively, our operating results could suffer |
| Completed acquisitions by us, such as the aforementioned Safe3w, Inc, Mobile Automation, Inc |
| transactions, or future acquisitions by us could also result in large and immediate write-offs or assumption of debt and contingent liabilities, either of which could harm our operating results |
| If we are unable to effectively manage future expansion, our business may be adversely impacted |
| We have experienced, and in the future may continue to experience, rapid growth in operations which has placed and could continue to place, a significant strain on our network operations, development of services, internal controls and other managerial, operating, and financial resources |
| If we do not manage future expansion effectively, our business will be harmed |
| To effectively manage any future expansion, we will need to improve our operational and financial systems and managerial controls and procedures, which include the following: • managing our research and development efforts for new and evolving technologies; • expanding the capacity and performance of our network and software infrastructure; • developing our administrative, accounting and management information systems and controls; and • effectively maintaining coordination among our various departments, particularly as we expand internationally |
| We currently are, and in the future may be, subject to securities class action lawsuits due to decreases in our stock price |
| We are at risk of being subject to securities class action lawsuits if our stock price declines substantially |
| Securities class action litigation has often been brought against a company following a decline in the market price of its securities |
| For example, in June 2004, we announced that we would not meet market expectations regarding our financial performance in the second quarter, and our stock price declined |
| Beginning on January 14, 2005, three purported class action complaints were filed against the Company and certain of its executive officers in United States District Court for the Northern District of California, purportedly on behalf of a class of investors who purchased iPass stock between April 22, 2004 and June 30, 2004 |
| The complaint alleges claims under Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 |
| On March 2, 2005, these cases were consolidated as In re iPass Securities Litigation, Case Nodtta 3:05-cv-00228-MHP On April 22, 2005, David Lutzke and Rhonda Lutzke were named lead plaintiffs |
| Named as defendants together with us are Kenneth D Denman, Donald C McCauley, Anurag Lal and Jon M Russo |
| The Consolidated Amended Complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 during an alleged “class period” from April 22, 2004 to June 30, 2004 by failing to inform investors of certain operational issues that allegedly led to declines in our revenue, earnings and growth prospects |
| iPass and the individual defendants moved to dismiss the complaint |
| The motion was heard on January 23, 2006, and the motion was granted on February 27, 2006 |
| The court granted plaintiffs leave to file an amended complaint, which shall be due by March 30, 2006 |
| In addition, beginning on March 25, 2005, a stockholder purporting to act on our behalf filed a lawsuit entitled Narendar Gupta, et al |
| Kenneth Denman, et al, Case Nodtta CIV445765 in the California Superior Court for the County of San Mateo against our directors and certain officers |
| iPass was also named as a nominal defendant solely in a derivative capacity |
| On April 6, 2005, a similar lawsuit entitled Eugene Danielson v |
| Kenneth D Denman, et al, Nodtta CIV446034 was filed in that same court |
| Both lawsuits were consolidated into a single action by stipulation and order dated April 26, 2005 |
| The derivative action is based on the same factual allegations and circumstances as the purported securities class actions and alleges state law claims for insider trading, breach of fiduciary duty, abuse of control, gross mismanagement, waste of 18 _________________________________________________________________ [75]Table of Contents corporate assets, and unjust enrichment and seeks monetary damages on behalf of iPass to be proven at trial |
| On May 5, 2005, the actions were consolidated as In re iPass, Inc |
| Plaintiffs filed a consolidated complaint on February 21, 2006, and the defendants have until March 28, 2006 within which to respond to the complaint |
| If our stock price declines substantially in the future, we may be the target of similar litigation |
| The current, and any future, securities litigation could result in substantial costs and divert management’s attention and resources, and could seriously harm our business |
| Litigation arising from disputes involving third parties could disrupt the conduct of our business |
| Because we rely on third parties to help us develop, market and support our service offerings, from time to time we have been, and we may continue to be, involved in disputes with these third parties |
| If we are unable to resolve these disputes favorably, our development, marketing or support of our services could be delayed or limited, which could materially and adversely affect our business |
| If licenses to third party technologies, including our license with RSA Security, do not continue to be available to us at a reasonable cost, or at all, our business and operations may be adversely affected |
| We license technologies from several software providers that are incorporated in our services |
| We anticipate that we will continue to license technology from third parties in the future |
| In particular, we license encryption technology from RSA Security |
| Our license agreement with RSA Security expired in February 2006 and automatically renewed for an additional three-year period |
| This license will continue to automatically renew for additional three-year periods upon expiration, unless terminated by us or by RSA Security |
| Licenses from third party technologies, including our license with RSA Security, may not continue to be available to us at a reasonable cost, or at all |
| The loss of these technologies or other technologies that we license could have an adverse effect on our services and increase our costs or cause interruptions or delays in our services until substitute technologies, if available, are developed or identified, licensed and successfully integrated into our services |
| Litigation arising out of intellectual property infringement could be expensive and disrupt our business |
| We cannot be certain that our products do not, or will not, infringe upon patents, trademarks, copyrights or other intellectual property rights held by third parties, or that other parties will not assert infringement claims against us |
| From time to time we have been, and we may continue to be, involved in disputes with these third parties |
| Any claim of infringement of proprietary rights of others, even if ultimately decided in our favor, could result in substantial costs and diversion of our resources |
| Successful claims against us may result in an injunction or substantial monetary liability, in either case which could significantly impact our results of operations or materially disrupt the conduct of our business |
| If we are enjoined from using a technology, we will need to obtain a license to use the technology, but licenses to third-party technology may not be available to us at a reasonable cost, or at all |
| New accounting pronouncements may impact our future financial position and results of operations |
| On January 1, 2006, we adopted Statement of Financial Accounting Standards Nodtta 123R, “Accounting for Stock-Based Compensation — Revised” (“SFAS 123R”), which requires the measurement and recognition of compensation expense for all stock-based compensation based on estimated fair values |
| As a result, our operating results for the first quarter of 2006 and for future periods will contain a charge for stock-based compensation related to employee stock options and employee stock purchases |
| The application of SFAS 123R requires the use of an option-pricing model to determine the fair value of share-based payment awards |
| This determination of fair value is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables |
| These variables include, but are not limited to, our expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors |
| Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable |
| Because our employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion the existing 19 _________________________________________________________________ [76]Table of Contents valuation models may not provide an accurate measure of the fair value of our employee stock options |
| Although the fair value of employee stock options is determined in accordance with SFAS 123R and SAB 107 using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction |
| We expect that our adoption of SFAS 123R will have a material impact on our financial statements and results of operations and this will continue to be the case for future periods |
| We cannot predict the effect that this adverse impact on our reported operating results will have on the trading price of our common stock |
| Risks Relating to Our Industry Security concerns may delay the widespread adoption of the Internet for enterprise communications, or limit usage of Internet-based services, which would reduce demand for our products and services |
| The secure transmission of confidential information over public networks is a significant barrier to further adoption of the Internet as a business medium |
| The Internet is a public network and information is sent over this network from many sources |
| Advances in computer capabilities, new discoveries in the field of code breaking or other developments could result in compromised security on our network or the networks of others |
| Security and authentication concerns with respect to the transmission over the Internet of confidential information, such as corporate access passwords and the ability of hackers to penetrate online security systems may reduce the demand for our services |
| Further, new access methods, devices, applications and operating systems have also introduced additional vulnerabilities which have been actively exploited by hackers |
| Internet-based worms and viruses, computer programs that are created to slow Internet traffic or disrupt computer networks or files by replicating through software or operating systems, are examples of events or computer programs that can disrupt users from using our Internet-based services and reduce demand for our services, potentially affecting our business and financial performance |
| In particular, certain Internet worms and viruses affected some of our customers and their mobile users, which may have negatively impacted our revenues |
| Furthermore, any well-publicized compromises of confidential information may reduce demand for Internet-based communications, including our services |
| Financial, political or economic conditions could adversely affect our revenues |
| Our revenues and profitability depend on the overall demand for enterprise connectivity services |
| The general weakening of the global economy from early 2001 to 2003 led to decreased trade and corporate spending on Internet infrastructure |
| In addition, in the past, terrorist attacks, including the attacks on the United States and internationally, have had a significant impact on global economic conditions and our operations |
| If there are further acts of terrorism, if hostilities involving the United States and other countries continue or escalate, or if other future financial, political, economic and other uncertainties or natural disasters arise, this could lead to a reduction in travel, including by business travelers who are substantial users of our services, and continue to contribute to a climate of economic and political uncertainty that could adversely affect our revenue growth and financial results |
| Government regulation of, and legal uncertainties regarding, the Internet could harm our business |
| Internet-based communication services generally are not subject to federal fees or taxes imposed to support programs such as universal telephone service |
| Changes in the rules or regulations of the US Federal Communications Commission or in applicable federal communications laws relating to the imposition of these fees or taxes could result in significant new operating expenses for us, and could negatively impact our business |
| Any new law or regulation, US or foreign, pertaining to Internet-based communications services, or changes to the application or interpretation of existing laws, could decrease the demand for our services, increase our cost of doing business or otherwise harm our business |
| There are an increasing number of laws and regulations pertaining to the Internet |
| These laws or regulations may relate to taxation and the quality of products and services |
| Furthermore, the applicability to the Internet of existing laws governing intellectual property ownership and infringement, taxation, encryption, obscenity, libel, employment, personal privacy, export or import matters and other issues is uncertain and developing and we are not certain how the possible application of these laws may affect us |
| Some of these laws may not contemplate or address the unique issues 20 _________________________________________________________________ [77]Table of Contents of the Internet and related technologies |
| Changes in laws intended to address these issues could create uncertainty in the Internet market, which could reduce demand for our services, increase our operating expenses or increase our litigation costs |