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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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Form 10-Q



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



For the three months ended June 30, 2005



| ̈ | 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: 000-25331



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Critical Path, Inc.



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|                         |  |                               
|------------------------ |  | ------------------------------
|A California Corporation |  | I.R.S. Employer No. 91-1788300



2 Harrison Street,
2ndFloor

San Francisco, California 94105

415-541-2500



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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 ̈



Indicate
by check mark whether Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No ̈



As of June
30, 2005, the Company had outstanding 35,004,422 shares of common stock, $0.001 par value per share (including 40,521 shares of Class A Non-Voting preference shares of our Nova Scotia subsidiary Critical Path Messaging Co. which can be exchanged at
any time for our common stock upon the election of the holder).



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PART I - FINANCIAL INFORMATION



ITEM 1. FINANCIAL STATEMENTS



CRITICAL PATH, INC.

CONDENSED
CONSOLIDATED BALANCE SHEETS



|                                                                                                                                              |  |                           |            |   |               |   |            |  
|--------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ---------- | - | ------------- | - | ---------- | -
|                                                                                                                                              |  | December 31,2004          |            |   | June 30, 2005 |  
|                                                                                                                                              |  | (in thousands; unaudited) |           
|Assets                                                                                                                                        |  |                           |            |   |               |   |            |  
|Current assets                                                                                                                                |  |                           |            |   |               |   |            |  
|Cash and cash equivalents                                                                                                                     |  | $                         | 23,239     |   |               | $ | 16,857     |  
|Accounts receivable, net                                                                                                                      |  |                           | 19,667     |   |               |   | 19,661     |  
|Prepaid and other current assets                                                                                                              |  |                           | 4,567      |   |               |   | 3,767      |  
|                                                                                                                                              |  |                           |            |   |               |   |            |  
|Total current assets                                                                                                                          |  |                           | 47,473     |   |               |   | 40,285     |  
|Property and equipment, net                                                                                                                   |  |                           | 11,379     |   |               |   | 7,244      |  
|Goodwill                                                                                                                                      |  |                           | 6,613      |   |               |   | 6,613      |  
|Restricted cash                                                                                                                               |  |                           | 2,702      |   |               |   | 278        |  
|Other assets                                                                                                                                  |  |                           | 1,032      |   |               |   | 1,729      |  
|                                                                                                                                              |  |                           |            |   |               |   |            |  
|Total assets                                                                                                                                  |  | $                         | 69,199     |   |               | $ | 56,149     |  
|                                                                                                                                              |  |                           |            |   |               |   |            |  
|Liabilities, mandatorily redeemable preferred stock and shareholders deficit                                                                 |  |                           |            |   |               |   |            |  
|Current liabilities                                                                                                                           |  |                           |            |   |               |   |            |  
|Accounts payable                                                                                                                              |  | $                         | 4,973      |   |               | $ | 4,988      |  
|Accrued liabilities                                                                                                                           |  |                           | 23,207     |   |               |   | 19,536     |  
|Deferred revenue                                                                                                                              |  |                           | 9,978      |   |               |   | 11,576     |  
|Capital lease and other obligations, current                                                                                                  |  |                           | 1,067      |   |               |   | 355        |  
|Notes payable, current                                                                                                                        |  |                           | 5,565      |   |               |   |           |  
|                                                                                                                                              |  |                           |            |   |               |   |            |  
|Total current liabilities                                                                                                                     |  |                           | 44,790     |   |               |   | 36,455     |  
|                                                                                                                                              |  |                          
|Deferred revenue                                                                                                                              |  |                           | 173        |   |               |   | 71         |  
|Embedded derivative liability                                                                                                                 |  |                           | 5,173      |   |               |   | 2,402      |  
|Notes payable, net of current portion                                                                                                         |  |                           | 8,875      |   |               |   | 16,698     |  
|                                                                                                                                              |  |                           |            |   |               |   |            |  
|Total liabilities                                                                                                                             |  |                           | 59,011     |   |               |   | 55,626     |  
|                                                                                                                                              |  |                           |            |   |               |   |            |  
|                                                                                                                                              |  |                          
|Commitments and contingencies (see Note 8)                                                                                                    |  |                           |            |   |               |   |            |  
|Mandatorily redeemable preferred stock, par value $0.001                                                                                      |  |                           | 122,377    |   |               |   | 116,248    |  
|                                                                                                                                              |  |                           |            |   |               |   |            |  
|Shareholders deficit                                                                                                                         |  |                           |            |   |               |   |            |  
|Common stock and paid-in-capital, par value $0.001: shares authorized: 200,000, shares issued and outstanding 21,182 and 35,045,
respectively |  |                           | 2,174,496  |   |               |   | 2,181,044  |  
|Common stock warrants                                                                                                                         |  |                           | 5,947      |   |               |   | 5,947      |  
|Unearned compensation                                                                                                                         |  |                           | (1,353     | ) |               |   | (873       | )
|Accumulated deficit                                                                                                                           |  |                           | (2,290,725 | ) |               |   | (2,299,631 | )
|Accumulated other comprehensive loss                                                                                                          |  |                           | (554       | ) |               |   | (2,212     | )
|                                                                                                                                              |  |                           |            |   |               |   |            |  
|Total shareholders deficit                                                                                                                   |  |                           | (112,189   | ) |               |   | (115,725   | )
|                                                                                                                                              |  |                           |            |   |               |   |            |  
|Liabilities, mandatorily redeemable preferred stock and shareholders deficit                                                                 |  | $                         | 69,199     |   |               | $ | 56,149     |  
|                                                                                                                                              |  |                           |            |   |               |   |            |  



The accompanying
notes are an integral part of these Condensed Consolidated Financial Statements.



Page 1



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CRITICAL PATH, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS



|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|-------------------------------------------------------------------------- |  | --------------------------------------------------- | ------- | - | ------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                           |  | Three months endedJune 30,                          |         |   | Six months ended June 30, |  
|                                                                           |  | 2004                                                |         |   | 2005                      |   |        | 2004 |  |   | 2005    |  
|                                                                           |  | (in thousands, except per share amounts; unaudited) |        
|Net revenue                                                                |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Software licensing                                                         |  | $                                                   | 5,407   |   |                           | $ | 4,771  |      |  | $ | 9,658   |   |  | $ | 9,216   |  
|Hosted messaging                                                           |  |                                                     | 3,711   |   |                           |   | 3,528  |      |  |   | 8,054   |   |  |   | 8,739   |  
|Professional services                                                      |  |                                                     | 2,936   |   |                           |   | 3,727  |      |  |   | 5,595   |   |  |   | 6,811   |  
|Maintenance and support                                                    |  |                                                     | 4,962   |   |                           |   | 5,083  |      |  |   | 10,787  |   |  |   | 9,783   |  
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Total net revenue                                                          |  |                                                     | 17,016  |   |                           |   | 17,109 |      |  |   | 34,094  |   |  |   | 34,549  |  
|                                                                           |  |                                                     |         |  
|Cost of net revenue                                                        |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Software licensing                                                         |  |                                                     | 1,708   |   |                           |   | 1,035  |      |  |   | 2,619   |   |  |   | 2,243   |  
|Hosted messaging                                                           |  |                                                     | 6,570   |   |                           |   | 3,766  |      |  |   | 12,951  |   |  |   | 8,890   |  
|Professional services                                                      |  |                                                     | 3,034   |   |                           |   | 2,318  |      |  |   | 6,128   |   |  |   | 4,722   |  
|Maintenance and support                                                    |  |                                                     | 1,322   |   |                           |   | 1,550  |      |  |   | 2,771   |   |  |   | 3,100   |  
|Stock-based expense                                                        |  |                                                     |        |   |                           |   | 43     |      |  |   | 5       |   |  |   | 107     |  
|Restructuring and other expenses                                           |  |                                                     | 175     |   |                           |   |       |      |  |   | 175     |   |  |   |        |  
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Total cost of net revenue                                                  |  |                                                     | 12,809  |   |                           |   | 8,712  |      |  |   | 24,649  |   |  |   | 19,062  |  
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Gross profit                                                               |  |                                                     | 4,207   |   |                           |   | 8,397  |      |  |   | 9,445   |   |  |   | 15,487  |  
|                                                                           |  |                                                     |         |  
|Operating expenses                                                         |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Selling and marketing                                                      |  |                                                     | 6,035   |   |                           |   | 3,926  |      |  |   | 12,974  |   |  |   | 8,573   |  
|Research and development                                                   |  |                                                     | 5,344   |   |                           |   | 3,644  |      |  |   | 11,123  |   |  |   | 8,537   |  
|General and administrative                                                 |  |                                                     | 3,771   |   |                           |   | 3,356  |      |  |   | 6,890   |   |  |   | 7,270   |  
|Stock-based expense                                                        |  |                                                     | 1,212   |   |                           |   | 212    |      |  |   | 1,253   |   |  |   | 456     |  
|Restructuring expense                                                      |  |                                                     | 1,144   |   |                           |   | 168    |      |  |   | 2,209   |   |  |   | 1,807   |  
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                   |  |                                                     | 17,506  |   |                           |   | 11,306 |      |  |   | 34,449  |   |  |   | 26,643  |  
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Operating loss                                                             |  |                                                     | (13,299 | ) |                           |   | (2,909 | )    |  |   | (25,004 | ) |  |   | (11,156 | )
|                                                                           |  |                                                     |         |  
|Other income (expense), net                                                |  |                                                     | 6,711   |   |                           |   | 2,395  |      |  |   | 10,228  |   |  |   | 4,241   |  
|Interest income (expense), net                                             |  |                                                     | (2,043  | ) |                           |   | (907   | )    |  |   | (3,473  | ) |  |   | (1,567  | )
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Loss before provision for income taxes                                     |  |                                                     | (8,631  | ) |                           |   | (1,421 | )    |  |   | (18,249 | ) |  |   | (8,482  | )
|                                                                           |  |                                                     |         |  
|Provision for income taxes                                                 |  |                                                     | (445    | ) |                           |   | (116   | )    |  |   | (811    | ) |  |   | (424    | )
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                                   |  |                                                     | (9,076  | ) |                           |   | (1,537 | )    |  |   | (19,060 | ) |  |   | (8,906  | )
|                                                                           |  |                                                     |         |  
|Accretion on mandatorily redeemable preferred stock                        |  |                                                     | (3,348  | ) |                           |   | (6,516 | )    |  |   | (6,495  | ) |  |   | (11,793 | )
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Net loss attributable to common shareholders                               |  | $                                                   | (12,424 | ) |                           | $ | (8,053 | )    |  | $ | (25,555 | ) |  | $ | (20,699 | )
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Net loss per share attributable to common shareholders  basic and diluted |  | $                                                   | (0.59   | ) |                           | $ | (0.27  | )    |  | $ | (1.21   | ) |  | $ | (0.73   | )
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Weighted average shares  basic and diluted                                |  |                                                     | 21,157  |   |                           |   | 29,369 |      |  |   | 21,074  |   |  |   | 28,361  |  
|                                                                           |  |                                                     |         |   |                           |   |        |      |  |   |         |   |  |   |         |  



The accompanying
notes are an integral part of these Condensed Consolidated Financial Statements.



Page 2



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CRITICAL PATH, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                        |  |                           |         |   |      |   |        |  
|------------------------------------------------------- |  | ------------------------- | ------- | - | ---- | - | ------ | -
|                                                        |  | Six months endedJune 30,  |        
|                                                        |  | 2004                      |         |   | 2005 |  
|                                                        |  | (in thousands; unaudited) |        
|Cash flow from operating activities:                    |  |                           |         |   |      |   |        |  
|Net loss                                                |  | $                         | (19,060 | ) |      | $ | (8,906 | )
|Provision (credit) for allowance for doubtful accounts  |  |                           | (120    | ) |      |   | 21     |  
|Depreciation                                            |  |                           | 4,839   |   |      |   | 4,667  |  
|Stock-based costs and expenses                          |  |                           | 1,258   |   |      |   | 563    |  
|Change in fair value of embedded derivative liabilities |  |                           | (9,560  | ) |      |   | (2,924 | )
|Amortization                                            |  |                           | 192     |   |      |   | 708    |  
|Loss on fixed asset disposal                            |  |                           | 56      |   |      |   |       |  
|Forgiveness of notes receivable                         |  |                           | 171     |   |      |   |       |  
|Restructuring charges, non-cash                         |  |                           | 544     |   |      |   | 1,453  |  
|Changes is assets and liabilities                       |  |                           |         |   |      |   |        |  
|Accounts receivable                                     |  |                           | (6,121  | ) |      |   | (2,047 | )
|Other assets                                            |  |                           | (620    | ) |      |   | (473   | )
|Accounts payable                                        |  |                           | (57     | ) |      |   | 983    |  
|Accrued liabilities                                     |  |                           | 3,170   |   |      |   | (4,642 | )
|Deferred revenue                                        |  |                           | 3,229   |   |      |   | 2,610  |  
|                                                        |  |                           |         |   |      |   |        |  
|Net cash used in operating activities                   |  |                           | (22,079 | ) |      |   | (7,987 | )
|                                                        |  |                           |         |   |      |   |        |  
|Cash flow from investing activities                     |  |                           |         |   |      |   |        |  
|Notes receivable from officers                          |  |                           | 240     |   |      |   |       |  
|Release of restricted cash                              |  |                           |        |   |      |   | 2,500  |  
|Purchases of property and equipment                     |  |                           | (1,715  | ) |      |   | (697   | )
|                                                        |  |                           |         |   |      |   |        |  
|Net cash used in investing activities                   |  |                           | (1,475  | ) |      |   | 1,803  |  
|                                                        |  |                           |         |   |      |   |        |  
|Cash flow from financing activities                     |  |                           |         |   |      |   |        |  
|Proceeds from the issuance of convertible notes, net    |  |                           | 30,165  |   |      |   | 7,000  |  
|Proceeds from the issuance of common stock, net         |  |                           | 1,009   |   |      |   |       |  
|Repayment of convertible notes                          |  |                           |        |   |      |   | (5,565 | )
|Payments on line of credit facility                     |  |                           | (2,298  | ) |      |   |       |  
|Principal payments on note and lease obligations        |  |                           | (485    | ) |      |   | (685   | )
|                                                        |  |                           |         |   |      |   |        |  
|Net cash used in financing activities                   |  |                           | 28,391  |   |      |   | 750    |  
|                                                        |  |                           |         |   |      |   |        |  
|Net change in cash and cash equivalents                 |  |                           | 4,837   |   |      |   | (5,434 | )
|Effect of exchange rates on cash and cash equivalents   |  |                           | (271    | ) |      |   | (948   | )
|Cash and cash equivalents, beginning of period          |  |                           | 18,984  |   |      |   | 23,239 |  
|                                                        |  |                           |         |   |      |   |        |  
|Cash and cash equivalents, end of period                |  | $                         | 23,550  |   |      | $ | 16,857 |  
|                                                        |  |                           |         |   |      |   |        |  



The accompanying
notes are an integral part of these Condensed Consolidated Financial Statements.



Page 3



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CRITICAL PATH, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS DEFICIT



|                                                                         |  |                                       |         |   |                                         |   |        |                     |  |                      |           |   |                                               |   |       |       |   |        |   |  |   |            |   |  |   |          |  
|------------------------------------------------------------------------ |  | ------------------------------------- | ------- | - | --------------------------------------- | - | ------ | ------------------- |  | -------------------- | --------- | - | --------------------------------------------- | - | ----- | ----- | - | ------ | - |  | - | ---------- | - |  | - | -------- | -
|                                                                         |  |                                       |         |   | Shareholders equity (deficit)          |  
|                                                                         |  | Mandatorily redeemablepreferred stock |         |   | Commonstock andadditionalpaid incapital |   |        | Commonstockwarrants |  | Unearnedcompensation |           |   | Accumulateddeficit and othercomprehensiveloss |   |       | Total |  
|                                                                         |  | AmendedSeries D                       |         |   | Series E                                |   |        |                     |  |                      |          
|                                                                         |  | (in thousands; unaudited)             |        
|Balance at December 31, 2004                                             |  | $                                     | 59,575  |   |                                         | $ | 62,802 |                     |  | $                    | 2,174,496 |   |                                               | $ | 5,947 |       | $ | (1,353 | ) |  | $ | (2,291,279 | ) |  | $ | (112,189 | )
|Accretion of dividend on mandatorily redeemable preferred stock          |  |                                       | 1,703   |   |                                         |   | 2,362  |                     |  |                      | (4,065    | ) |                                               |   |      |       |   |       |   |  |   |           |   |  |   | (4,065   | )
|Accretion to redemption value for mandatorily redeemable preferred stock |  |                                       | 2,786   |   |                                         |   | 4,942  |                     |  |                      | (7,749    | ) |                                               |   |      |       |   |       |   |  |   |           |   |  |   | (7,749   | )
|Conversion of preferred stock to common stock                            |  |                                       | (10,055 | ) |                                         |   | (7,867 | )                   |  |                      | 18,355    |   |                                               |   |      |       |   |       |   |  |   |           |   |  |   | 18,355   |  
|Common stock issued under Employee Stock Purchase Plan                   |  |                                       |        |   |                                         |   |       |                     |  |                      | 5         |   |                                               |   |      |       |   |       |   |  |   |           |   |  |   | 5        |  
|Issuance of restricted stock, net                                        |  |                                       |        |   |                                         |   |       |                     |  |                      | 2         |   |                                               |   |      |       |   |       |   |  |   |           |   |  |   | 2        |  
|Unearned compensation related to grants of restricted stock              |  |                                       |        |   |                                         |   |       |                     |  |                      |          |   |                                               |   |      |       |   | (56    | ) |  |   |           |   |  |   | (56      | )
|Amortization of unearned compensation                                    |  |                                       |        |   |                                         |   |       |                     |  |                      |          |   |                                               |   |      |       |   | 536    |   |  |   |           |   |  |   | 536      |  
|Foreign currency translation adjustments                                 |  |                                       |        |   |                                         |   |       |                     |  |                      |          |   |                                               |   |      |       |   |       |   |  |   | (1,658     | ) |  |   | (1,658   | )
|Net loss                                                                 |  |                                       |        |   |                                         |   |       |                     |  |                      |          |   |                                               |   |      |       |   |       |   |  |   | (8,906     | ) |  |   | (8,906   | )
|                                                                         |  |                                       |         |   |                                         |   |        |                     |  |                      |           |   |                                               |   |       |       |   |        |   |  |   |            |   |  |   |          |  
|Balance at June 30, 2005                                                 |  | $                                     | 54,009  |   |                                         | $ | 62,239 |                     |  | $                    | 2,181,044 |   |                                               | $ | 5,947 |       | $ | (873   | ) |  | $ | (2,301,843 | ) |  | $ | (115,725 | )
|                                                                         |  |                                       |         |   |                                         |   |        |                     |  |                      |           |   |                                               |   |       |       |   |        |   |  |   |            |   |  |   |          |  



The accompanying
notes are an integral part of these Condensed Consolidated Financial Statements.



Page 4



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CRITICAL PATH, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Note 1  Basis of Presentation and Summary of Significant Accounting Policies



Basis of Presentation



The consolidated financial statements include the accounts of the Company, and its wholly owned and majority-owned subsidiaries. All significant inter-company balances and transactions have been eliminated in
consolidation.



These interim financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America for interim financial information, and the rules and regulations of the United States Securities and Exchange Commission (SEC) for interim financial statements
and accounting policies, consistent, in all material respects, with those applied in preparing our audited consolidated financial statements included in our Annual Report on Form 10-K and Form 10-K/A for the fiscal year ended December 31, 2004. The
unaudited financial information furnished herein reflects all adjustments, consisting only of normal recurring adjustments, that in our opinion are necessary to fairly state our consolidated financial position, the results of operations, cash flows
and shareholders deficit for the periods presented. This Quarterly Report on Form 10-Q should be read in conjunction with our audited financial statements for the year ended December 31, 2004, included in the 2004 Form 10-K. The condensed
consolidated statement of operations for the three and six months ended June 30, 2005 are not necessarily indicative of results to be expected for any subsequent periods or for the entire fiscal year ending December 31, 2005.



Liquidity and Capital Resources



The Company has focused on capital financing initiatives in order to maintain current and
planned operations. The Company has operated at a loss since inception and its history of losses from operations and cash flow deficits, in combination with its cash balances, have raised concerns about the Companys ability to fund its
operations. Consequently, in 2003 and 2004 the Company secured additional funds through both debt and equity financing activities that involved the sale of convertible notes and the completion of a rights offering. Most recently, in December 2004
the Company drew $11.0 million from an $18.0 million round of debt financing and in March 2005, drew down the remaining $7.0 million. The Company is not required to make any payments of principal or interest under this $18.0 million debt financing
until maturity in December 2007. If the Company is unable to increase its revenues or if the Company is unable to reduce the amount of cash used by its operating activities during 2005, the Company may be required to undertake additional
restructuring alternatives, or seek additional debt financing although its ability to incur additional indebtedness is subject to certain limitations as discussed in the section below captioned Ability to incur additional
indebtedness. Additionally, on April 12, 2005, the Nasdaq Stock Market Inc. (Nasdaq) issued the Company notice that it was not in compliance with the minimum closing bid price requirement. On June 7, 2005, the Company received notice from
Nasdaq that it was not in compliance with the minimum market value requirement. As a result of these notices, the Company is faced with delisting proceedings. The Company must regain compliance with the Nasdaq rules by September 6, 2005 in the case
of the minimum market value requirement and by October 10, 2005 in the case of the minimum closing bid price requirement, or its common stock will be de-listed from the Nasdaq National Market. If it is delisted from the Nasdaq National Market, the
Company will apply to be listed on the Nasdaq Small Cap Market, and if it fails to qualify for listing on that market it will be listed on the Over-the-Counter (OTC) Bulletin Board. Even if the Company is able to regain compliance for the Nasdaq
National Market, these notices and potential movement to a new exchange may also impact the Companys ability to raise additional capital if needed.



With the Companys history of operating losses and cash used to support operating activities, the primary sources of capital have come from both debt and equity
financings that have been completed over the past several years. The Companys principal sources of liquidity include cash and cash equivalents. As of June 30, 2005, the Company had cash and cash equivalents available for operations totaling
$16.9 million, of which $8.2 million was located in accounts outside the United States and is not readily



Page 5



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available for domestic operations. However, the Company intends to pursue the investigation of restructuring its foreign subsidiaries which, if successful,
may provide easier access to the repatriation of a greater portion of the cash located in accounts outside the United States. Additionally, the Company is currently evaluating the newly enacted American Jobs Creation Act of 2004 (the AJCA) and is
not yet in a position to decide whether, or to what extent, the AJCA will enable the Company to repatriate foreign earnings that have not yet been remitted to the United States. As of June 30, 2005, the readily available cash resources in the United
States were $8.8 million. As of June 30, 2005, the Company had $0.3 million of cash classified on its balance sheet as restricted cash which is primarily related to cash collateralized letters of credit primarily related to facility leases. This
cash is not readily available for operations.



Based on the Companys
recent financing activities, cash expected to be generated from operations and recent restructure activities the Company believes that there is sufficient cash to meet cash operating requirements for the next 12 months as well as the on-going
investments in capital equipment to support the Companys research and development efforts and hosted data center expansion plans. For the long-term, the Company believes that the operating activities will be able to provide the liquidity and
capital resources sufficient to support the Companys business. At June 30, 2005, the Company had no borrowings under its credit facility with Silicon Valley Bank because the borrowing availability had been eliminated and the Company was
required to cash collateralize the Companys letters of credit related to facility leases which total approximately $0.3 million.



Ability to incur additional indebtedness



Under the terms of the Companys line of credit, the Company is required to obtain the consent of Silicon Valley Bank to incur additional indebtedness. Additionally,
subject to limited exceptions, the Company must seek the consent of its investors in order to incur any additional indebtedness.



Segment Information



The Company does not currently manage its business in a manner that requires it to report financial results on a segment basis. The Company currently operates in one segment, digital communications software and
services, and management uses one measure of profitability. Revenue information on a product and service basis has been disclosed in the Companys statement of operations.



Stock-Based Compensation



Pursuant to the requirements of Statement of Financial Accounting Standards (SFAS) No. 148,Accounting for Stock-based Compensation  Transition and
Disclosure, pro forma information regarding net loss and net loss per share is required to be presented as if the Company had accounted for employee stock option grants and activities under the Companys Employee Stock Purchase Plan using
the fair value method of SFAS No. 123, as amended by SFAS No. 148. Had compensation cost been recognized based on the fair value at the date of grant for options granted and activities under the Companys Employee Stock Purchase Plan, the pro
forma amounts of the Companys net loss and net loss per share would have been as follows:



Page 6



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|                                                                                                          |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | ------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                          |  | Three months ended June 30,              |         |   | Six months ended June 30, |  
|                                                                                                          |  | 2004                                     |         |   | 2005                      |   |        | 2004 |  |   | 2005    |  
|                                                                                                          |  | (in thousands, except per share amounts) |        
|Net loss attributable to common shares - as reported                                                      |  | $                                        | (12,424 | ) |                           | $ | (8,053 | )    |  | $ | (25,555 | ) |  | $ | (20,699 | )
|Add:                                                                                                      |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Stock-based employee compensation expense included in reported net loss attributable to common shares     |  |                                          | 1,212   |   |                           |   | 255    |      |  |   | 1,258   |   |  |   | 563     |  
|Deduct:                                                                                                   |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Total stock-based employee compensation expense determined under a fair value based method for all grants |  |                                          | (1,312  | ) |                           |   | (929   | )    |  |   | (3,873  | ) |  |   | (2,332  | )
|                                                                                                          |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Net loss attributable to common shares-pro forma                                                          |  | $                                        | (12,524 | ) |                           | $ | (8,727 | )    |  | $ | (28,170 | ) |  | $ | (22,468 | )
|                                                                                                          |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Basic and diluted net loss per share attributable to common shares-as reported                            |  | $                                        | (0.59   | ) |                           | $ | (0.27  | )    |  | $ | (1.21   | ) |  | $ | (0.73   | )
|                                                                                                          |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Basic and diluted net loss per share attributable to common shares-pro forma                              |  | $                                        | (0.59   | ) |                           | $ | (0.30  | )    |  | $ | (1.34   | ) |  | $ | (0.79   | )
|                                                                                                          |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  



The Company calculated the fair value
of each option grant on the date of grant using the Black-Scholes option pricing model, as prescribed by SFAS No. 123, using the following assumptions:



|                          |  |                            |   |  |                          |   |  |        |  |              
|------------------------- |  | -------------------------- | - |  | ------------------------ | - |  | ------ |  | -------------
|                          |  | Three months endedJune 30, |   |  | Six months endedJune 30,
|                          |  | 2004                       |   |  | 2005                     |   |  | 2004   |  | 2005         
|Risk free interest rate   |  | 3.0                        | % |  | 3.7                      | % |  | 3.0%   |  | 4.1%-3.7%    
|Expected lives (in years) |  | 4                          |   |  | 4                        |   |  | 4      |  | 4            
|Dividend yield            |  | 0.0                        | % |  | 0.0                      | % |  | 0.0%   |  | 0.0%         
|Expected volatility       |  | 146.0                      | % |  | 135.0                    | % |  | 146.0% |  | 142.0%-135.0%



The Company calculated the fair value
of the activity under the Employee Stock Purchase Plan using the Black-Scholes option pricing model, as prescribed by SFAS 123, using the following assumptions:



|                          |  |                             |  |                           |  |               |  |              
|------------------------- |  | --------------------------- |  | ------------------------- |  | ------------- |  | -------------
|                          |  | Three months ended June 30, |  | Six months ended June 30,
|                          |  | 2004                        |  | 2005                      |  | 2004          |  | 2005         
|Risk free interest rate   |  | 2.31%-3.66%                 |  | 3.7%                      |  | 2.31%-3.66%   |  | 2.06%-3.7%   
|Expected lives (in years) |  | 2                           |  | 2                         |  | 2             |  | 2            
|Dividend yield            |  | 0.0%                        |  | 0.0%                      |  | 0.0%          |  | 0.0%         
|Expected volatility       |  | 129.0%-139.8%               |  | 129.0%                    |  | 129.0%-139.8% |  | 132.9%-129.0%



Recent Accounting Pronouncements



In May 2005, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 154, Accounting Changes and Error Corrections. SFAS No. 154 replaces Accounting Principles Board (APB) No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes
in Interim Financial Statements. SFAS No. 154 changes the requirements for the accounting for and reporting of a change in accounting principle and applies to all voluntary changes in accounting principle. This statement will be effective for
accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company believes adoption of this new standard will not have a significant adverse impact on its financial position and results of operations.



Page 7



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In April 2005, the SEC amended the compliance dates for SFAS No. 123R, Shared-Based Payment. The new rule allows
public companies to implement SFAS No. 123R at the beginning of their next fiscal year that begins after June 15, 2005. The Company will be required to adopt SFAS No. 123R in the first quarter of 2006 and begin to recognize stock-based compensation
related to employee equity awards in its condensed consolidated statements of operations using a fair value based method on a prospective basis. Since the Company currently accounts for equity awards granted to its employees using the intrinsic
value method under APB No. 25, the Company expects the adoption of SFAS No. 123R will have a significant adverse impact on its financial position and results of operations.



In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB No. 107). SAB No. 107 covers key topics related to the implementation
of SFAS No. 123R which include the valuation models, expected volatility, expected option term, income tax effects of SFAS No. 123R, classification of stock-based compensation cost, capitalization of compensation costs, and disclosure requirements.
The Company expects the adoption of SAB No. 107 will have a significant adverse impact on its financial position and results of operations in connection with SFAS No. 123R in the first quarter of 2006.



In March 2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional
Asset Retirement Obligations (FIN No. 47). FIN No. 47 clarifies that a company should record a liability for a conditional asset retirement obligation when incurred if the fair value of the obligation can be reasonably estimated. This
interpretation further clarified conditional asset retirement obligation, as used in SFAS No. 143, Accounting for Asset Retirement Obligations, as a legal obligation to perform an asset retirement activity in which the timing and/or method of
settlement are conditional on a future event that may or may not be within the control of the entity. FIN No. 47 is effective for companies no later than the end of their fiscal year ending after December 15, 2005. The Company does not expect the
adoption of FIN No. 47 to have an impact on its financial position and results of operations.



In December 2004, the FASB issued SFAS No. 153,Exchange of Nonmonetary Assets, which is an amendment to APB Opinion No. 29. The guidance in APB Opinion No. 29,Accounting for Nonmonetary Transactions,
is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that opinion, however, included certain exceptions to that principle. This statement amends APB
Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has
commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The adoption of SFAS No. 153 is not expected to have a material impact on the Companys financial position or results
of operations.



Note 2  Restructuring Activities



The following table summarizes the strategic restructuring costs incurred by the Company
during the six months ended June 30, 2005.



|                               |  |                     |      |   |                                                        |   |        |       |  |   |        |  
|------------------------------ |  | ------------------- | ---- | - | ------------------------------------------------------ | - | ------ | ----- |  | - | ------ | -
|                               |  | Workforce reduction |      |   | Facility andoperations consolidation and other charges |   |        | Total | 
|                               |  | (in thousands)      |     
|Liability at December 31, 2004 |  | $                   | 201  |   |                                                        | $ | 553    |       |  | $ | 754    |  
|Restructure charge             |  |                     | 311  |   |                                                        |   | 1,495  |       |  |   | 1,806  |  
|Cash payments                  |  |                     | (477 | ) |                                                        |   | (1,700 | )     |  |   | (2,177 | )
|Adjustments                    |  |                     | (187 | ) |                                                        |   |       |       |  |   | (187   | )
|                               |  |                     |      |   |                                                        |   |        |       |  |   |        |  
|Liability at June 30, 2005     |  | $                   | (152 | ) |                                                        | $ | 348    |       |  | $ | 196    |  
|                               |  |                     |      |   |                                                        |   |        |       |  |   |        |  



Page 8



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During 2003, the Company restructured certain of its facility lease obligations and eliminated certain management
positions in an effort to reduce both short-term and long-term cash requirements. During the six months ended June 30, 2005, the Company recorded restructure charges totaling $1.8 million, related to these activities of which $1.3 million was
recorded in the three months ended March 31, 2005.



During the six months ended
June 30, 2005, the Company recorded a restructuring charge totaling $1.8 million, of which, $1.3 million was recorded during the three months ended March 31, 2005 related to the relocation of the Companys headquarters facility as discussed
below and the balance related to consolidation of data centers and the elimination of certain employee positions.



In September 2004, the Company received a non-binding notice from the landlord of its headquarters facility in San Francisco, California that the landlord had found a new
tenant for the Companys offices located at 350 The Embarcadero per the landlords substitution right in the First Amendment to Lease between SRI Hills Plaza Venture, LLC and Critical Path, Inc. (the Amendment). On March 15, 2005, the Company
received the Substitution Notice from the landlord as required per the Amendment. In accordance with the Substitution Notice, the Company vacated its facilities at 350 The Embarcadero and moved into new office space provided at 2 Harrison Street on
June 29, 2005.



On May 5, 2005, the Company entered into the Second Amendment
to Lease with PPF Off 345 Spear Street, L.P., to amend the Lease dated as of November 16 2001, as amended, under which the Company leases its headquarter facilities in San Francisco, California. Under the terms of the second amendment, the Company
moved into new office space at 2 Harrison Street, 2ndFloor, San Francisco, California and vacated its facility at
350 The Embarcadero on June 29, 2005. The new office space into which the Company relocated is comprised of two suites consisting of approximately 22,881 square feet and will be leased for a term of five years, however; the Company has an early
termination option whereby the Company can reduce the occupancy of the premises to one of the two suites after 18 months. In connection with the second amendment, the Company made a lease termination payment related to the facility at 350 the
Embarcadero totaling approximately $1.3 million during the three months ended June 30, 2005; however, the annual rent, on a cash basis, for the Companys new headquarter facility will decline from approximately $2.5 million per year to less
than approximately $0.7 million per year on average over the term of the lease.



Note 3  Goodwill



At June 30, 2005, the Company had $6.6
million of goodwill. In accordance with SFAS No. 142, the Company ceased amortizing its goodwill in January 2002.



Note 4  Convertible Notes and Promissory Notes



53/4% Convertible Subordinated
Notes



On the due date of April 1, 2005, the Company paid $5.7
million to retire the outstanding principal and accrued interest on the 53/4% Convertible Subordinated Notes.



13.9% Promissory Notes



In December 2004, the Company issued $11.0 million in principal amount of 13.9% Promissory
Notes (the 13.9% Notes) to General Atlantic Partners 74, L.P., Gapstar, LLC, GAP Coinvestment Partners II, L.P., GAPCO GmbH & Co. KG., Cenwell Limited, Campina Enterprises Limited, Great Affluent Limited, Dragonfield Limited, Lion Cosmos Limited
and Richmond III, LLC (collectively the investors). As part of the financing transaction, the Company issued warrants to purchase 235,712 shares of Series F preferred stock at a per share purchase price of $14 per share, which is
equivalent to $1.40 per share on a common equivalent basis.



In March 2005, the
Company issued the remaining $7.0 million in principal amount of the 13.9% Notes to the investors. As part of this financing transaction, the Company also issued warrants to purchase 149,998 shares of Series F preferred stock at a per share purchase
price of $14 per share, which is equivalent to $1.40 per share on a common equivalent basis.



Page 9



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The 13.9% Notes accrue interest at a rate of 13.9% per annum, however; the Company is not obligated to make interest
payments on the notes prior to their maturity date of December 30, 2007. The 13.9% Notes are due and payable on the earlier to occur of the maturity of the 13.9% Notes on December 30, 2007, when declared due and payable upon the occurrence of an
event of default, or a change of control of the Company.



The proceeds from the
financing transaction were allocated to the 13.9% Notes and warrants based upon their relative estimated fair values. The estimated fair value of the warrants issued in connection with the 13.9% Notes has been classified as a derivative instrument
and recorded as a liability on the Companys balance sheet in accordance with current authoritative guidance. In accordance with the provisions of SFAS No. 133, Accounting for Derivative Instruments, the Company is required to adjust the
carrying value of the instrument to its fair value at each balance sheet date and recognize any change since the prior balance sheet date as a component of Other Income (Expense).



At June 30, 2005, the 13.9% Notes were carried on the balance sheet as long-term Notes payable as follows (in thousands):



|                                                                                                         |  |   |        |  
|-------------------------------------------------------------------------------------------------------- |  | - | ------ | -
|Proceeds from the issuance of the 13.9% Notes                                                            |  | $ | 18,000 |  
|Less: proceeds allocated to the fair value of the Series F preferred stock warrant derivative instrument |  |   | (2,711 | )
|Add: accretion to redemption value                                                                       |  |   | 378    |  
|Add: accrued interest                                                                                    |  |   | 1,031  |  
|                                                                                                         |  |   |        |  
|Carrying value of 13.9% Notes                                                                            |  | $ | 16,698 |  
|                                                                                                         |  |   |        |  



Note 5  Comprehensive Loss



The components of comprehensive loss are as follows:



|                                         |  |                             |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|---------------------------------------- |  | --------------------------- | ------- | - | ------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                         |  | Three months ended June 30, |         |   | Six months ended June 30, |  
|                                         |  | 2004                        |         |   | 2005                      |   |        | 2004 |  |   | 2005    |  
|                                         |  | (in thousands)              |        
|Net loss attributable to common shares   |  | $                           | (12,424 | ) |                           | $ | (8,053 | )    |  | $ | (25,555 | ) |  | $ | (20,699 | )
|Foreign currency translation adjustments |  |                             | (579    | ) |                           |   | (1,196 | )    |  |   | (1,266  | ) |  |   | (1,658  | )
|                                         |  |                             |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|                                         |  | $                           | (13,003 | ) |                           | $ | (9,249 | )    |  | $ | (26,821 | ) |  | $ | (22,357 | )
|                                         |  |                             |         |   |                           |   |        |      |  |   |         |   |  |   |         |  



There were no tax effects allocated to
any components of comprehensive loss during the three and months ended June 30, 2004 or 2005.



Page 10



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Note 6  Net Loss per Share Attributed to Common Shareholders



Net loss per common share is calculated as follows:



|                                                                                                                  |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|----------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | ------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                  |  | Three months ended June 30,              |         |   | Six months ended June 30, |  
|                                                                                                                  |  | 2004                                     |         |   | 2005                      |   |        | 2004 |  |   | 2005    |  
|                                                                                                                  |  | (in thousands, except per share amounts) |        
|Net loss attributable to common shares                                                                            |  | $                                        | (12,424 | ) |                           | $ | (8,053 | )    |  | $ | (25,555 | ) |  | $ | (20,699 | )
|                                                                                                                  |  |                                          |         |  
|Weighted average shares outstanding                                                                               |  |                                          | 21,401  |   |                           |   | 31,032 |      |  |   | 21,262  |   |  |   | 30,110  |  
|Weighted average shares subject to repurchase agreements                                                          |  |                                          | (244    | ) |                           |   | (1,622 | )    |  |   | (188    | ) |  |   | (1,708  | )
|Weighted average shares held in escrow related to acquisitions                                                    |  |                                          |        |   |                           |   | (41    | )    |  |   |        |   |  |   | (41     | )
|                                                                                                                  |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Shares used in the computation of basic and diluted net loss attributable to common shareholders per common share |  |                                          | 21,157  |   |                           |   | 29,369 |      |  |   | 21,074  |   |  |   | 28,361  |  
|                                                                                                                  |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  
|Net loss attributable to common shareholders per common share                                                     |  | $                                        | (0.59   | ) |                           | $ | (0.27  | )    |  | $ | (1.21   | ) |  | $ | (0.73   | )
|                                                                                                                  |  |                                          |         |   |                           |   |        |      |  |   |         |   |  |   |         |  



As of June 30, 2004 and 2005, there
were 59.4 million and 115.4 million, respectively, potential common shares that were excluded from the determination of diluted net loss per share, as the effect of such shares on a weighted average basis is anti-dilutive.



Note 7  Mandatorily Redeemable Preferred stock



Series D Cumulative Redeemable Convertible Preferred Stock



In December 2001, the Company completed a financing transaction with a group of investors
and their affiliated entities. In connection with this financing transaction, the Company issued 4 million shares of its Series D Cumulative Redeemable Convertible Preferred Stock (Series D preferred stock), in a private offering,
resulting in gross cash proceeds of approximately $30 million, and the simultaneous retirement of approximately $65 million in face value of the Companys outstanding convertible subordinated notes. The investors were led by General Atlantic
Partners LLC and affiliates and included Hutchison Whampoa Limited and affiliates and Vectis Group LLC and affiliates. In addition, General Atlantic LLC was granted warrants to purchase 625,000 shares of the Companys Common Stock in connection
with this offering.



At issuance, costs of $3.1 million were recorded as a
reduction of the carrying amount of the Series D preferred stock and will accrete over the term of the Series D preferred stock. Additionally, at issuance, the Series D preferred stock was deemed to have an embedded beneficial conversion feature
which was limited to the net proceeds allocable to preferred stock of approximately $42 million. The value of the beneficial conversion feature, at issuance, was initially recorded as a reduction of the carrying amount of the Series D preferred
stock and will accrete over the term of the Series D preferred stock.



The
Series D preferred stock issued in the financing transaction ranks senior to all of the Companys Common Stock in priority of dividends, rights of redemption and payment upon liquidation. The fair value ascribed to the preferred stock was based
on actual cash paid by independent investors and the approximate fair value of the 53/4% Notes retired in
connection with the offering. The principal terms of the preferred stock included an automatic redemption on November 8, 2006, cumulative dividends at a rate of 8% per year, compounded on a semi-annual basis and payable in cash or additional shares
of Series D preferred stock, conversion into shares of Common Stock calculated based on the Accreted Value which is, the purchase price plus accrued dividends divided by $4.20, and preference in the return of equity in any liquidation or change of
control.



The purchase agreement provides for a preferential return of
equity to the Series D preferred stockholders, before any return of equity to the common shareholders, and also provides for the Series D preferred stockholders to participate on a pro rata basis with the common shareholders, in any remaining
equity, once the preferential return has been satisfied. Under the terms of this provision, the preferential return of equity is equal to the purchase price of the Series D preferred stock plus all dividends that would have accrued during the term
of the preferred stock, even if a change in control occurs prior to the



Page 11



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redemption date. The right to receive a preferential return lapses if either: (i) Critical Path is sold for a price per share of Series D preferred stock,
had each such share been converted into Common Stock prior to change in control of at least four times the Accreted Value, or (ii) Critical Paths stock trades on NASDAQ for 60 days prior to the change-in-control at an average price of not less
than four times the Accreted Value. As part of the Companys November 2003 private placement of 10% Senior Secured Convertible Notes, the Company agreed to seek shareholder approval to amend the terms of the Series D preferred stock to, among
other things, amend the Series D preferred stock liquidation preference upon a liquidation and change of control, to eliminate the participation feature, to reduce the conversion price from $4.20 to $1.50 and to reduce the amount of dividends to
which the holders of Series D preferred stock are entitled.



The warrants are
exercisable at any time after November 8, 2002 until November 8, 2006 at an exercise price of $4.20, and convert into one share of the Companys Common Stock. A portion of the proceeds received for the Series D preferred stock was allocated to
the warrants and the preferred stock, based upon their relative fair market values. As a result of this allocation, approximately $5.3 million of the proceeds were allocated to the warrants, which was recorded as a reduction of the carrying value of
the Series D preferred stock. Using the Black-Scholes option pricing model, assuming a four-year term, 200% volatility, a risk-free rate of 6.0% and no dividend yield, the fair market value of the warrants was $6.2 million. As part of the
Companys November 2003 private placement of 10% Senior Secured Convertible Notes (Senior Notes), the Company agreed to seek shareholder approval to amend the warrants to reduce the exercise price per share from $4.20 to $1.50.



In July 2004, at a special meeting of shareholders, the Companys shareholders approved
proposals to amend and restate the certificate of determination of preferences of Series D preferred stock (the Amended Series D). As part of this amendment, the automatic redemption date was changed to July 2008 and the dividend accrual rate was
reduced to 53/4%. The dividends which had accrued on the Series D preferred stock totaling approximately $12.2
million were recorded as a reduction to the carrying value of the Amended Series D. This amount was recorded as a reduction of the carrying amount of the Amended Series D and will accrete over the term of the Amended Series D. As of June 30, 2005 if
the holders of Amended Series D preferred stock voluntarily opt to redeem, the conversion value of all Amended Series D preferred stock, as accreted, is $62.2 million. Additionally, the Amended Series D preferred stock contains a liquidation
preference of $22 per share.



In January 2005, the Company converted
581,818 shares of Series D preferred stock, plus accrued dividends of $2.0 million, held by the Vectis Group LLC and affiliates into 6,701,943 shares of common stock.



The following table sets forth the carrying value and liquidation values of the Amended Series D preferred stock at June 30, 2005 (in
thousands):



|                                                                                  |  |              |         |  
|--------------------------------------------------------------------------------- |  | ------------ | ------- | -
|                                                                                  |  | June 30,2005 |        
|                                                                                  |  |              |        
|Beginning balance-Amended Series D preferred stock at December 31, 2004           |  | $            | 59,575  |  
|Add amortization and accretion                                                    |  |              | 4,489   |  
|Less value of Series D preferred stock converted to common stock at June 30, 2005 |  |              | (10,055 | )
|                                                                                  |  |              |         |  
|Carrying value of Amended Series D preferred stock at June 30, 2005               |  | $            | 54,009  |  
|                                                                                  |  |              |         |  
|Liquidation value of Amended Series D preferred stock (at $22 per share)          |  | $            | 79,349  |  
|                                                                                  |  |              |         |  



Series E Redeemable Convertible
Preferred Stock



During the three months ended September 30, 2004, the
Company issued a total of approximately 55.9 million shares of Series E Redeemable Convertible Preferred Stock (Series E preferred stock). In July



Page 12



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2004, the Company issued approximately 30.6 million shares of Series E preferred stock to convert $45.5 million of the Senior Notes plus accrued interest,
issued 21.9 million shares of Series E preferred stock to convert $32.8 million of the 53/4% Notes and issued
approximately 0.8 million shares of Series E preferred stock to convert certain holders of Series D preferred stock into Series E preferred stock. In August 2004, the Company issued approximately 2.6 million shares of Series E preferred stock in
connection with its rights offering from which the Company received gross proceeds of approximately $4.0 million.



The Series E preferred stock ranks senior to all preferred and common stock of the Company in priority of dividends, rights of redemption and payment upon liquidation.
The principal terms of the Series E preferred stock include an automatic redemption on July 9, 2008, cumulative dividends at a rate of 53/4% per year, dividends are not paid in cash but are added to the value of the Series E preferred stock on June 30 and December 31 each year, and conversion into shares of common stock calculated based
on the quotient of the Series E accreted value divided by the Series E conversion price, $1.50.



At issuance, the total amount of costs associated with converting the Companys debt into Series E preferred stock and costs associated with the rights offering, totaling approximately $4.6 million, will accrete
over the term of the Series E preferred stock. Additionally, the conversion of the $45.5 million Senior Notes into the Series E preferred stock was deemed to have a beneficial conversion feature totaling approximately $16.3 million. The value of the
beneficial conversion feature, at issuance, was initially recorded as a reduction of the carrying amount of the Series E preferred stock and will accrete over the term of the Series E preferred stock.



During the six months ended June 30, 2005, upon receiving notice from certain investors, the
Company converted approximately 5.0 million shares of Series E preferred stock and accrued dividends into approximately 5.2 million shares of the Companys Common Stock. As of June 30, 2005, there were approximately 50.9 million shares of
Series E preferred stock outstanding.



The carrying value of the Series E
preferred stock at June 30, 2005 is as follows (in thousands):



|                                                                |  |              |        |  
|--------------------------------------------------------------- |  | ------------ | ------ | -
|                                                                |  | June 30,2005 |       
|                                                                |  |              |       
|Beginning balance-Series E preferred stock at December 31, 2004 |  | $            | 62,802 |  
|Add amortization and accretion                                  |  |              | 7,304  |  
|Less amount allocated to beneficial conversion feature          |  |              |       |  
|Less value of Series E preferred stock converted to common      |  |              | (7,867 | )
|                                                                |  |              |        |  
|Carrying value of Series E preferred stock                      |  | $            | 62,239 |  
|                                                                |  |              |        |  
|Liquidation value of Series E preferred stock                   |  | $            | 80,642 |  
|                                                                |  |              |        |  



Series F Redeemable Convertible
Preferred Stock



In December 2004, the Companys Board of Directors
authorized the issuance of up to 450,000 shares of Series F Redeemable Convertible Preferred Stock (Series F preferred stock). The Series F preferred stock will rank equally with the Series E preferred stock, and will rank senior to all other
capital stock with respect to rights on liquidation, dissolution and winding up. The Series F preferred stock will accrue dividends at a simple annual rate of 53/4% of the purchase price of $14.00 (equivalent to $1.40 per share on a common equivalent basis), whether or not declared by the board of directors. Dividends in respect of the
Series F preferred stock will not be paid in cash but will be added to the value of the Series F preferred stock and will be taken into account for purposes of determining the liquidation and change in control preference, conversion rate and voting
rights.



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The Company must declare or pay dividends on the Series F preferred stock when the Company declares or pay dividends to
the holders of common stock. Holders of Series F preferred stock are entitled to notice of all shareholders meetings and are entitled to vote on all matters submitted to the Shareholders for a vote, voting together with the holders of the
common stock and all other classes of capital stock entitled to vote, voting as a single class (except where a separate vote is required by the Companys amended and restated articles of incorporation, its bylaws or California law). The holders
of Series F preferred stock will be entitled to vote as a separate class on any amendment to the terms or authorized number of shares of Series F preferred stock, the issuance of any equity security ranking senior to the Series F preferred stock and
the redemption of or the payment of a dividend in respect of any junior security. At any time, holders of Series F preferred stock may elect to convert their Series F preferred stock into shares of common stock. Each share of Series F preferred
Stock is currently convertible into ten shares of common stock. After three years from the date the Series E preferred stock is first issued, the Company may call for redemption of the Series F preferred stock under certain circumstances. On the
fourth anniversary of the date the Series E preferred stock is first issued, the Company must call for redemption of the Series F preferred stock.



At June 30, 2005, no shares of Series F preferred stock were outstanding. Warrants to purchase 385,710 shares of Series F preferred stock were issued and outstanding as
of June 30, 2005 in connection with the issuance of the 13.9% Notes.



Accretion on Mandatorily Redeemable Preferred Stock



Accretion
on mandatorily redeemable preferred stock represents the accrued dividends and accretion of the beneficial conversion features of our outstanding Series D and E preferred stock as well as the accretion to the redemption value of the outstanding
Series D preferred stock. The following table sets forth the accretion on mandatorily redeemable preferred stock for the periods indicated:



|                                           |  |                             |       |                           |   |       |  |      |       |  |   |       
|------------------------------------------ |  | --------------------------- | ----- | ------------------------- | - | ----- |  | ---- | ----- |  | - | ------
|                                           |  | Three months ended June 30, |       | Six months ended June 30,
|                                           |  | 2004                        |       | 2005                      |   | 2004  |  | 2005
|                                           |  | (in thousands)             
|Accrued dividends                          |  | $                           | 1,289 |                           | $ | 2,026 |  | $    | 2,578 |  | $ | 4,065 
|Accretion of beneficial conversion feature |  |                             | 2,059 |                           |   | 3,901 |  |      | 3,917 |  |   | 4,944 
|Accretion to redemption value              |  |                             |      |                           |   | 589   |  |      |      |  |   | 2,784 
|                                           |  |                             |       |                           |   |       |  |      |       |  |   |       
|                                           |  | $                           | 3,348 |                           | $ | 6,516 |  | $    | 6,495 |  | $ | 11,793
|                                           |  |                             |       |                           |   |       |  |      |       |  |   |       



Note 8  Commitments and
Contingencies



Leases



The Company leases office space and equipment under noncancelable operating and capital
leases with various expiration dates through 2014. Rent expense for the six months ended June 30, 2005 totaled $2.6 million. Future minimum lease payments under noncancelable operating and capital leases are as follows:



|                                                      |  |                |     |                 |   |       
|----------------------------------------------------- |  | -------------- | --- | --------------- | - | ------
|                                                      |  | CapitalLeases  |     | OperatingLeases
|                                                      |  | (In thousands)
|Year Ending December 31                               |  |                |     |                 |   |       
|2005 (remaining nine months ending December 31, 2005) |  | $              | 257 |                 | $ | 1,389 
|2006                                                  |  |                | 87  |                 |   | 2,173 
|2007                                                  |  |                | 18  |                 |   | 1,531 
|2008                                                  |  |                |    |                 |   | 1,285 
|2009                                                  |  |                |    |                 |   | 1,194 
|2010 and beyond                                       |  |                |     |                 |   | 2,525 
|                                                      |  |                |     |                 |   |       
|Total minimum lease payments                          |  | $              | 362 |                 | $ | 10,097
|                                                      |  |                |     |                 |   |       



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In connection with the Companys acquisition of Critical Path Pacific in June 2002, the Company assumed a capital
lease with a termination date of August 2006. The capital lease obligation totaled $1.6 million at December 31, 2003. During 2004, the Company negotiated the early termination of this capital lease and will make capital lease payments totaling
approximately $0.2 million through the remainder of 2005.



Other Contractual
Obligations



The Company entered into other contractual obligations which
total $2.3 million at June 30, 2005. These obligations are primarily associated with the future purchase of equipment and software, the maintenance of hardware and software products being utilized within engineering and hosted operations, and the
management of data center operations and network infrastructure storage for the Companys hosted operations. These obligations are expected to be completed over the next 2 years, including $1.0 million in 2005.



Relocation of San Francisco Offices



During the first quarter of 2005, we recorded a restructure charge totaling $1.6 million, of
which, $1.3 million is related to the relocation of our headquarters facility as discussed below and the balance related to consolidation of data centers and the elimination of certain employee positions. In September 2004, the Company received a
non-binding notice from the landlord of its headquarters facility in San Francisco, California that the landlord had found a new tenant for the Companys offices located at 350 The Embarcadero per the landlords substitution right in the First
Amendment to Lease between SRI Hills Plaza Venture, LLC and Critical Path, Inc. (the Amendment). On March 15, 2005, the Company received the Substitution Notice from the landlord as required per the Amendment. In accordance with the Substitution
Notice, the Company vacated its facilities at 350 The Embarcadero and moved into new office space provided at 2 Harrison Street on June 29, 2005.



On May 5, 2005, the Company entered into the Second Amendment to Lease with PPF Off 345 Spear Street, L.P., to amend the Lease dated as of November 16 2001, as amended,
under which the Company leases its headquarter facilities in San Francisco, California. Under the terms of the second amendment, the Company moved into new office space at 2 Harrison Street, 2ndFloor, San Francisco, California and vacated its facility at 350 The Embarcadero on June 29, 2005. The new office space into which the Company relocated is
comprised of two suites consisting of approximately 22,881 square feet and will be leased for a term of five years, however; the Company has an early termination option whereby the Company can reduce the occupancy of the premises to one of the two
suites after 18 months. In connection with the second amendment, the Company made a lease termination related to the facility at 350 the Embarcadero payment totaling approximately $1.3 million during the three months ended June 30, 2005; however,
the annual rent, on a cash basis, for the Companys new headquarter facility will decline from approximately $2.5 million per year to less than approximately $0.7 million per year on average over the term of the lease.



Service Level Agreements



Certain net revenues are derived from contractual relationships that typically have one to
three year terms. Certain agreements require minimum performance standards regarding the availability and response time of email services. If these standards are not met, such contracts are subject to termination and the Company could be subject to
monetary penalties.



Litigation and Investigations



The Company is a party to lawsuits in the normal course of its business. Litigation in
general, and securities and intellectual property litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. Other than as described below,
the Company is not a party to any other material legal proceedings.



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Securities Class Action in Southern District of New York. Beginning in July 2001, a number of securities class
action complaints were filed against us, and certain of our former officers and directors and underwriters connected with our initial public offering (IPO) of common stock in the U.S. District Court for the Southern District of New York (In re
Initial Public Offering Sec. Litig.). The purported class action complaints were filed by individuals who allege that they purchased our common stock at the initial and secondary public offerings between March 29, 1999 and December 6, 2000. The
complaints allege generally that the prospectus under which such securities were sold contained false and misleading statements with respect to discounts and excess commissions received by the underwriters as well as allegations of
laddering whereby underwriters required their customers to purchase additional shares in the aftermarket in exchange for an allocation of IPO shares. The complaints seek an unspecified amount in damages on behalf of persons who purchased
our common stock during the specified period. Similar complaints have been filed against 55 underwriters and more than 300 other companies and other individuals. The over 1,000 complaints have been consolidated into a single action. We have reached
an agreement in principle with the plaintiffs to resolve the cases. The proposed settlement involves no monetary payment and no admission of liability. However, the settlement is subject to approval by the Court. The Company had not recorded a
liability against this claim as of June 30, 2005.



Cable & Wireless
Liquidating Trust. In August 2004, we received a demand letter from the Cable & Wireless Liquidating Trust, or the Trust, notifying us of the Trusts claim that Cable & Wireless, USA, Inc. made preferential payment to us of
approximately $1.1 million within the 90-day preference period before Cable & Wireless filed for bankruptcy. We do not believe that we received any preferential payments from Cable & Wireless and communicated our position to the Trust in a
letter dated September 3, 2004. To our knowledge, no formal proceedings have been commenced based on this dispute. However, the Company intends to defend itself vigorously if the Trust pursues this claim. The Company had not recorded a liability
against this claim as of June 30, 2005.



Indemnifications. The Company
provides general indemnification provisions in its license agreements. In these agreements, the Company generally states that it will defend or settle, at its own expense, any claim against the customer by a third party asserting a patent,
copyright, trademark, trade secret or proprietary right violation related to any products that the Company has licensed to the customer. The Company agrees to indemnify its customers against any loss, expense or liability, including reasonable
attorneys fees, from any damages alleged against the customer by a third party in its course of using products sold by the Company. The Company has not received any claims under this indemnification and does not know of any instances in which
such a claim may be brought against the Company in the future.



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Under California law, in connection with the Companys charter documents and indemnification agreements the Company
entered into with its executive officers and directors, the Company must indemnify its current and former officers and directors to the fullest extent permitted by law. The indemnification covers any expenses and liabilities reasonably incurred in
connection with the investigation, defense, settlement or appeal of legal proceedings. The Company has made payments in connection with the indemnification of officers and directors in connection with past lawsuits and governmental investigations.



Note 9  Property and Equipment



The following table sets forth the Companys property and equipment balances by
category for the periods indicated:



|                                                |  |                  |          |   |              |   |          |  
|----------------------------------------------- |  | ---------------- | -------- | - | ------------ | - | -------- | -
|                                                |  | December 31,2004 |          |   | June 30,2005 |  
|                                                |  | (in thousands)   |         
|Computer equipment and software                 |  | $                | 120,063  |   |              | $ | 120,237  |  
|Furniture and fixtures                          |  |                  | 6,627    |   |              |   | 4,948    |  
|Leasehold improvements                          |  |                  | 2,145    |   |              |   | 2,069    |  
|                                                |  |                  |          |   |              |   |          |  
|                                                |  |                  | 128,835  |   |              |   | 127,254  |  
|Less: accumulated depreciation and amortization |  |                  | (117,456 | ) |              |   | (120,010 | )
|                                                |  |                  |          |   |              |   |          |  
|                                                |  | $                | 11,379   |   |              | $ | 7,244    |  
|                                                |  |                  |          |   |              |   |          |  



During the three months ended March
31, 2005, the Company accelerated the depreciation on certain assets related to a messaging provisioning platform after it was determined the assets would be taken out of service before the end of their originally estimated useful life. Depreciation
expense totaled $1.8 million and $4.7 million for the three and six months ended June 30, 2005, respectively.



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



This Quarterly Report on Form 10-Q and the following disclosures contain forward-looking statements within the meaning of the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995, as amended and in effect from time to time. The words anticipates, expects, intends, plans, believes, seek,
proposed, and estimate and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include statements regarding our ability to operate in the future, our
ability to obtain funding, the adequacy of funds to meet anticipated operating needs, our future strategic, operational and financial plans, possible financing, strategic or business combination transactions, anticipated or projected revenues,
expenses and operational growth, markets and potential customers for our products and services, the continued seasonality of our business, plans related to sales strategies and global sales efforts, the anticipated benefits of our relationships with
strategic partners, growth of our competition, our ability to compete, investments in product development, anticipated restructuring and costs associated with



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our leases for our current facilities, our litigation strategy, use of future earnings, the features, benefits and performance of our current and future
products and services, plans to reduce operating costs through continued expense reduction, the anticipated effect of the transition of our hosted messaging environment from an out-sourced model to one that we perform in-house, the effect of the
repayment of debt, our ability to improve our internal control over financial reporting, and our belief as to our ability to successfully emerge from the restructuring and refocusing of our operations. These forward-looking statements are subject to
risks and uncertainties that could cause actual results to differ materially from those projected. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to,
our management of expenses and restructuring activities, failure to obtain additional financing on favorable terms or at all, the effect of the conversion of our preferred stock, the liquidation preference of our preferred stock, the accrual of
dividends for our preferred stock, risks associated with our internal controls over financial reporting and our ability to address any material weaknesses in our internal controls over financial reporting, risks associated with an inability to
maintain continued compliance with Nasdaq National Market listing requirements and delisting actions by such market, difficulties of forecasting future results due to our evolving business strategy, failure to meet sales and revenue forecasts, the
emerging nature of the market for our products and services, turnover within and integration of senior management, board of directors members and other key personnel, difficulties in our strategic plans to exit certain products and services
offerings, failure to expand our sales and marketing activities, potential difficulties associated with strategic relationships, investments and uncollected bills, general economic conditions in markets in which we do business, risks associated with
our international operations, inability to predict future trading prices of our common stock which have fluctuated significantly in the past, foreign currency fluctuations, unplanned system interruptions and capacity constraints, software defects,
and those discussed in Additional Factors That May Affect Future Operating Results and elsewhere in this report. Readers are cautioned not to place undue reliance on these forward-looking statements. The forward-looking statements speak
only as of the date hereof. We expressly disclaim any obligation to publicly release the results of any revisions to these forward-looking statements to reflect events or circumstances after the date of this filing.



All references to Critical Path, we, our, or the
Company mean Critical Path, Inc. and its subsidiaries, except where it is clear from the context that such terms mean only the parent company and excludes subsidiaries.



This Quarterly Report on Form 10-Q includes numerous trademarks and registered trademarks of Critical Path. Products or service names of
other companies mentioned in this Quarterly Report on Form 10-Q may be trademarks or registered trademarks of their respective owners.



Overview



We deliver software and services that enable the rapid deployment of highly scalable value-added solutions for messaging and identity management. Our messaging and identity management solutions help organizations
expand the range of digital communications services they provide while helping to reduce overall costs. Our messaging solutions, which are available both as licensed software and as hosted services, provide integrated access to a broad range of
communication and collaboration applications from wireless devices, web browsers, desktop clients, and voice systems. Our identity management solutions are designed to reduce burdens on helpdesks, simplify the deployment of key security
infrastructure, enable compliance with new regulatory mandates and help reduce the cost and effort of deploying applications and services to distributed organizations, mobile users, suppliers and customers.



Our target markets for our messaging and identity management solutions include wireless
carriers and service providers as well as enterprises and government agencies. We generate most of our revenues from telecommunications operators and from large enterprises. We believe wireless carriers, Internet service providers, or ISPs, and
fixed-line service providers purchase our products and services primarily to offer new services to their subscribers. While they may also purchase our products and services to lower their cost of operating existing services or infrastructure, their
spending is often tied to the level of investment they are willing to make on new revenue-generating services. Large enterprises typically buy our products and services to reduce their costs of operations particularly for handling distributed
workforces or consolidations of multiple organizations, improve the security of their infrastructure, facilitate compliance with new regulatory mandates, and to enable new applications to be deployed for their employees or users.



We generate revenues from four primary sources:



Software license sales. Our messaging applications, which are marketed as components
of our Memova Messaging offering, are usually sold as a perpetual license on a per-user basis, one for each person who might access the capabilities provided by the software. Our identity management software is usually sold as a perpetual license
according to the number of data elements and different business systems being managed. These layered applications are usually licensed per user. Our Memova Anti-Abuse offering is usually sold as a term license on a per product basis.



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Hosted messaging services. For our hosted messaging services, customers pay initial setup fees and regular
monthly, quarterly or annual subscriptions for the services they would like to be able to access.



Professional services. We offer a range of different services designed to help our customers make more effective use of our products and services, including installation, migration, training services and custom
engineering. Our licensed messaging and identity management software may require integration with customers existing infrastructure. In addition, our consultants offer expertise and experience in designing and delivering new services, features
and functions.



Maintenance and support services. We offer a variety of
software support and maintenance plans that enable customers of our licensed software to receive expedited technical support and access to new releases of our software. Most customers initially subscribe to these services when purchasing our
software and then renew their subscriptions on a regular basis.



We believe
that wireless carriers and service providers are increasingly seeking to offer more differentiated services and diversify into new markets. In addition, enterprises and government agencies are faced with similar needs to deliver a broader range of
information services while reducing the costs of operating such services and ensuring that privacy and security are maintained. We believe this provides a growth opportunity for the messaging and directory infrastructure market. However, the growth
of this market and our business is also faced with many challenges, including the emerging nature of the market, the demand for licensed solutions for messaging and identity management products and outsourced messaging services, rapid technological
change, competition and the recent decline in worldwide technology spending.



Restructuring Initiatives



We have operated at a loss since
our inception and as of June 30, 2005, we had an accumulated deficit of approximately $2.3 billion, which includes a $1.3 billion charge for impairment of goodwill and other long-lived assets that we recorded in fiscal year 2000. We have undertaken
numerous restructuring initiatives in an effort to align our operating structure not only to the business and economic environments through which we have operated but also in response to our changing business in an effort to generate net income. For
example:



| |  |  | During 2001, we evaluated our various products, services, facilities and the business plan under which we were operating. In connection with this review, we implemented and
substantially completed a strategic restructuring plan that involved reorganizing and refocusing our product and service offerings, a reduction in workforce and a facilities and operations consolidation. By the end of 2001, we had divested all of
the products and services deemed to be non-core to our continuing operations, reduced headcount by 44%, reduced the number of facilities by 65% and implemented other cost cutting measures, resulting in a significant reduction in overall operating
expenses.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During 2002, we restructured to reduce our expense levels to be consistent with the then current business climate and eliminated 39 positions and terminated additional leases.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During 2003, we continued our restructuring initiatives in an effort to further reduce our operating expense levels and reduce our long-term cash obligations. We further
consolidated office locations, restructured certain of our facility leases, reduced our global workforce by approximately 190 positions and outsourced certain positions and services to lower cost service providers.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | During 2004, we expanded our restructuring activities in an effort to reduce both short-term and long-term cash requirements by focusing our business on messaging solutions for
service providers. These activities included the reduction of fixed costs through the restructuring of contracts, consolidation of certain activities to offices in Toronto, Canada and Dublin, Ireland from higher cost areas such as the San Francisco
Bay area, the elimination of approximately 20% of our workforce and the reduced use of third party contractors. This effort began in August 2004 and continued into 2005.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During the first half of 2005, we recorded a restructuring charge totaling $1.8 million, of which, $1.3 million is related to the relocation of our headquarters facility as
discussed below and the balance is related to consolidation of data centers and the elimination of certain employee positions.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In September 2004, we received a non-binding notice from the landlord of our headquarters facility in San Francisco, California that the landlord had found a new tenant
for our offices located at 350 The Embarcadero per the landlords substitution right in the First Amendment to Lease between SRI Hills Plaza Venture, LLC and Critical Path, Inc. (the Amendment). On March 15, 2005, we received the Substitution Notice
from the landlord as required per the Amendment. In accordance with the Substitution Notice, we vacated our facilities at 350 The Embarcadero and moved into new office space provided at 2 Harrison Street on June 29, 2005. On May 5, 2005, we entered
into the Second Amendment to Lease with PPF Off 345 Spear Street, L.P., to amend the Lease dated as of November 16, 2001, as amended, under which we lease our headquarter facilities in San Francisco, California.



Under the terms of the second amendment, we moved into new office space at 2 Harrison Street,
2ndFloor, San Francisco, California and vacated our facility at 350 The Embarcadero on June 29, 2005. The new
office space into which we relocated is comprised of two suites consisting of approximately 22,881 square feet and will be leased for a term of five years, however; we have an early termination option whereby we can reduce the occupancy of the
premises to one of the two suites after 18 months. In connection with the second amendment, we made a lease termination payment totaling approximately $1.3 million related to the facility at 350 the Embarcadero during the three months ended June 30,
2005; however, the annual rent, on a cash basis, for our new headquarter facility will decline from approximately $2.5 million per year to less than approximately $0.7 million per year on average over the term of the lease.



In addition to these formal restructuring initiatives, we have sought to aggressively manage
our cost structure, identifying incremental savings where possible. We intend to continue to aggressively manage our expenses while maintaining strong service levels to our customers. At June 30, 2005, we had a $0.2 million liability related to our
restructuring activities, the majority of which we expect will be paid during 2005.



Critical Accounting Policies



There have been no material
changes to our critical accounting policies and estimates as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2004.



Liquidity and Capital Resources



We have focused on capital financing initiatives in order to maintain current and planned operations. We have operated at a loss since inception and our history of losses
from operations and cash flow deficits, in combination with our cash balances, raise concerns about our ability to fund our operations. Consequently, in 2003 and 2004 we secured additional funds through both debt and equity financing activities that
involved the sale of convertible notes and the completion of a rights offering. Most recently, in December 2004 we drew $11.0 million from an $18.0 million round of debt financing and in March 2005, we drew down the remaining $7.0 million. We are
not required to make any payments of principal or interest under this $18.0 million debt financing until maturity in December 2007. If we are unable to increase our revenues or if we are unable to reduce the amount of cash used by our operating
activities during 2005, we may be required to undertake additional restructuring alternatives, or seek additional



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debt financing although our ability to incur additional indebtedness is subject to certain limitations as discussed in the section below captioned
Ability to incur additional indebtedness. Additionally, on April 12, 2005, the Nasdaq Stock Market Inc. (Nasdaq) issued us notice that we were not in compliance with the minimum closing bid price requirement. On June 7, 2005, we
received notice from Nasdaq that we were not in compliance with the minimum market value requirement. As a result of these notices, we are faced with delisting proceedings. We must regain compliance with these Nasdaq rules by September 6, 2005 in
the case of the minimum market value requirement and by October 10, 2005 in the case of the minimum closing bid price requirement, or our common stock will be de-listed from the Nasdaq National Market. If we are delisted from the Nasdaq National
Market, we will apply to be listed on the Nasdaq Small Cap Market, and if we fail to qualify for listing on this market, our common stock will trade on the Over-the-Counter (OTC) Bulletin Board. Even if we are able to regain compliance for the
Nasdaq National Market, these notices and potential movement to a new exchange may also impact our ability to raise additional capital if needed. We do not believe equity financing on terms reasonably acceptable is currently available.



The following table sets forth our net losses attributable to common shareholders and the
cash used to support our operating activities for the periods indicated:



|                                             |  |                            |         |   |        |   |        |                          |  |   |        |  |      |   |  |      |         |   |   |   |         |   |  |   |        |  |     |  
|-------------------------------------------- |  | -------------------------- | ------- | - | ------ | - | ------ | ------------------------ |  | - | ------ |  | ---- | - |  | ---- | ------- | - | - | - | ------- | - |  | - | ------ |  | --- | -
|                                             |  | Three months endedJune 30, |         |   | Change |   |        | Six months endedJune 30, |  |   | Change | 
|                                             |  |                            |         |  
|                                             |  | 2004                       |         |   | 2005   |   |        | $                        |  | % |        |  | 2004 |   |  | 2005 |         |   | $ |   | %       |  
|                                             |  | (in thousands)             |        
|Net loss attributable to common shareholders |  | $                          | (12,424 | ) |        | $ | (8,053 | )                        |  | $ | 4,371  |  | -35  | % |  | $    | (25,555 | ) |   | $ | (20,699 | ) |  | $ | 4,856  |  | -19 | %
|Net cash used by operating activities        |  |                            | (12,765 | ) |        |   | (6,367 | )                        |  |   | 6,398  |  | -50  | % |  |      | (22,079 | ) |   |   | (7,987  | ) |  |   | 14,092 |  | -64 | %



With our history of operating losses
and cash used to support our operating activities, our primary sources of capital have come from both debt and equity financings that we have completed over the past several years. Our principal sources of liquidity include our cash and cash
equivalents. As of June 30, 2005, we had cash and cash equivalents available for operations totaling $17.0 million, of which $8.2 million was located in accounts outside the United States and which is not readily available for our domestic
operations. However, we intend to pursue the investigation of restructuring our foreign subsidiaries which, if successful, may provide us easier access to the repatriation of a greater portion of the cash located in accounts outside the United
States. Additionally, we are currently evaluating the newly enacted American Jobs Creation Act of 2004 (the AJCA) and are not yet in a position to decide whether, or to what extent, the AJCA will enable us to repatriate foreign earnings that have
not yet been remitted to the United States. Accordingly, our readily available cash resources in the United States as of June 30, 2005 were $8.8 million. As of June 30, 2005, we had $0.3 million of cash classified on our balance sheet as restricted
cash which is primarily related to cash collateralized letters of credit primarily related to facility leases. This cash is not readily available for operations.



Based on our recent financing activities, cash expected to be generated from operations and recent restructure activities we believe that
there is sufficient cash to meet cash operating requirements for the next 12 months as well as the on-going investments in capital equipment to support our research and development efforts and hosted data center expansion plans. For the long-term,
we believe that our operating activities will be able to provide the liquidity and capital resources sufficient to support our business. At June 30, 2005, we had no borrowings under our credit facility with Silicon Valley Bank because the borrowing
availability had been eliminated and we were required to cash collateralize the Companys letters of credit related to facility leases which total approximately $0.3 million.



Cash and cash equivalents



The following table sets forth our cash and cash equivalents balance as of the dates indicated:



|                          |  |                  |        |              |   |        |   |   |        |   |  |     |  
|------------------------- |  | ---------------- | ------ | ------------ | - | ------ | - | - | ------ | - |  | --- | -
|                          |  | December 31,2004 |        | June 30,2005 |   | Change |  
|                          |  |                  |        | $            |   |        | % |  
|                          |  | (in thousands)   |        |              |   |       
|Cash and cash equivalents |  | $                | 23,239 |              | $ | 16,857 |   | $ | (6,382 | ) |  | -27 | %



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Total cash and cash equivalents decreased primarily as a result of the cash used to support our operating activities
partially offset by cash provided by both our investing and financing activities as set forth in the table below (in thousands):



|                                                      |  |   |        |  
|----------------------------------------------------- |  | - | ------ | -
|Beginning balance at December 31, 2004                |  | $ | 23,239 |  
|                                                      | 
|Net cash used by operating activities                 |  |   | (7,987 | )
|Net cash provided by investing activities             |  |   | 1,803  |  
|Net cash provided by financing activities             |  |   | 750    |  
|                                                      |  |   |        |  
|Net increase in cash and cash equivalents             |  |   | (5,434 | )
|Effect of exchange rates on cash and cash equivalents |  |   | (948   | )
|                                                      |  |   |        |  
|Ending balance at June 30, 2005                       |  | $ | 16,857 |  
|                                                      |  |   |        |  



Net cash used by operating
activities. Our operating activities used $8.0 million of cash during the six months ended June 30, 2005. This cash was used to support our net loss of $8.9 million, adjusted for non-cash items, including: depreciation and amortization of
$5.4 million, decreases in the fair value of a preferred stock instrument of ($2.9) million and stock-based expenses of $0.6 million as well as a $2.0 million increase in accounts receivable, a $4.6 million decrease in accrued liabilities partially
offset by a $2.6 million increase in deferred revenue.



Our primary source of
operating cash flow is the collection of accounts receivable from our customers and the timing of payments to our vendors and service providers. We measure the effectiveness of our collections efforts by an analysis of the average number of days our
accounts receivable are outstanding, or DSOs. The following table sets forth our accounts receivable balances and DSOs as of the dates indicated:



|                         |  |                        |        |              |   |        |   |   |    |   |  |    |  
|------------------------ |  | ---------------------- | ------ | ------------ | - | ------ | - | - | -- | - |  | -- | -
|                         |  | December 31,2004       |        | June 30,2005 |   | Change |  
|                         |  |                        |        | $            |   |        | % |  
|                         |  | (dollars in thousands) |        |              |   |       
|Accounts receivable, net |  | $                      | 19,667 |              | $ | 19,661 |   | $ | (6 | ) |  | 0  | %
|DSOs (days) (a)          |  |                        | 91     |              |   | 103    |   |   | 12 |   |  | 13 | %

---

|(a) | DSOs equal accounts receivable, net, divided by the quotient of revenues divided by 90.
|--- | ---------------------------------------------------------------------------------------



Accounts receivable balances remained relatively unchanged primarily as a result of a decrease in the value of the Euro against the U.S.
dollar from December 31, 2004 to June 30, 2005 which was offset by an increase in foreign currency denominated accounts receivable outstanding. DSOs increased primarily as a result of slower collections in Europe and an increase in maintenance
billings at the end of the quarter (for which revenue will be recognized in future periods). We believe that our DSOs at June 30, 2005 are slightly higher than industry norms and will be an area of management focus for improvement during the third
quarter of 2005.



Our accrued liabilities decreased $4.6 million during the six
months ended June 30, 2005 primarily as a result of liabilities we have paid that were accrued for at December 31, 2004, declining cost of net revenues and operating expenses and a decline in the value of our foreign currency denominated accrued
liabilities primarily as a result of the decline in the value of the Euro against the U.S. dollar. Deferred revenue has increased during the six months ended June 30, 2005 primarily as a result of the



Page 22



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deferral of revenue from sales of our Memova Anti-Abuse offerings during the six months ended June 30, 2005 due to the term nature of the end user licenses
underlying offering which was partially offset by a decline in the value of our foreign currency denominated deferred revenue primarily as a result of the decline in the value of the Euro against the U.S. dollar.



A number of non-cash items, such as: depreciation and amortization, stock-based expenses,
accretion related to our preferred stock and certain restructuring charges have been charged to expense and impacted our net losses during the three and six months ended June 30, 2005. To the extent these non-cash items increase or decrease in
amount and increase or decrease our future operating results, there will be no corresponding impact on our cash flows. Our operating cash flows will be impacted in the future based on our operating results, our ability to collect our accounts
receivable on an efficient basis, and the timing of payments to our vendors for accounts payable.



We face restrictions on our ability to use cash held outside of the United States for purposes other than the operation of each of our respective foreign subsidiaries that hold that cash. For example, our ability to
use cash held in a given European subsidiary for any reason other than the operation of such subsidiary may be subject to local laws that could prevent the transfer of cash from Europe to any other foreign or domestic account. Additionally, we are
exposed to foreign currency exchange rate risk inherent in our sales commitments, anticipated sales, contracts with vendors, and working capital, as a significant portion or our worldwide operations have a functional currency other than the United
States dollar. The impact of future exchange rate fluctuations cannot be predicted adequately. To date, we have not sought to hedge the risks associated with fluctuations in exchange rates.



Revenue generated from the sale of our products and services may not increase to a level that
exceeds our expenses or could fluctuate significantly as a result of changes in customer demand or acceptance of future products. Although we expect to continue to review our operating expenses, if we are not successful in achieving a cost reduction
or generating sufficient revenues, our cash flow from operations will continue to be negatively impacted.



Net cash used by investing activities. Our investing activities provided $1.8 million of cash during the six months ended June 30, 2005 primarily as a result of the release of restricted cash which
collateralized the letter of credit for our facility at 350 The Embarcadero in San Francisco. The cash provided from the release of this letter of credit was partially offset by purchases of equipment primarily used to support the hosted messaging
operations infrastructure and research and development efforts. We will be required to continue to make investments in capital equipment during 2005 to support our on-going research and development efforts and hosted data center expansion plans. We
expect to fund these purchases through the use of our available cash resources and through leasing arrangements, if available, on terms we find acceptable.



Cash provided by financing activities. Our financing activities provided $0.8 million of cash during the six months ended June 30, 2005 primarily as a
result of the $7.0 million we drew in March 2005 from the $18.0 million round of debt financing we closed in December 2004 partially offset by the cash used to retire our outstanding 53/4% Convertible Subordinated Notes and payments of capital leases.



Ability to incur additional indebtedness



Under the terms of our line of credit, we are required to obtain the consent of Silicon Valley Bank to incur additional indebtedness. Additionally, subject to limited
exceptions, we must seek the consent of our investors in order to incur any additional indebtedness.



We have no present understandings, commitments or agreements for any material acquisitions of, or investments in, other complementary businesses, products or technologies. We continually evaluate potential
acquisitions of, or investments in, other businesses, products and technologies, and may in the future utilize our cash resources or may require additional equity or debt financing to accomplish any acquisitions or investments. These alternatives
could increase liquidity through the infusion of investment capital by third-party investors or decrease our liquidity as a result of Critical Path seeking to fund expansion into these markets. Such expansions might also cause an increase in capital
expenditures and operating expenses.



Page 23



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Contractual Obligations and Commitments



The table below sets forth our significant cash obligations and commitments as of June 30, 2005.



|                                     |  |                |         |                                 |   |       |  |      |       |      |   |        |  |            |         |  |   |       |  |   |      
|------------------------------------ |  | -------------- | ------- | ------------------------------- | - | ----- |  | ---- | ----- | ---- | - | ------ |  | ---------- | ------- |  | - | ----- |  | - | -----
|                                     |  |                |         | Fiscal years ended December 31,
|                                     |  | Total          |         | Remaining 6 months2005          |   | 2006  |  | 2007 |       | 2008 |   | 2009   |  | Thereafter
|                                     |  | (in thousands)
|13.9% Notes                          |  | $              | 26,792  |                                 | $ |      |  | $    |      |      | $ | 26,792 |  | $          |        |  | $ |      |  | $ |     
|Mandatory redeemable preferred stock |  |                | 166,392 |                                 |   |      |  |      |      |      |   |       |  |            | 166,392 |  |   |      |  |   |     
|Operating lease obligations          |  |                | 10,097  |                                 |   | 1,389 |  |      | 2,173 |      |   | 1,531  |  |            | 1,285   |  |   | 1,194 |  |   | 2,525
|Capital lease obligations            |  |                | 362     |                                 |   | 257   |  |      | 87    |      |   | 18     |  |            |        |  |   |      |  |   |     
|Other purchase obligations (1)       |  |                | 2,343   |                                 |   | 1,017 |  |      | 1,136 |      |   | 190    |  |            |        |  |   |      |  |   |     
|                                     |  |                |         |                                 |   |       |  |      |       |      |   |        |  |            |         |  |   |       |  |   |      
|Total Contractual Cash Obligations   |  | $              | 205,986 |                                 | $ | 2,663 |  | $    | 3,396 |      | $ | 28,531 |  | $          | 167,677 |  | $ | 1,194 |  | $ | 2,525
|                                     |  |                |         |                                 |   |       |  |      |       |      |   |        |  |            |         |  |   |       |  |   |      

---

|(1) | Represent certain contractual obligations related to licensed software, maintenance contracts and network infrastructure storage costs.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------



Results of Operations



In view of the rapidly evolving nature of our business, prior acquisitions, organizational restructuring, and limited operating history, we
believe that period over period comparisons of revenues and operating results, including gross profit margin and operating expenses as a percentage of total net revenues, are not meaningful and should not be relied upon as indications of future
performance. We do not believe that our historical fluctuations in revenues, expenses or personnel are indicative of future results.



Page 24



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The following table sets forth our results of operations for the three and six months ended June 30, 2004 and 2005.



|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|-------------------------------------------------------------------------- |  | ---------------------------------------- | ------- | - | ------ | - | ------ | ------------------------- |  | - | ------ | - |  | ---- | - |  | ---- | ------- | - | - | - | ------- | - |  | - | ------ | - |  | ---- | -
|                                                                           |  | Three months ended June 30,              |         |   | Change |   |        | Six months ended June 30, |  |   | Change |  
|                                                                           |  |                                          |         |  
|                                                                           |  | 2004                                     |         |   | 2005   |   |        | $                         |  |   | %      |   |  | 2004 |   |  | 2005 |         |   | $ |   |         | % | 
|                                                                           |  | (in thousands, except per share amounts) |        
|NET REVENUE                                                                |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|Software licensing                                                         |  | $                                        | 5,407   |   |        | $ | 4,771  |                           |  | $ | (636   | ) |  | -12  | % |  | $    | 9,658   |   |   | $ | 9,216   |   |  | $ | (442   | ) |  | -5   | %
|Hosted messaging                                                           |  |                                          | 3,711   |   |        |   | 3,528  |                           |  |   | (183   | ) |  | -5   | % |  |      | 8,054   |   |   |   | 8,739   |   |  |   | 685    |   |  | 9    | %
|Professional services                                                      |  |                                          | 2,936   |   |        |   | 3,727  |                           |  |   | 791    |   |  | 27   | % |  |      | 5,595   |   |   |   | 6,811   |   |  |   | 1,216  |   |  | 22   | %
|Maintenance and support                                                    |  |                                          | 4,962   |   |        |   | 5,083  |                           |  |   | 121    |   |  | 2    | % |  |      | 10,787  |   |   |   | 9,783   |   |  |   | (1,004 | ) |  | -9   | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|Total net revenue                                                          |  |                                          | 17,016  |   |        |   | 17,109 |                           |  |   | 93     |   |  | 1    | % |  |      | 34,094  |   |   |   | 34,549  |   |  |   | 455    |   |  | 1    | %
|                                                                           |  |                                          |         |   |        |   |        |                          
|COST OF NET REVENUE                                                        |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|Software licensing                                                         |  |                                          | 1,708   |   |        |   | 1,035  |                           |  |   | (673   | ) |  | -39  | % |  |      | 2,619   |   |   |   | 2,243   |   |  |   | (376   | ) |  | -14  | %
|Hosted messaging                                                           |  |                                          | 6,570   |   |        |   | 3,766  |                           |  |   | (2,804 | ) |  | -43  | % |  |      | 12,951  |   |   |   | 8,890   |   |  |   | (4,061 | ) |  | -31  | %
|Professional services                                                      |  |                                          | 3,034   |   |        |   | 2,318  |                           |  |   | (716   | ) |  | -24  | % |  |      | 6,128   |   |   |   | 4,722   |   |  |   | (1,406 | ) |  | -23  | %
|Maintenance and support                                                    |  |                                          | 1,322   |   |        |   | 1,550  |                           |  |   | 228    |   |  | 17   | % |  |      | 2,771   |   |   |   | 3,100   |   |  |   | 329    |   |  | 12   | %
|Stock-based expense                                                        |  |                                          |        |   |        |   | 43     |                           |  |   | 58     |   |  | 0    | % |  |      | 5       |   |   |   | 107     |   |  |   | 58     |   |  | 1160 | %
|Restructuring and other expenses                                           |  |                                          | 175     |   |        |   |       |                           |  |   | (175   | ) |  | -100 | % |  |      | 175     |   |   |   |        |   |  |   | (175   | ) |  | -100 | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|Total cost of net revenue                                                  |  |                                          | 12,809  |   |        |   | 8,712  |                           |  |   | (4,097 | ) |  | -32  | % |  |      | 24,649  |   |   |   | 19,062  |   |  |   | (5,587 | ) |  | -23  | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|GROSS PROFIT                                                               |  |                                          | 4,207   |   |        |   | 8,397  |                           |  |   | 4,190  |   |  | 100  | % |  |      | 9,445   |   |   |   | 15,487  |   |  |   | 6,042  |   |  | 64   | %
|                                                                           |  |                                          |         |   |        |   |        |                          
|OPERATING EXPENSES                                                         |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|Selling and marketing                                                      |  |                                          | 6,035   |   |        |   | 3,926  |                           |  |   | (2,109 | ) |  | -35  | % |  |      | 12,974  |   |   |   | 8,573   |   |  |   | (4,401 | ) |  | -34  | %
|Research and development                                                   |  |                                          | 5,344   |   |        |   | 3,644  |                           |  |   | (1,700 | ) |  | -32  | % |  |      | 11,123  |   |   |   | 8,537   |   |  |   | (2,586 | ) |  | -23  | %
|General and administrative                                                 |  |                                          | 3,771   |   |        |   | 3,356  |                           |  |   | (415   | ) |  | -11  | % |  |      | 6,890   |   |   |   | 7,270   |   |  |   | 380    |   |  | 6    | %
|Stock-based expense                                                        |  |                                          | 1,212   |   |        |   | 212    |                           |  |   | (1,000 | ) |  | -83  | % |  |      | 1,253   |   |   |   | 456     |   |  |   | (797   | ) |  | -64  | %
|Restructuring expense                                                      |  |                                          | 1,144   |   |        |   | 168    |                           |  |   | (976   | ) |  | -85  | % |  |      | 2,209   |   |   |   | 1,807   |   |  |   | (402   | ) |  | -18  | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|Total operating expenses                                                   |  |                                          | 17,506  |   |        |   | 11,306 |                           |  |   | (6,200 | ) |  | -35  | % |  |      | 34,449  |   |   |   | 26,643  |   |  |   | (7,806 | ) |  | -23  | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|OPERATING LOSS                                                             |  |                                          | (13,299 | ) |        |   | (2,909 | )                         |  |   | 10,390 |   |  | -78  | % |  |      | (25,004 | ) |   |   | (11,156 | ) |  |   | 13,848 |   |  | -55  | %
|Other income (expense), net                                                |  |                                          | 6,733   |   |        |   | 2,395  |                           |  |   | (4,338 | ) |  | -64  | % |  |      | 10,400  |   |   |   | 4,241   |   |  |   | (6,159 | ) |  | -59  | %
|Interest income (expense), net                                             |  |                                          | (2,065  | ) |        |   | (907   | )                         |  |   | 1,158  |   |  | -56  | % |  |      | (3,645  | ) |   |   | (1,567  | ) |  |   | 2,078  |   |  | -57  | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|Loss before provision for income taxes                                     |  |                                          | (8,631  | ) |        |   | (1,421 | )                         |  |   | 7,210  |   |  | -84  | % |  |      | (18,249 | ) |   |   | (8,482  | ) |  |   | 9,767  |   |  | -54  | %
|Provision for income taxes                                                 |  |                                          | (445    | ) |        |   | (116   | )                         |  |   | 329    |   |  | -74  | % |  |      | (811    | ) |   |   | (424    | ) |  |   | 387    |   |  | -48  | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|NET LOSS                                                                   |  |                                          | (9,076  | ) |        |   | (1,537 | )                         |  |   | 7,539  |   |  | -83  | % |  |      | (19,060 | ) |   |   | (8,906  | ) |  |   | 10,154 |   |  | -53  | %
|Accretion on mandatorily redeemable preferred stock                        |  |                                          | (3,348  | ) |        |   | (6,516 | )                         |  |   | (3,168 | ) |  | 95   | % |  |      | (6,495  | ) |   |   | (11,793 | ) |  |   | (5,298 | ) |  | 82   | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS                               |  | $                                        | (12,424 | ) |        | $ | (8,053 | )                         |  | $ | 4,371  |   |  | -35  | % |  | $    | (25,555 | ) |   | $ | (20,699 | ) |  | $ | 4,856  |   |  | -19  | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|Net loss per share attributable to common shareholders - basic and diluted |  | $                                        | (0.59   | ) |        | $ | (0.27  | )                         |  | $ | 0.31   |   |  | -53  | % |  | $    | (1.21   | ) |   | $ | (0.73   | ) |  | $ | 0.48   |   |  | -40  | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  
|Weighted average shares - basic and diluted                                |  |                                          | 21,157  |   |        |   | 29,369 |                           |  |   | 8,212  |   |  | 39   | % |  |      | 21,074  |   |   |   | 28,361  |   |  |   | 7,287  |   |  | 35   | %
|                                                                           |  |                                          |         |   |        |   |        |                           |  |   |        |   |  |      |   |  |      |         |   |   |   |         |   |  |   |        |   |  |      |  



NET REVENUE



Total net revenues increased slightly during the three months ended June 30, 2005 as
compared to the three months ended June 30, 2004 primarily as a result of increased revenue from our professional services, which was partially offset by decreased revenue from our software licenses. Total net revenues increased during the six
months ended June 30, 2005 as compared to the six months ended June 30, 2004 primarily as a result of increased revenue from our professional services and hosted messaging solutions, which was partially offset by decreased revenue from our
maintenance and support services and our software licenses. International revenues, primarily from Europe, increased during the three and six months ended June 30, 2005 as compared to the three and six months ended June 30, 2004 which were partially
offset by decreased revenues from North America during the same periods.



| |  |  | Software licensing. Software license revenue decreased during the three months ended June 30, 2005 as compared to the three months ended June 30, 2004 primarily due to
(i) decreased license sales of our identity management and messaging server software, which are marketed as components of our Memova Messaging offering, and (ii) decreased license sales of certain third party software we resell. These
decreases were partially offset by increased revenue from our recently introduced Memova Anti-Abuse offering. We believe the decrease in revenue from license sales of the third-party anti-virus and anti-spam software is a result of customers
replacing such software with our Memova Anti-Abuse solution.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Page 25



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For the six months ended June 30, 2005, software license revenue decreased as compared to the six months
ended June 30, 2004 due to decreased license sales of our identity management and messaging server software partially offset by increased revenue from the sale of our Memova Anti-Abuse offering and the third party software we resell.



| |  |  | Hosted messaging. Hosted messaging revenue decreased approximately 5%, or $0.2 million, during the three months ended June 30, 2005 as compared to the three months
ended June 30, 2004 primarily as a result of contract terminations by customers. Hosted messaging revenue increased during the six months ended June 30, 2005 as compared to the six months ended June 30, 2004 primarily as a result of revenue
recognized from our hosted messaging service with T-Mobile in 2005 until expiration of the contract on March 31, 2005. While these services were being provided to T-Mobile during the three and six months ended June 30, 2004, we had not received
final acceptance from T-Mobile on the installation of the service and therefore did not recognize any revenue from T-Mobile during such periods.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Professional services. Professional services revenue increased during the three and six months ended June 30, 2005 as compared to the three and six months ended June
30, 2004 primarily as a result of increased revenue from services projects in Europe and delivery of previously developed professional service solutions during the three and six months ended June 30, 2005. During the six months ended June 30, 2005,
one client accounted for approximately 22% of professional services revenue; however, as this project is nearing completion we expect a small decline in professional services revenue during the three months ended June 30, 2005.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Maintenance and support. Maintenance and support revenue increased slightly during the three months ended June 30, 2005 as compared to the three months ended June 30,
2004. Maintenance and support revenue decreased during the six months ended June 30, 2005 as compared to the six months ended June 30, 2004 primarily due to late renewals of and the associated catch-up of revenue from support contracts in North
America primarily in the three months ended March 31, 2004 that did not recur during the three months ended March 31, 2005.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



During the three months ended June 30, 2005, we had one customer which accounted for 13% of our total revenue.



The following table sets forth our total revenues and percent of revenue by region for the
three and six months ended June 30, 2004 and 2005:



|                       |  |                             |        |  |        |   |      |                           |        |  |        |   |  |   |      |   |  |      |   |  |   |        |      |     |   |  |   |        |  |     |   |  |   |        |   |  |     |  
|---------------------- |  | --------------------------- | ------ |  | ------ | - | ---- | ------------------------- | ------ |  | ------ | - |  | - | ---- | - |  | ---- | - |  | - | ------ | ---- | --- | - |  | - | ------ |  | --- | - |  | - | ------ | - |  | --- | -
|                       |  | Three months ended June 30, |        |  | Change |   |      | Six months ended June 30, |        |  | Change |  
|                       |  | 2004                        |        |  |        |   | 2005 |                           |        |  |        | $ |  |   | %    |   |  | 2004 |   |  |   |        | 2005 |     |   |  |   | $      |  |     | % | 
|                       |  | (in thousands)              |       
|North America          |  | $                           | 5,237  |  | 31     | % |      | $                         | 4,547  |  | 27     | % |  | $ | (690 | ) |  | -13  | % |  | $ | 11,463 |      | 34  | % |  | $ | 8,627  |  | 25  | % |  | $ | (2,836 | ) |  | -25 | %
|Europe                 |  |                             | 11,064 |  | 65     | % |      |                           | 11,982 |  | 70     | % |  |   | 918  |   |  | 8    | % |  |   | 20,904 |      | 61  | % |  |   | 24,590 |  | 71  | % |  |   | 3,686  |   |  | 18  | %
|Latin America          |  |                             | 287    |  | 2      | % |      |                           | 273    |  | 2      | % |  |   | (14  | ) |  | -5   | % |  |   | 684    |      | 2   | % |  |   | 526    |  | 2   | % |  |   | (158   | ) |  | -23 | %
|Asia pacific           |  |                             | 429    |  | 3      | % |      |                           | 307    |  | 2      | % |  |   | (122 | ) |  | -28  | % |  |   | 1,042  |      | 3   | % |  |   | 806    |  | 2   | % |  |   | (236   | ) |  | -23 | %
|                       |  |                             |        |  |        |   |      |                           |        |  |        |   |  |   |      |   |  |      |   |  |   |        |      |     |   |  |   |        |  |     |   |  |   |        |   |  |     |  
|Subtotal international |  |                             | 11,780 |  | 69     | % |      |                           | 12,562 |  | 73     | % |  |   | 782  |   |  | 7    | % |  |   | 22,630 |      | 66  | % |  |   | 25,922 |  | 75  | % |  |   | 3,292  |   |  | 15  | %
|                       |  |                             |        |  |        |   |      |                           |        |  |        |   |  |   |      |   |  |      |   |  |   |        |      |     |   |  |   |        |  |     |   |  |   |        |   |  |     |  
|                       |  | $                           | 17,017 |  | 100    | % |      | $                         | 17,109 |  | 100    | % |  | $ | 92   |   |  | 1    | % |  | $ | 34,093 |      | 100 | % |  | $ | 34,549 |  | 100 | % |  | $ | 456    |   |  | 1   | %
|                       |  |                             |        |  |        |   |      |                           |        |  |        |   |  |   |      |   |  |      |   |  |   |        |      |     |   |  |   |        |  |     |   |  |   |        |   |  |     |  



International revenues increased in
total and as a proportion of our total revenue for the three and six months ended June 30, 2005 primarily due to growing demand within our existing European customer base and revenue recognized from our hosted messaging services. Revenue in North
America decreased in total and as a proportion of our total revenue for the three and six months



Page 26



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ended June 30, 2005 primarily due to decreased sales of hosted messaging services as a result of customers terminating or reducing their hosted messaging
services with us as discussed above as well as decreased maintenance and support revenues.



COST OF NET REVENUE AND GROSS MARGIN



Cost of
net revenue decreased for the three and six months ended June 30, 2005 as compared to the three and six months ended June 30, 2004 primarily as a result of reduced hosted messaging, software licensing and professional services costs.



| |  |  | Software licensing. Software license cost of revenue consists primarily of third-party royalty costs. Software license cost of revenues decreased during the three and
six months ended June 30, 2005 as compared to the three and six months ended June 30, 2004 primarily due to an increased proportion of revenue from our lower cost Memova Anti-Abuse products which is replacing sales of the lower margin third party
products which we resell.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Hosted messaging. Hosted messaging cost of revenue consists primarily of costs incurred in the delivery and support of hosted messaging services, including employee
related costs, depreciation and amortization expenses, Internet co-location and connection fees, hardware maintenance costs as well as other direct and allocated costs. Hosted messaging costs decreased during the three and six months ended June 30,
2005 as compared to the three and six months ended June 30, 2004 primarily due to decreased outsourcing and equipment rental costs partially offset by increased employee related costs as a result of the transition to performing our hosted services
in-house rather than being outsourced, which was one of the restructuring activities undertaken in 2004 and which continued into the first half of 2005. This net decrease was also partially offset by recognition of $0.6 million of previously
deferred costs recognized during the three months ended March 31, 2005 related to our hosted messaging service with T-Mobile (there were no deferred costs recognized related to T-Mobile during the three or six months ended June 30, 2004).
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Professional services. Professional services cost of revenue consists primarily of employee related and third party contractor costs providing installation, migration,
training services and custom engineering for both our hosted messaging and licensed solutions as well as other direct and allocated costs. Professional services costs decreased for the three and six months ended June 30, 2005 as compared to the
three and six months ended June 30, 2004 primarily due to a decrease in the use of third-party contractors as a result of improved utilization of our internal consultants, and a decrease in employee related costs as a result of our restructure
activities during 2004.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Maintenance and support. Maintenance and support cost of revenues consists primarily of employee related and third party contractor costs related to the customer
support functions for both our hosted messaging and licensed solutions as well as other direct and allocated costs. Maintenance and support costs increased during the three and six months ended June 30, 2005 as compared to the three and six months
ended June 30, 2004 primarily due to an increase in employee related costs.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stock-based expense. Stock-based expense represents the charges recorded in connection with modifications made to employee stock option plans, stock option grants to
non-employee contractors and warrants issued to third parties as well as amortization of restricted stock-based compensation given to employees. Stock-based expenses increased during the three and six months ended June 30, 2005 as compared to the
three and six months ended June 30, 2004 primarily as a result of increased amortization of costs related to grants of restricted stock to certain employees during the latter half of 2004.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our total gross margin, which is gross profit divided by total net revenue, increased to 49%
for the three months ended June 30, 2005 from 25% for the three months ended June 30, 2004. Total gross margin for



Page 27



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the six months ended June 30, 2005 increased to 45% from 28% for the six months ended June 30, 2004. These increases are primarily due to the decrease in our
net cost of revenue and the increase in our net revenue as discussed above.



OPERATING EXPENSES



Total operating expenses decreased primarily due
to reduced selling and marketing, research and development expenses, general and administrative, stock-based expenses and restructuring expenses.



| |  |  | Sales and marketing. Sales and marketing expense consist primarily of employee costs, including commissions, as well as travel and entertainment, third party
contractor costs, advertising, public relations, other marketing related costs as well as other direct and allocated costs. Sales and marketing expenses decreased during the three and six months ended June 30, 2005 as compared to the three and six
months ended June 30, 2004, primarily as a result of our restructuring activities in 2004.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



During the three months ended June 30, 2005, employee-related expenses decreased $1.3 million and travel and entertainment expenses decreased $0.2 million
as compared to the three months ended June 30, 2004 primarily as a result of the termination of employees through our restructure activities. Our sales and marketing staff decreased by 31 employees to an average of 48 employees for the three months
ended June 30, 2005 from an average of 79 employees for the three months ended June 30, 2004. Additionally, facility related costs decreased $0.2 million and third-party contractor expenses decreased $0.1 million during the three months ended June
30, 2005 as compared to the three months ended June 30, 2004.



During the six months ended June 30, 2005, employee-related expenses decreased $2.7 million and travel and entertainment expenses decreased $0.4 million primarily as a result of the termination of employees through our restructure
activities. Our sales and marketing staff decreased by 29 employees to an average of 52 employees for the six months ended June 30, 2005 from an average of 81 employees for the six months ended June 30, 2004. Additionally, facility related costs
decreased $0.4 million and third-party contractor expenses decreased $0.3 million during the six months ended June 30, 2005 as compared to the six months ended June 30, 2004.



While our sales and marketing staff has decreased year over year, we are currently expecting to increase our sales and
marketing staff in certain key regions to support sales of our new Memova consumer offerings.



| |  |  | Research and development. Research and development expense consist primarily of employee related costs, depreciation and amortization of capital equipment associated
with research and development activities, facility related costs, third-party contractor costs as well as other direct and allocated costs.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Research and development expenses decreased during the three months ended June 30, 2005 as compared to the three months ended June 30, 2004 primarily as a
result of a $1.0 million decrease in employee-related expenses and a decrease of $0.3 million in third party contractor costs, primarily as a result of our restructure activities which focused our development efforts on our core messaging products.
Our research and development staff decreased by 49 employees, most of whom were related to development of non-core solutions, to an average of 84 employees for the three months ended June 30, 2005 from an average of 133 employees for the three
months ended June 30, 2004.



Research and development expenses
decreased during the six months ended June 30, 2005 as compared to the six months ended June 30, 2004 primarily as a result of a $1.8 million decrease in employee related expenses and a decrease of $1.0 million in third party contractor costs,
primarily as a result of our restructure activities which focused our development efforts on our core messaging products. Our research and development staff decreased by 45 employees, most of whom were related to development of non-core solutions,
to an average of 89 employees for the six months ended June 30, 2005 from an average of 134 employees for the six months ended June 30, 2004. During the six months ended June 30, 2005, these decreases were partially offset by an increase of $0.5
million in depreciation expenses primarily as a result of the acceleration of depreciation on certain assets related to a messaging provisioning platform after it was determined the assets would be taken out of service before the end of their
originally estimated useful life.



We are considering
increasing our investment in research and development related to our Memova consumer offerings.



Page 28



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| |  |  | General and administrative. General and administrative expense consist primarily of employee-related costs, fees for outside professional services, insurance and other
direct and allocated indirect costs. General and administrative expenses decreased during the three months ended June 30, 2005 as compared to the three months ended June 30, 2004 primarily due to an accrual for past-due state and local business
related taxes of $0.9 million and one-time charges of $0.6 million recorded in connection with the severance agreement with our former chief executive officer during 2004 which did not reoccur in 2005, partially offset by a $0.3 million increase in
accounting related fees related to our Sarbanes-Oxley 404 compliance project, a $0.5 million increase in facility related allocations and a $0.3 million increase in legal related expenses. General and administrative staff decreased by 1 employee to
an average of 55 employees for the three months ended June 30, 2005 from an average of 56 employees for the three months ended June 30, 2004.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



General and administrative expenses increased during the six months ended June 30, 2005 as compared to the six months ended June 30, 2004, primarily due
to a $1.4 million increase in accounting related fees related to our Sarbanes-Oxley 404 compliance project and a $0.8 million increase in facility related allocations partially offset by a $0.3 million decrease in employee related costs, the state
and local business related taxes and the one-time severance charge in 2004 as mentioned above. General and administrative staff decreased by 3 employees to an average of 54 employees for the six months ended June 30, 2005 from an average of 57
employees for the six months ended June 30, 2004.



Included in
general and administrative expenses are costs related to the initial implementation and compliance with the requirements of Sarbanes-Oxley 404 (section 404) for the fiscal year ended December 31, 2004. Excluding our own time and resources, our
initial costs to comply with section 404, excluding costs related to the audit of our financial statements, were approximately $2.1 million. For the fiscal year ended December 31, 2004, the total external costs of compliance with section 404 and our
financial statement audit totaled approximately $3.0 million as compared to approximately $0.6 million for 2003. The 2004 external costs of compliance were incurred primarily in the last half of 2004 and the first half of 2005. As a result of our
on-going compliance with section 404 and remediation of material weaknesses and significant deficiencies resulting from our initial compliance efforts, we expect that general and administrative expenses will increase in future periods.



| |  |  | Stock-based expense. Stock-based expense represents the charges recorded in connection with modifications made to employee stock option plans, stock option grants to
non-employee contractors and warrants issued to third parties as well as amortization of certain stock-based compensation given to employees. Stock-based expenses for the three and six months ended June 30, 2005 decreased primarily as a result of
the one-time charges we recorded in connection with the severance agreement between us and our former chief executive officer which happened in 2004 but it did not reoccur in 2005.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Restructuring expense. Restructuring expense consists primarily of costs associated with employee severance benefits, the consolidation of facilities and operations
and exiting from the sale of non-core products as a result of our restructuring actions. The following table provides additional information with respect to the types of restructuring charges included in our operating expenses for the periods
indicated.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Page 29



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|                                       |  |                             |       |        |   |     |                           |   |        |   |  |      |   |      |   |       |  |   |       |  |   |        |   |  |     |  
|-------------------------------------- |  | --------------------------- | ----- | ------ | - | --- | ------------------------- | - | ------ | - |  | ---- | - | ---- | - | ----- |  | - | ----- |  | - | ------ | - |  | --- | -
|                                       |  | Three months ended June 30, |       | Change |   |     | Six months ended June 30, |   | Change |  
|                                       |  |                             |       |       
|                                       |  | 2004                        |       | 2005   |   | $   |                           |   | %      |   |  | 2004 |   | 2005 |   | $     |  |   | %     | 
|                                       |  | (in thousands)              |      
|Employee severance benefits            |  | $                           | 839   |        | $ | 64  |                           | $ | (775   | ) |  | -92  | % |      | $ | 1,795 |  | $ | 311   |  | $ | (1,484 | ) |  | -83 | %
|Facility and operations consolidations |  |                             | 301   |        |   | 95  |                           |   | (206   | ) |  | -68  | % |      |   | 373   |  |   | 1,435 |  |   | 1,062  |   |  | 285 | %
|Non-core product divestitures          |  |                             | 4     |        |   | 9   |                           |   | 5      |   |  | 126  | % |      |   | 41    |  |   | 61    |  |   | 20     |   |  | 49  | %
|                                       |  |                             |       |        |   |     |                           |   |        |   |  |      |   |      |   |       |  |   |       |  |   |        |   |  |     |  
|                                       |  | $                           | 1,144 |        | $ | 168 |                           | $ | (976   | ) |  | -85  | % |      | $ | 2,209 |  | $ | 1,807 |  | $ | (402   | ) |  | -18 | %
|                                       |  |                             |       |        |   |     |                           |   |        |   |  |      |   |      |   |       |  |   |       |  |   |        |   |  |     |  



Total restructuring expense decreased
during the three and six months ended June 30, 2005 as compared to the three and six months ended June 30, 2004 primarily as a result of the reduced cost of employee severance benefits as the number of positions eliminated was reduced. Facility and
operations consolidation restructure costs increased during the six months ended June 30, 2005 as compared to June 30, 2004, primarily due to the $1.3 million lease termination payment as discussed in the above section captioned Restructuring
Initiatives. At June 30, 2005, we had a $0.2 million liability related to our restructuring activities, the majority of which we expect will be paid during 2005.



OTHER INCOME (EXPENSE), NET



Other income (expense), net consists primarily of gains and losses on foreign exchange transactions and changes in the fair value of the derivatives in our preferred
stock instruments. In accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 133,Accounting for Derivative Instruments, we are required to adjust the carrying value of the derivatives to their fair value at
each balance sheet date and recognize any change since the prior balance sheet date as a component of other income or expense. The following table sets forth the components of other income (expense), net for the periods indicated.



|                                                              |  |                            |       |        |      |   |                          |  |        |                |   |  |      |   |  |      |        |   |  |   |       |  |   |        |   |  |      |  
|------------------------------------------------------------- |  | -------------------------- | ----- | ------ | ---- | - | ------------------------ |  | ------ | -------------- | - |  | ---- | - |  | ---- | ------ | - |  | - | ----- |  | - | ------ | - |  | ---- | -
|                                                              |  | Three months endedJune 30, |       | Change |      |   | Six months endedJune 30, |  | Change |               
|                                                              |  | 2004                       |       |        | 2005 |   | $                        |  |        | %              |   |  | 2004 |   |  | 2005 |        | $ |  |   | %     | 
|                                                              |  | (in thousands)             |       |        |      |   |                          |  |        | (in thousands) |   |  |      |   |  |     
|Foreign exchange gain (loss)                                  |  | $                          | 622   |        |      | $ | 1,126                    |  | $      | 504            |   |  | 81   | % |  | $    | 984    |   |  | $ | 1,173 |  | $ | 189    |   |  | 19   | %
|Writeoff of option to purchase                                |  |                            | (312  | )      |      |   |                         |  |        | 312            |   |  | -100 | % |  |      | (312   | ) |  |   |      |  |   | 312    |   |  | -100 | %
|Gain from changes in the fair value of derivative instruments |  |                            | 6,400 |        |      |   | 1,258                    |  |        | (5,142         | ) |  | -80  | % |  |      | 9,560  |   |  |   | 2,924 |  |   | (6,636 | ) |  | -69  | %
|Other                                                         |  |                            | 1     |        |      |   | 11                       |  |        | 10             |   |  | 998  | % |  |      | 18     |   |  |   | 144   |  |   | 126    |   |  | 700  | %
|                                                              |  |                            |       |        |      |   |                          |  |        |                |   |  |      |   |  |      |        |   |  |   |       |  |   |        |   |  |      |  
|                                                              |  | $                          | 6,711 |        |      | $ | 2,395                    |  | $      | (4,316         | ) |  | -64  | % |  | $    | 10,250 |   |  | $ | 4,241 |  | $ | (6,009 | ) |  | -59  | %
|                                                              |  |                            |       |        |      |   |                          |  |        |                |   |  |      |   |  |      |        |   |  |   |       |  |   |        |   |  |      |  



Other income
(expense), net, decreased during the three and six months ended June 30, 2005 as compared to the three and six months ended June 30, 2004 primarily as a result of the value of the derivative instruments declining less during the three and six months
ended June 30, 2005 than during the three and six months ended June 30, 2004 resulting in a reduction of the gain year-over-year.



Our Series D preferred stock issued in 2001 and warrants to purchase shares of our Series F preferred stock issued in December 2004 and March 2005 contain derivative
instruments. In accordance with the provisions of SFAS No. 133,Accounting for Derivative Instruments, we are required to adjust the carrying value of the instruments to their fair value at each balance sheet date and recognize any change
since the prior balance sheet date as a component of other income or expense. The estimated fair value of these derivative instruments at June 30, 2005 was $2.4 million.



Page 30



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INTEREST INCOME (EXPENSE)



Interest income consists primarily of interest earnings on cash and cash equivalents and interest expense consists primarily of the interest expense and amortization of
issuance costs related to the 13.9% Notes issued in December 2004 and March 2005, as well as interest on certain capital leases and other long-term obligations. The following table sets forth the components of interest expense for the periods
indicated.



|                                               |  |                            |        |   |        |   |      |                           |  |   |        |   |  |      |   |  |      |        |   |   |   |        |   |  |   |        |   |  |      |  
|---------------------------------------------- |  | -------------------------- | ------ | - | ------ | - | ---- | ------------------------- |  | - | ------ | - |  | ---- | - |  | ---- | ------ | - | - | - | ------ | - |  | - | ------ | - |  | ---- | -
|                                               |  | Three months endedJune 30, |        |   | Change |   |      | Six months ended June 30, |  |   | Change |  
|                                               |  | 2004                       |        |   | 2005   |   |      | $                         |  |   | %      |   |  | 2004 |   |  | 2005 |        |   | $ |   |        | % | 
|                                               |  | (in thousands)             |       
|Interest Income                                |  | $                          | 22     |   |        | $ | 130  |                           |  | $ | 108    |   |  | 491  | % |  | $    | 72     |   |   | $ | 268    |   |  | $ | 96     |   |  | 86   | %
|Senior Notes                                   |  |                            | (1,210 | ) |        |   |     |                           |  |   | 1,210  |   |  | -100 | % |  |      | (2,017 | ) |   |   |       |   |  |   | 2,017  |   |  | -100 | %
|53/4%
Notes                                    |  |                            | (551   | ) |        |   |     |                           |  |   | 551    |   |  | -100 | % |  |      | (1,098 | ) |   |   | (80    | ) |  |   | 1,018  |   |  | -93  | %
|13.9% Notes                                    |  |                            |       |   |        |   | (852 | )                         |  |   | (852   | ) |  | 0    | % |  |      |       |   |   |   | (1,427 | ) |  |   | (1,427 | ) |  | 0    | %
|Amortization of debt issuance costs            |  |                            | (134   | ) |        |   | (136 | )                         |  |   | (2     | ) |  | 1    | % |  |      | (222   | ) |   |   | (145   | ) |  |   | 77     |   |  | -35  | %
|Line of credit facility                        |  |                            | (115   | ) |        |   |     |                           |  |   | 115    |   |  | -100 | % |  |      | (185   | ) |   |   | (90    | ) |  |   | 95     |   |  | -51  | %
|Capital leases and other long-term obligations |  |                            | (55    | ) |        |   | (49  | )                         |  |   | 6      |   |  | -11  | % |  |      | (123   | ) |   |   | (93    | ) |  |   | 30     |   |  | -24  | %
|                                               |  |                            |        |   |        |   |      |                           |  |   |        |   |  |      |   |  |      |        |   |   |   |        |   |  |   |        |   |  |      |  
|                                               |  | $                          | (2,043 | ) |        | $ | (907 | )                         |  | $ | 1,136  |   |  | -56  | % |  | $    | (3,473 | ) |   | $ | (1,567 | ) |  | $ | 1,906  |   |  | -55  | %
|                                               |  |                            |        |   |        |   |      |                           |  |   |        |   |  |      |   |  |      |        |   |   |   |        |   |  |   |        |   |  |      |  



Interest expense decreased during the
three and six months ended June 30, 2005 as compared to the three and six months ended June 30, 2004 primarily as a result of the conversion of the 10% Senior Convertible Notes (Senior Notes) to shares of Series E preferred stock in July 2004 and
the retirement of the 53/4% Notes on April 1, 2005 partially offset by interest related to the 13.9% Notes
issued in December 2004 and March 2005.



PROVISION FOR INCOME TAXES



The provision for income taxes represents the tax on the income generated by
certain of our European subsidiaries operations. No current provision or benefit for United States federal or state income taxes has been recorded as we have incurred net operating losses for income tax purposes since our inception. Additionally, no
deferred provision or benefit for federal or state income taxes has been recorded as we are in a net deferred tax asset position for which a full valuation allowance has been provided due to uncertainty of realization.



ACCRUED DIVIDENDS AND ACCRETION ON MANDATORILY REDEEMABLE PREFERRED STOCK



Accretion on mandatorily redeemable preferred stock represents the accrued dividends and
accretion of the beneficial conversion features of our outstanding Series D and E preferred stock as well as the accretion to the redemption value of the outstanding Series D preferred stock (see Note 7  Mandatorily Redeemable Preferred
Stock).



Page 31



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The following table sets forth the components of the accretion on mandatorily redeemable preferred stock for the periods
indicated.



|                                           |  |                            |       |        |   |       |                          |   |        |   |  |      |   |      |   |       |  |   |        |  |   |        |   |  |     |  
|------------------------------------------ |  | -------------------------- | ----- | ------ | - | ----- | ------------------------ | - | ------ | - |  | ---- | - | ---- | - | ----- |  | - | ------ |  | - | ------ | - |  | --- | -
|                                           |  | Three months endedJune 30, |       | Change |   |       | Six months endedJune 30, |   | Change |  
|                                           |  | 2004                       |       | 2005   |   | $     |                          |   | %      |   |  | 2004 |   | 2005 |   | $     |  |   | %      | 
|                                           |  | (in thousands)             |      
|Accrued dividends                          |  | $                          | 1,289 |        | $ | 2,026 |                          | $ | 737    |   |  | 57   | % |      | $ | 2,578 |  | $ | 4,065  |  | $ | 1,487  |   |  | 58  | %
|Accretion of beneficial conversion feature |  |                            | 2,059 |        |   | 3,901 |                          |   | (1,471 | ) |  | -71  | % |      |   | 3,917 |  |   | 4,944  |  |   | (1,133 | ) |  | -29 | %
|Accretion to redemption value              |  |                            |      |        |   | 589   |                          |   | 3,901  |   |  | 0    | % |      |   |      |  |   | 2,784  |  |   | 4,943  |   |  | 0   | %
|                                           |  |                            |       |        |   |       |                          |   |        |   |  |      |   |      |   |       |  |   |        |  |   |        |   |  |     |  
|                                           |  | $                          | 3,348 |        | $ | 6,516 |                          | $ | 3,167  |   |  | 95   | % |      | $ | 6,495 |  | $ | 11,793 |  | $ | 5,297  |   |  | 82  | %
|                                           |  |                            |       |        |   |       |                          |   |        |   |  |      |   |      |   |       |  |   |        |  |   |        |   |  |     |  



ADDITIONAL FACTORS
THAT MAY AFFECT FUTURE OPERATING RESULTS



We have a history of
losses, expect continuing losses and may never achieve profitability.



We have not achieved profitability in any period and may continue to incur net losses in accordance with generally accepted accounting principles for the foreseeable future. In addition, we intend to continue to spend resources on
maintaining and strengthening our business, and this may, in the near term, cause our operating expenses to increase and our operating results to decline.



In past quarters, we have spent heavily on technology and infrastructure development. We may continue to spend substantial financial and other resources to further
develop and introduce new messaging solutions, and to improve our sales and marketing organizations, strategic relationships and operating infrastructure. We expect that our cost of revenues, sales and marketing expenses, general and administrative
expenses, operations, research and customer support expenses and depreciation and amortization expenses could continue to increase in absolute dollars and may increase as a percent of revenues. In addition, in future periods we may incur significant
non-cash charges related to stock-based compensation. If revenues do not correspondingly increase, our operating results could decline. If we continue to incur net losses in future periods, we may not be able to retain employees, or fund investments
in capital equipment, sales and marketing programs, and research and development to successfully compete. We also may never obtain sufficient revenues to exceed our cost structure and achieve profitability. If we do achieve profitability, we may not
be able to sustain or increase profitability in the future. This may also, in turn, cause the price of our common stock to demonstrate volatility and/or continue to decline.



Our failure to continue to carefully manage expenses and restructuring activities could require us to use substantial resources and
cause our operating results to decline.



In the past, our management
of operational expenses, including the restructurings of our operations, have placed significant strain on managerial, operational and financial resources and contributed to our history of losses. In addition, we may need to improve or replace our
existing operational, customer service and financial systems, procedures and controls and/or incur incremental costs of compliance with legislation, such as the Sarbanes-Oxley Act of 2002. Any failure to properly manage these systems and procedural
transitions or these incremental compliance costs could impair our ability to attract and service customers, and could cause us to incur higher operating costs and delays in the execution of our business plan. If we cannot manage restructuring
activities and expenses effectively, our business and operating results could decline.



We may need to raise additional capital and may need to initiate other operational strategies to continue our operations.



In the future, we may be required to raise additional funds, particularly if we are unable to generate positive cash flow as a result of our operations. Such financing
may not be available in sufficient amounts or on terms acceptable to us. Additionally, we face a number of challenges in operating our business, including our ability to overcome viability concerns held by our current and prospective customers given



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our recent capital needs and the amount of resources necessary to maintain worldwide operations. Concerns about our long-term viability may cause our stock
price to fall and impair our ability to raise additional capital and may create a concern among our current and future customers and vendors as to whether we will be able to fulfill our contractual obligations. As a result, current and future
customers may determine not to do business with us, which would cause our revenues to decline.



Certain of our cash resources are not readily available for our operations.



We face restrictions on our ability to use cash that we currently hold outside of the United States for purposes other than the operation of each of our respective
foreign subsidiaries that hold such cash. For example, our ability to use cash held in a given European subsidiary for any reason other than the operation of that subsidiary may result in certain tax liabilities and are subject to local laws that
could prevent the transfer of cash from that subsidiary to any other foreign or domestic account. At June 30, 2005, approximately $8.2 million was held outside of the United States. Our inability to utilize this cash could slow our ability to grow
our business and reach our business objectives. We may also be forced to incur certain costs, such as tax liabilities, to be able to use this cash for domestic operations, which could cause our expenses to increase and our operating results to
decline. In addition, approximately $0.3 of our cash is restricted, primarily to support our letters of credit related to certain facility leases and is therefore unavailable for our operating activities.



We may not be able to maintain our listing on the Nasdaq National Market, and if we
fail to do so, the price and liquidity of our common stock may decline.



The Nasdaq Stock Market has quantitative maintenance criteria for the continued listing of common stock on the Nasdaq National Market. The current requirements affecting us include (i) having total assets of at least $50 million, (ii)
having total revenue of $50 million, (iii) maintaining a minimum market value of our common stock of $15 million, and (iv) maintaining a minimum closing bid price per share of $1.00. On April 12, 2005, the Nasdaq Stock Market Inc. issued us a letter
that we were not in compliance with the minimum closing bid price requirement. On June 7, 2005, we received notice from the Nasdaq Stock Market Inc. that we were not in compliance with the minimum market value requirement. As a result of these
notices, we are faced with delisting proceedings. We must regain compliance with the Nasdaq Stock Market by September 6, 2005 in the case of the minimum market value requirement and by October 10, 2005 in the case of the minimum closing bid price
requirement, or our common stock will be de-listed from the Nasdaq National Market. If we are de-listed from the Nasdaq National Market, we will apply to be listed on the Nasdaq Small Cap Market, and if we fail to qualify for listing on that market,
we will be listed on the Over-the-Counter (OTC) Bulletin Board. Even if we are able to regain compliance with these requirements for continued listing, we may nevertheless in the future be unable to comply with these or the other quantitative
maintenance criteria or any of the other Nasdaq National Markets listing requirements or other rules, or other markets listing requirements to the extent our stock is listed elsewhere, in the future. If we fail to maintain continued listing on
the Nasdaq National Market and must move to a market with less liquidity, our stock price may further decline. If we are de-listed from the Nasdaq National Market and our common stock is traded on either the Nasdaq Small Cap Market or the
Over-the-Counter (OTC) Bulletin Board, it could have a material adverse effect on the market price of, and the liquidity of the trading market for, our common stock.



The conversion of our preferred stock would result in a substantial number of additional shares of common stock outstanding, which
could decrease the price of our common stock.



Our preferred stock can
be converted into common stock at anytime in the discretion of the holder of preferred stock. For example, during the three months ended June 30, 2005, at the request of certain holders of our Series E preferred stock, we converted approximately 5.0
million shares of Series E preferred stock into approximately 5.2 million shares of common stock. As of June 30, 2005, there were 3.5 million shares of Series D preferred stock outstanding, which were convertible into approximately 41.5 million
shares of common stock. In addition, we have approximately 50.9 million shares of Series E preferred stock outstanding, which are convertible as of June 30, 2005, at the option of the holders, into approximately 53.8 million shares of common stock.
On May 5, 2005, we filed a Form S-3/A pursuant to a demand from holders of Series E preferred stock to register 28.6 million shares of common stock issuable



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upon conversion of their shares of Series E preferred stock. Any conversion of our preferred stock into common stock would increase the number of additional
shares of common stock that may be sold into the market, which could substantially decrease the price of our common stock.



Our preferred stock carries a substantial liquidation preference, which could significantly impact the return to common equity holders upon an acquisition.



In the event of liquidation, dissolution, winding up or change of
control of Critical Path, the holders of Series E preferred stock would be entitled to receive $1.50 per share of Series E preferred stock plus all accrued dividends on such shares before any proceeds from the liquidation, dissolution or winding up
is paid with respect to any other series or class of our capital stock. Accordingly, at June 30, 2005, the approximately 50.9 million shares of Series E preferred stock outstanding currently have an aggregate liquidation preference of approximately
$80.6 million. The aggregate amount of the preference will increase as the shares of Series E preferred stock accrue dividends based on simple interest at an annual rate of 53/4%. After all of the then outstanding shares of Series E preferred stock have received payment of their liquidation preference, the holders of Series D preferred stock would be
entitled to receive the greater of $13.75 per share of Series D preferred stock plus all accrued dividends on such shares (which, as of June 30, 2005, would result in an aggregate liquidation preference of approximately $62.2 million) or $22 per
share (which currently would equal a liquidation preference of $77.5 million) before any proceeds from the liquidation, dissolution, winding up or change in control is paid to holders of our common stock. Holders of our common stock will not receive
any proceeds from a liquidation, winding up or dissolution, including from a change of control, until after the liquidation preferences of our Series E preferred stock and our Series D preferred stock are paid in full. Consequently, although we
would likely be required under applicable law to obtain the separate class approval of the holders of our common stock for a change of control or the sale of all or substantially all of the shares of Critical Path, it is possible that such a
transaction could result in all or substantially all of the proceeds of such transaction being distributed to the holders of our Series E preferred stock and Series D preferred stock.



From time to time we engage in discussions with or receive proposals from third parties
relating to potential acquisitions or strategic transactions that could constitute a change of control. While we have not engaged in any transaction of this type in the past, we will in the future continue to evaluate potential business combinations
or strategic transactions which, if consummated, may constitute a change of control and trigger the liquidation preferences described above.



As the preferred stock accrues dividends, the number of shares of common stock issuable upon conversion will increase, which may increase the dilution to our
holders of common stock and further decrease the price of our common stock.



Currently, shares of Series D preferred stock and shares of Series E preferred stock accrue dividends at a rate of 53/4% per year. If the maximum amount of dividends accrue on the outstanding shares of Series D preferred stock and Series E preferred stock prior to the automatic call for redemption date, the number of shares of common stock issuable
upon conversion will increase by approximately 15.7 million shares to approximately 110.9 million shares of common stock.



We have identified material weaknesses in our disclosure controls and procedures and our internal control over financial reporting, which, if not remedied
effectively, could have an adverse effect on the trading price of our common stock and otherwise seriously harm our business.



Management through, in part, the documentation, testing and assessment of our internal control over financial reporting pursuant to the rules promulgated by the SEC under
Section 404 of the Sarbanes-Oxley Act of 2002 and Item 308 of Regulation S-K has concluded that our disclosure controls and procedures and our internal control over financial reporting had material weaknesses as of December 31, 2004. We have taken
certain actions to begin to address those material weaknesses. Management filed its final report relating to its assessment of the effectiveness of internal control over financial reporting on May 2, 2005. Our inability to remedy our material
weaknesses promptly and effectively could have a material adverse effect on our business, results of operations and financial condition, as well as impair



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our ability to meet our quarterly and annual reporting requirements in a timely manner. These effects could in turn adversely affect the trading price of our
common stock. Prior to the remediation of these material weaknesses, there remains risk that the transitional controls on which we currently rely will fail to be sufficiently effective, which could result in a material misstatement of our financial
position or results of operations and require a restatement. In addition, even if we are successful in strengthening our controls and procedures, such controls and procedures may not be adequate to prevent or identify irregularities or facilitate
the fair presentation of our financial statements or SEC reporting.



Failure or circumvention of our controls and procedures could seriously harm our business.



We are making significant changes in our internal control over financial reporting and our disclosure controls and procedures. Any system of controls, however well
designed and operated, is based in part on certain assumptions and can provide only reasonable, and not absolute, assurances that the objectives of the system are met. In addition, the effectiveness of our remediation efforts and of our internal
controls is subject to limitations, including the assumptions used in identifying the likelihood of future events and the inability to eliminate misconduct completely. As a result, our remediation efforts to improve our internal control over
financial reporting may not prevent all improper acts or ensure that all material information will be made known to management in a timely fashion. In addition, because substantial additional costs may be necessary to implement these remedial
measures, our limited resources may cause a further delay in remediating all of our material weaknesses. The failure or circumvention of our controls, policies and procedures or of our remediation efforts could have a material adverse effect on our
business, results of operations and financial condition.



Unplanned
system interruptions and capacity constraints could reduce our ability to provide messaging services and could harm our business reputation.



Our customers have, in the past, experienced some interruptions in our hosted messaging service. We believe that these interruptions will continue to occur from time to
time. Our ability to retain existing customers and attract new customers will suffer and our revenues will decline if we experience frequent or long system interruptions that result in the unavailability or reduced performance of systems or networks
or reduce our ability to provide email services. We expect to experience occasional temporary capacity constraints due to unanticipated sharply increased traffic, which may cause unanticipated system disruptions, slower response times, impaired
quality and degradation in levels of customer service. If this were to continue to happen, our ability to retain existing customers and attract new customers could suffer dramatically and our revenues would decline.



We have entered into hosted messaging agreements with some customers that require minimum
performance standards, including standards regarding the availability and response time of messaging services. If we fail to meet these standards, our customers could terminate their relationships with us and we could be subject to contractual
monetary penalties.



Due to our evolving business strategy and the nature
of the markets in which we compete, our future revenues are difficult to predict and our quarterly operating results may fluctuate.



We cannot accurately forecast our revenues as a result of our evolving business strategy and the emerging nature of the messaging and directory infrastructure market.
Forecasting is further complicated by recent strategic and operational restructurings, as well as fluctuations in license revenues as a percentage of total revenues from 40% in 2002 to 31% in 2003 to 27% in 2004 and most recently, 28% in the six
months ended June 30, 2005. Our revenues in some past quarters fell and could continue to fall short of expectations if we experience delays or cancellations of even a small number of orders. We often offer volume-based pricing, which may affect our
operating margins. A number of factors are likely to cause fluctuations in operating results, including, but not limited to:



| |  |  | the demand for licensed solutions for messaging, and identity management products;
| | - |  | ----------------------------------------------------------------------------------



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| |  |  | the demand for outsourced messaging services generally and the use of messaging and identity management infrastructure products and services in particular;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to attract and retain qualified personnel with industry expertise, particularly sales personnel;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | our ability to attract and retain customers and maintain customer satisfaction;
| | - |  | -------------------------------------------------------------------------------



| |  |  | the ability to upgrade, develop and maintain our systems and infrastructure and to effectively respond to the rapid technology change of the messaging and identity management
infrastructure market;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the budgeting and payment cycles of our customers and potential customers;
| | - |  | --------------------------------------------------------------------------



| |  |  | the amount and timing of operating costs and capital expenditures relating to expansion of business and infrastructure;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to quickly handle and alleviate technical difficulties or system outages;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | the announcement or introduction of new or enhanced services by competitors;
| | - |  | ----------------------------------------------------------------------------



| |  |  | general economic and market conditions and their affect on our operations and the operations of our customers; and
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | the effect of war, terrorism and any related conflicts or similar events worldwide.
| | - |  | -----------------------------------------------------------------------------------



In addition to the factors set forth above, our GAAP financial results have been and will continue to be impacted by the extent to which we
incur non-cash charges associated with stock-based arrangements with employees and non-employees. In particular, during the year ended December 31, 2004, we incurred stock-based compensation expense of $1.9 million and $0.6 million for the six
months ended June 30, 2005 relating to the issuance of common stock and the grant of options and warrants to employees and non-employees. Grants of options and warrants also may be dilutive to existing shareholders.



Our revenues and operating results have declined and could continue to decline as a result of
the elimination of product or service offerings. Future decisions to eliminate revise or limit any other offerings of a product or service would involve other factors that could cause our revenues to decline and our expenses to increase, including
the expenditure of capital, the realization of losses, further reductions in our workforce, facility consolidation or the elimination of revenues along with the associated costs.



As a result of the foregoing, we do not believe that period-to-period comparisons of operating results are a good indication of future
performance. It is likely that operating results in some quarters will be below market expectations. In this event, the price of our common stock is likely to prove volatile and/or subject to further declines.



We may be unable to grow our business through effective sales and marketing, which
could cause our operating results to decline.



Our ability to increase
revenues will depend on our ability to successfully recruit, train and retain experienced and effective sales and marketing personnel and for our personnel to achieve results once they are employed with us. Competition for experienced and effective
personnel in certain markets is intense and we may not be able to hire and retain personnel with relevant experience. The complexity and implementation of our messaging and identity management infrastructure products and services require highly
trained sales and marketing personnel to educate prospective customers regarding the use and benefits of our products and services. Current and prospective customers, in turn, must, in some



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cases, be able to educate their end-users. Any delays or difficulties encountered in our staffing and training efforts would impair our ability to attract
new customers and enhance our relationships with existing customers, and ultimately, grow revenues. This would also adversely impact the timing and extent of our revenues from quarter to quarter and overall or could jeopardize sales altogether.
Because we have experienced turnover in our sales force and have fewer resources than many of our competitors, our sales and marketing organizations may not be able to compete successfully against the sales and marketing organizations of our
competitors. Moreover, our competitors frequently have larger and more established sales forces calling upon potential customers with more frequency. In addition, certain of our competitors have longer and closer relationships with the senior
management of customers who decide whose technologies and solutions to deploy. If we do not successfully operate and grow our sales and marketing activities, our revenues and operating results could decline and the price of our common stock could
continue to decline.



We have experienced significant turnover of senior
management and our current executive management team has been together for a limited time, which could slow the growth of our business and cause our operating results to decline.



Throughout 2004 we announced a series of changes in our management that included the departure of many senior executives, and there have
also been many changes in our board of directors. Many of the members of our current board of directors and senior executives joined us in 2004, and we may continue to make additional changes to our senior management team. If our new management team
is unable to accomplish our business objectives, our ability to grow our business and successfully meet operational challenges could be severely impaired. We do not have long-term employment agreements with any of our executive officers. It is
possible that this high turnover at our senior management levels may also continue for a variety of reasons. The loss of the services of one or more of our key senior executive officers could also affect our ability to successfully implement our
business objectives, which could slow the growth of our business and cause our operating results to decline. For these reasons, our shareholders may lose confidence in our management team and decide to dispose of our common stock, which could cause
the price of our common stock to decline.



We depend on strategic
relationships with our customers and others and the loss of such relationships could cause our revenues to decline.



We depend on strategic relationships with our customers and others to expand distribution channels and opportunities and to undertake joint marketing efforts. Our ability
to increase revenues depends upon aggressively marketing our services through new and existing strategic relationships.



We also depend on the ability of our customers to aggressively sell and market our services to their end-users. If we lose any strategic relationships, fail to fully
exploit our relationships, or fail to develop new strategic relationships, we could encounter increased difficulty in selling our products and services.



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A limited number of customers and markets account for a high percentage of our revenues and if we lose a major
customer, are unable to attract new customers, or the markets which we serve suffer financial difficulties, our revenues could decline.



We expect that sales of our products and services to a limited number of customers will continue to account for a high percentage of our revenue for the foreseeable
future. For example, for the six months ended June 30, 2005, our top ten customers accounted for approximately 37% of our total revenues and for the years ended December 31, 2002, 2003 and 2004, our top 10 customers accounted for approximately 31%,
27% and 34%, respectively, of our total revenues. During the three months ended June 30, 2005, we had one customer which accounted for 13% of our total revenue. Our future success depends on our ability to retain our current customers, and to
attract new customers, in our target markets. The loss of one or several major customers, whether through termination of agreements, acquisitions or bankruptcy, could significantly reduce our revenues. Our agreements with our customers typically
have terms of one to three years often with automatic one-year renewals and can be terminated without cause upon certain notice periods that vary among our agreements and range from a period of 30 to 120 days notice.



In addition, a number of our customers, particularly for our hosted services business and in
the technology industry, have also suffered from falling revenue. For example, the telecommunications industry during the six months ended June 30, 2005, accounted for approximately 32% of the revenues from our top ten customers whereas for the
fiscal years ended December 31, 2002, 2003 and 2004 it accounted for approximately 44%, 52% and 57%, respectively, of the revenues from our top ten customers. The relative financial performance of our customers will continue to impact our sales
cycles and our ability to attract new business. Worldwide technology spending has also decreased in recent quarters across all industries. If our customers terminate their agreements for any reason before the end of the contract term, the loss of
the customer would reduce our current and future revenues. Also, if we are unable to enter into agreements with new customers and develop business with our existing customers, our business will not grow and we will not generate additional revenues.



If we are unable to successfully compete in our product market, our
ability to retain our customers and attract new customers could decline.



Because we have a variety of messaging and directory infrastructure products and services, we encounter different competitors at each level of our products and services. Our primary competitors of our messaging solutions include Sun
Microsystems iPlanet, OpenWave Systems, Inc., Mirapoint, Inc., IronPort Systems, Inc., Comverse, Inc. and Microsoft Corporation. In the identity management market, we compete primarily with Sun Microsystems iPlanet, Microsoft
Corporation, IBM Corporation, Siemens Corporation, Computer Associates and Novell Corporation. Our competitors for customers seeking outsourced hosted messaging solutions include Outblaze Limited and BlueTie, Inc. If we are unable to successfully
compete in our product market, our ability to retain our customers and attract new customers could decline.



We believe that some of the competitive factors affecting the market for messaging and identity management infrastructure solutions include:



| |  |  | breadth of platform features and functionality of our offerings and the sophistication and innovation of competitors;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | total cost of ownership and operation;
| | - |  | --------------------------------------



| |  |  | scalability, reliability, performance and ease of expansion and upgrade;
| | - |  | ------------------------------------------------------------------------



| |  |  | ease of integration to customers existing systems; and
| | - |  | -------------------------------------------------------



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| |  |  | flexibility to enable customers to manage certain aspects of their systems internally and leverage outsourced services in other cases when resources, costs and time to market
reasons favor an outsourced offering.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We believe competition
will continue to be fierce and further increase as our market grows and attracts new competition, current competitors aggressively pursue customers, increase the sophistication of their offerings and as new participants enter the market. Many of our
current and potential competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than we do and may enter into strategic or commercial
relationships with larger, more established and better-financed companies. Any delay in our development and delivery of new services or enhancement of existing services would allow our competitors additional time to improve their service or product
offerings, and provide time for new competitors to develop and market messaging and directory infrastructure products and services and solicit prospective customers within our target markets. Increased competition could result in pricing pressures,
reduced operating margins and loss of market share, any of which could cause our financial results to decline.



We may not be able to respond to the rapid technological change of the messaging industry.



The messaging industry is characterized by rapid technological change, changes in user and customer requirements and preferences, and the emergence of new industry
standards and practices that could render our existing services, proprietary technology and systems obsolete. We must continually develop or introduce and improve the performance, features and reliability of our services, particularly in response to
competitive offerings. Our success depends, in part, on our ability to enhance our existing email and messaging services and to develop new services, functionality and technology that address the increasingly sophisticated and varied needs of
prospective customers. If we do not properly identify the feature preferences of prospective customers, or if we fail to deliver email features that meet the standards of these customers, our ability to market our service successfully and to
increase revenues could be impaired. The development of proprietary technology and necessary service enhancements entails significant technical and business risks and requires substantial expenditures and lead-time. We may not be able to keep pace
with the latest technological developments. We may also be unable to use new technologies effectively or adapt services to customer requirements or emerging industry standards.



Our sales cycle is lengthy, and any delays or cancellations in orders in a particular quarter could cause our operating results to be
below expectations, which may cause our stock price to decline.



Because we sell complex and sophisticated technology, our sales cycle, in particular with respect to our software solutions, can be long and unpredictable, often taking between four to 18 months. Because of the nature of our product and
service offerings it can take many months of customer education and product evaluation before a purchase decision is made. In addition, many factors can influence the decision to purchase our product and service offerings including budgetary
restraints and decreases in capital expenditures, quarterly fluctuations in operating results of customers and potential customers, the emerging and evolving nature of the internet-based services and wireless services markets. Furthermore, general
global economic conditions, and weakness in global securities markets, continuing recessionary spending levels, and a protracted slowdown in technology spending in particular, have further lengthened and affected our sales cycle. Such factors have
led to and could continue to lead to delays and postponements in purchasing decisions and in many cases cancellations of anticipated orders. Any delay or cancellation in sales of our products or services could cause our operating results to be lower
than those projected and cause our stock price to decline.



Limitations
of our director and officer liability insurance may cause us to use our capital resources, which could cause our financial results to decline or slow our growth.



Our current director and officer liability insurance may not be adequate for the liabilities and expenses potentially incurred in connection
with future claims. To the extent liabilities, expenses or settlements exceed the limitations or are outside of the scope of coverage, our business and financial condition could materially decline.



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Under California law, in connection with our charter documents and indemnification agreements we entered into with our
executive officers and directors, we must indemnify our current and former officers and directors to the fullest extent permitted by law. The indemnification covers any expenses and liabilities reasonably incurred in connection with the
investigation, defense, settlement or appeal of legal proceedings. We have made payments and may continue to make payments in connection with the indemnification of officers and directors in connection with lawsuits and possibly pending
investigations. However, it is unlikely that our director and officer liability insurance will be available to cover such payments.



We may experience difficulty in attracting and retaining key personnel, which may negatively affect our ability to develop new products or services or retain and
attract customers.



The loss of the services of key personnel may
create a negative perception of our business and adversely affect our ability to achieve our business goals. Our success also depends on our ability to recruit, retain and motivate highly skilled sales and marketing, operational, technical and
managerial personnel. Competition for these people is intense and we may not be able to successfully recruit, train or retain qualified personnel. If we fail to do so, we may be unable to develop new products or services or continue to provide a
high level of customer service, which could result in the loss of customers and revenues. In addition, volatility and declines in our stock price may also affect our ability to retain key personnel, all of whom have been granted stock-based
incentive compensation. Over the past year we have reduced our work force and eliminated jobs to balance the size of our employee base with anticipated revenue levels. Reductions in our workforce could make it difficult to motivate and retain
remaining employees or attract needed new employees, and could also affect our ability to deliver products and solutions in a timely fashion and to provide a high level of customer service and support.



We do not have long-term employment agreements with any of our key personnel. In addition, we
do not maintain key person life insurance on our employees and have no plans to do so. The loss of the services of one or more of our current key personnel could make it difficult to successfully implement our business objectives.



If we are not successful in implementing strategic plans for our operations, our
expenses may not be offset by our corresponding sales and our financial results could significantly decline.



In 2002, we incurred a number of restructuring charges related to the resizing of our business. These efforts included additional facilities and equipment lease
terminations, continuing expense management and headcount reductions. In 2003, we continued to restructure our operations including consolidating some office locations and reducing our global workforce by approximately 175 positions, or
approximately 30% of the workforce. In 2004, we expanded our restructuring activities in an effort to reduce both short-term and long-term cash requirements. These activities included the reduction of fixed costs through the restructuring of
contracts, consolidation of certain activities to offices in Toronto, Canada and Dublin, Ireland from higher cost areas such as the San Francisco Bay area and the elimination of approximately 20% of employee positions and reduced use of third party
contractors. Most recently, during the first six months of 2005, we restructured the lease for, and relocated, our headquarter facilities. We expect to continue to make determinations about the strategic future of our business and operations, and
our ability to execute on such plans effectively could affect our future operations. A failure to execute successfully on such plans and to plan appropriately could cause our expenses to continue to outpace our revenues and our financial condition
to significantly decline.



We may experience a decrease in market demand
due to the slowed global economy, which has been further stymied by the concerns of terrorism, war and social and political instability.



Economic growth has slowed significantly in the United States and internationally. In addition, terrorist attacks across the world and turmoil and war in the Middle East
have increased the uncertainty in the global economy and may further add to the decline in the international business environment. A substantial portion of our business is derived from international sales, and the continued decline in the global
economy could have a more severe impact on our financial results than on the results of some of



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our competitors. The effects of terrorist attacks, particularly in Europe where we derive a significant portion of our revenue, and other similar events and
the war in Iraq could contribute further to the slowdown of the already slumping market demand for goods and services, including digital communications software and services. If the global economy continues to decline as a result of the recent
economic, political and social turmoil, or if there are further terrorist attacks in the United States or elsewhere, or as a result of war in the Middle East and elsewhere, we may experience decreases in the demand for our products and services,
which may cause our operating results to decline.



We may face continued
technical, operational and strategic challenges preventing us from successfully integrating or divesting acquired businesses.



Acquisitions involve risks related to the integration and management of acquired technology, operations and personnel. In addition, in connection with our strategic
restructuring, we elected to divest or discontinue many of the acquired businesses. Both the integration and divestiture of acquired businesses have been and will continue to be complex, time consuming and expensive processes, which may disrupt and
distract our management. With respect to integration, we must operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices to be successful. With
respect to the divestitures, the timing and transition of those businesses and their customers to other entities has required and will continue to require resources from our legal, finance and corporate development teams as well as expenses
associated with the conclusion of those transactions, winding up of entities and businesses. In addition to the added costs of the divestitures, we may not ultimately achieve anticipated benefits and/or cost reductions from such divestitures.



In the past, due to the significant underperformance of some of our
acquisitions relative to expectation, we eliminated certain acquired product or service offerings through termination, sale or other disposition. Such decisions to eliminate or limit our offering of an acquired product or service involved and could
continue to include the expenditure of capital, the realization of losses, further reduction in workforce, facility consolidation and the elimination of revenues along with the associated costs, any of which could cause our operating results to
decline.



We currently license many third-party technologies and may need
to license further technologies, which could delay and increase the cost of product and service developments.



We intend to continue to license certain technologies from third parties and incorporate them into our products and services, including web server technology, virus and
anti-spam solutions, storage and encryption technology and billing and customer tracking solutions. The market is evolving and we may need to license additional technologies to remain competitive. We may not be able to license these technologies on
commercially reasonable terms or at all. To the extent we cannot license needed technologies or solutions, we may have to devote our resources to the development of such technologies, which could delay and increase the cost of product and service
developments.



In addition, we may fail to integrate successfully any licensed
or hosted technology into our services. These third-party in-licenses may expose us to increased risks, including risks related to the integration of new technology, potential patent and copyright infringement issues, the diversion of resources from
the development of proprietary technology, and an inability to generate revenues from new technology sufficient to offset associated acquisition and maintenance costs. In addition, an inability to obtain needed licenses could delay product and
service development until equivalent technology can be identified, licensed and integrated. Any delays in services or integration problems could hinder our ability to retain and attract customers and cause our business and operating results to
suffer.



Changes in the regulatory environment for the operation of our
business or those of our customers could pose risks.



Few laws
currently apply directly to activity on the Internet and the messaging business; however, new laws are proposed and other laws made applicable to Internet communications every year. In particular,



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the operations of our business faces risks associated with privacy, confidentiality of user data and communications, consumer protection, taxation, content,
copyright, trade secrets, trademarks, antitrust, defamation and other legal issues. In particular, legal concerns with respect to communication of confidential data have affected our financial services and health care customers due to newly enacted
federal legislation. The growth of the industry and the proliferation of Internet-based messaging devices and services may prompt further legislative attention to our industry and thus invite more regulatory control of our business. The imposition
of more stringent protections or new regulations and application of laws to our business could burden our company and those with which we do business. Any decreased generalized demand for our services or the loss of, or decrease, in business by a
key partner due to regulation or the expense of compliance with any regulation, could either increase the costs associated with our business or affect revenue, either of which could cause our financial condition or operating results to decline.
Certain of our service offerings include operations subject to the Digital Millennium Copyright Act of 1998 and the European Unions recent privacy directives. Our efforts to remain in compliance with DMCA and the EU privacy directives may not
be sufficient. New legislation and case law may also affect our products and services and the manner in which we offer them, which could cause our revenues to decline.



In addition, the applicability of laws and regulations directly applicable to the businesses of our customers, particularly customers in the
fields of banking and health care, will continue to affect us. The security of information about our customers end-users continues to be an area where a variety of laws and regulations with respect to privacy and confidentiality are enacted.
As our customers implement the protections and prohibitions with respect to the transmission of end user data, our customers will look to us to assist them in remaining in compliance with this evolving area of regulation. In particular the
Gramm-Leach-Bliley Act contains restrictions with respect to the use and protection of banking records for end-users whose information may pass through our system and the Health Insurance Portability and Accountability Act contains provisions that
require our customers to ensure the confidentiality of their customers health care information.



Finally, the Sarbanes-Oxley Act of 2002 and new rules subsequently implemented by the Securities and Exchange Commission have required changes in corporate governance practices of public companies. In addition to
final rules and rule proposals already made by the Securities and Exchange Commission, the Nasdaq Stock Market has adopted revisions to its requirements for listed companies. We are currently reviewing all of our accounting policies and practices,
legal disclosure and corporate governance policies under the new legislation, including those related to our relationships with our independent registered public accounting firm, enhanced financial disclosures, internal controls, board and board
committee practices, corporate responsibility and loan practices, and intend fully to comply with such laws. We expect these new rules and regulations to make it more difficult for us to attract and retain qualified executive officers and qualified
members of our board of directors, particularly to serve on our various committees of the Board including, in particular, the audit committee.



We may have liability for Internet content and we may not have adequate liability insurance.



As a provider of messaging and directory services, we face potential liability for defamation, negligence, copyright, patent or trademark
infringement and other claims based on the nature and content of the materials transmitted via our services. We do not screen the content generated by our users or their customers, and we could be exposed to liability with respect to this content.
Furthermore, some foreign governments, such as Germany, have enforced laws and regulations related to content distributed over the Internet that are more strict than those currently in place in the United States. In some instances, we may be subject
to criminal liability in connection with Internet content transmission.



Our
current insurance may not cover claims of these types or may not be adequate to indemnify us for all liability that may be imposed. There is a risk that a single claim or multiple claims, if successfully asserted against us, could exceed the total
of our coverage limits. There also is a risk that a single claim or multiple claims asserted against us may not qualify for coverage under our insurance policies as a result of coverage exclusions that are contained within these policies. Should
either of these risks occur, capital contributed by our shareholders might need to be used to settle claims. Any imposition of liability, particularly liability that is not covered by insurance or is in excess of insurance coverage could result in
substantial out-of-pocket costs to us, or could result in the imposition of criminal penalties.



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Unknown software defects could disrupt our services and harm our business and reputation.



Our software products are inherently complex. Additionally, our product and service
offerings depend on complex software, both internally developed and licensed from third parties. Complex software often contains defects or errors in translation, particularly when first introduced or when new versions are released or localized for
international markets. We may not discover software defects in our products or that affect new or current services or enhancements until after they are deployed. Despite testing, it is possible that defects may occur in the software. These defects
could cause service interruptions, which could damage our reputation or increase service costs, cause us to lose revenue, delay market acceptance or divert development resources.



If our system security is breached, our reputation could suffer and our revenues could decline.



A fundamental requirement for online communications is the secure transmission of
confidential information over public networks. Third parties may attempt to breach our security or that of our customers. If these attempts are successful, customers confidential information, including customers profiles, passwords,
financial account information, credit card numbers or other personal information could be breached. We may be liable to our customers for any breach in security and a breach could harm our reputation. We rely on encryption technology licensed from
third parties. Our servers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays or loss of data. We may be required to expend significant capital and other resources
to license encryption technology and additional technologies to protect against security breaches or to alleviate problems caused by any breach. Failure to prevent security breaches may make it difficult to retain and attract customers and cause us
to spend additional resources that could cause our operating results to decline.



We rely on trademark, copyright, trade secret laws, contractual restrictions and patents to protect our proprietary rights, and if these rights are not sufficiently protected, our ability to compete and generate revenue could be
harmed.



We rely on a combination of trademark, copyright and trade
secret laws, contractual restrictions, such as confidentiality agreements and licenses, and patents to establish and protect our proprietary rights, which we view as critical to our success. Our ability to compete and grow our business could suffer
if these rights are not adequately protected. Despite the precautionary measures we take, unauthorized third parties may infringe or copy portions of our services or reverse engineer or obtain and use information that we regard as proprietary, which
could harm our competitive position and market share. In addition, we have several patents pending in the United States and may seek additional patents in the future. However, the status of United States patent protection in the software industry is
not well defined and will evolve as the U.S. Patent and Trademark Office grants additional patents. We do not know if our patent applications or any of our future patent applications will be issued with the scope of the claims sought, if at all, or
whether any patents we have received or will receive will be challenged or invalidated.



Our proprietary rights may not be adequately protected because:



| |  |  | laws and contractual restrictions may not prevent misappropriation of our technologies or deter others from developing similar technologies;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of this unauthorized use; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | end user license provisions in our contracts that protect us against unauthorized use, copying, transfer and disclosure of the licensed program may be unenforceable.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



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In addition, the laws of some foreign countries may not protect proprietary rights to the same extent as do the laws of
the United States. Our means of protecting proprietary rights in the United States or abroad may not be adequate and competitors may independently develop similar technology. Additionally, we cannot be certain that our products do not infringe
issued patents that may relate to our products. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which relate to our software products.



If we do not successfully address the risks inherent in the conduct of our
international operations, our revenues and financial results could decline.



Revenues from international sales accounted for 75% of our revenues in the six months ended June 30, 2005 and 54%, 62% and 68% of our revenues in 2002, 2003 and 2004, respectively. We intend to continue to operate in international markets
and to spend significant financial and managerial resources to do so. If revenues from international operations do not exceed the expense of establishing and maintaining these operations, our business and our ability to increase revenue and improve
our operating results could suffer. We have limited experience in international operations and may not be able to compete or operate effectively in international markets. We face certain risks inherent in conducting business internationally,
including:



| |  |  | difficulties and costs of staffing and managing international operations;
| | - |  | -------------------------------------------------------------------------



| |  |  | fluctuations in currency exchange rates and imposition of currency exchange controls;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | differing technology standards and language and translation issues;
| | - |  | -------------------------------------------------------------------



| |  |  | difficulties in collecting accounts receivable and longer collection periods;
| | - |  | -----------------------------------------------------------------------------



| |  |  | changes in regulatory requirements, including U.S. export restrictions on encryption technologies;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | political and economic instability;
| | - |  | -----------------------------------



| |  |  | potential adverse tax consequences; and
| | - |  | ---------------------------------------



| |  |  | significantly reduced protection for intellectual property rights in some countries.
| | - |  | ------------------------------------------------------------------------------------



Any of these factors could harm our international operations and, consequently, our business and consolidated operating results.
Specifically, failure to successfully manage international growth could result in higher operating costs than anticipated or could delay or preclude altogether our ability to generate revenues in key international markets.



The significant equity ownership by the General Atlantic Investors and the Cheung Kong
Investors may limit the ability of our other shareholders to influence significant corporate decisions which could delay or prevent a change of control or depress our stock price.



Following the conversion of the notes held by the General Atlantic Investors and the Cheung
Kong Investors into Series E preferred stock and the amendment of the terms of our Series D preferred stock, as of June 30, 2005, the General Atlantic Investors beneficially own approximately 29% of our outstanding securities (which represents
approximately 17.8% of the voting power) and the Cheung Kong Investors beneficially own approximately 20.4% of our outstanding securities (which represents approximately 19.2% of the voting power). In addition, the holders of our Series D preferred
stock, which is controlled by the General Atlantic Investors, are entitled to elect one director and the Cheung Kong Investors have the right to elect one director. Currently, one of our directors is affiliated with General



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Atlantic Investors and one of our directors is affiliated with the Cheung Kong Investors. As a result, the General Atlantic Investors and the Cheung Kong
Investors, although not affiliated, may have the ability, acting together, to control the outcome of shareholder votes, including votes concerning the election of a majority of our directors, approval of merger transactions involving us and the sale
of all or substantially all of our assets or other business combination transactions, charter and bylaw amendments and other significant corporate actions, which could delay or prevent a change in control or depress our stock price.



The significant equity ownership by the General Atlantic Investors and the Cheung Kong
Investors may result in potential conflicts of interests, which could adversely affect the holders of our common stock, delay a change in control and depress our stock price.



The significant equity ownership by each of the General Atlantic Investors and the Cheung Kong Investors could create conflicts of interest
between these majority shareholders and our other shareholders and between the General Atlantic Investors and the Cheung Kong Investors. For example, the General Atlantic Investors and the Cheung Kong Investors may only approve a change in control
transaction that results in the payment of their liquidation preference even if our other shareholders oppose the transaction, which could depress the price of our common stock. Alternatively, the General Atlantic Investors and the Cheung Kong
Investors may prevent or delay a corporate transaction that is favored by our other shareholders. In addition, it is also possible that the risk that the General Atlantic Investors and the Cheung Kong Investors may disagree on approving a
significant corporate transaction, for example a change in control transaction, could limit the number of potential partners willing to pursue such a transaction with us or limit the price that investors might be willing to pay for future shares of
our common stock.



The use of our net operating losses could be limited
if an ownership change occurred during the preceding three-year period.



The use of our net operating losses could be limited if an ownership change occurred during the preceding three-year period as a result of, for example, the issuance of Series E preferred stock upon conversion of the 10% notes,
the amendment to the terms of the Series D preferred stock or the exercise of the subscription rights. In general, under applicable federal income tax rules, an ownership change is considered to have occurred if the percentage of the
value of our stock owned by our 5% shareholders increased by more than 50 percentage points over the lowest percentage of the value of our stock owned by such shareholders over the preceding three-year period.



Due to the fact that a full valuation allowance has been provided for the net deferred tax
asset relating to our net operating losses, we have never analyzed whether events such as the issuance of Series E preferred stock upon conversion of the 10% notes, the amendment to the terms of the Series D preferred stock and/or the exercise of
the subscription rights in the rights offering caused us to undergo an ownership change for federal income tax purposes. If such an ownership change were considered to have occurred, our use of our pre-change net operating losses would generally be
limited annually to the product of the long-term tax-exempt rate as of the time the ownership change occurred and the value of our stock immediately before the ownership change. (The current long-term tax-exempt rate is 4.72%.) This could increase
our federal income tax liability if we generate taxable income in the future. There can be no assurance that the Internal Revenue Service would not be able to successfully assert that we have undergone one or more ownership changes in the preceding
three-year period.



Our stock price has demonstrated volatility and
overall declines during recent quarters and continued volatility in the stock market may cause further fluctuations and/or decline in our stock price.



The trading price of our common stock has been and may continue to experience volatility, wide fluctuations and declines. For example, during the three months ended
June 30, 2005, the closing sale prices of our common stock on the Nasdaq National Market ranged from $0.75 on April 5, 2005 to $0.42 on May 24, 2005. More recently, on August 5, 2005, the closing sale price of our common stock was $0.33. Our stock
price may further decline or fluctuate in response to any number of factors and events,



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such as announcements related to technological innovations, intense regulatory scrutiny and new corporate and securities and other legislation, strategic and
sales relationships, new product and service offerings by us or our competitors, litigation outcomes, changes in senior management, changes in financial estimates and recommendations of securities analysts, the operating and stock price performance
of other companies that investors may deem comparable, news reports relating to trends in our markets and the market for our stock, media interest in accounting scandals and corporate governance questions, overall market conditions and domestic and
international economic factors unrelated to our performance. In addition, the stock market in general, particularly with respect to technology stocks, has experienced extreme volatility and a significant cumulative decline in recent quarters. This
volatility and decline has affected many companies, including our company, irrespective of the specific operating performance of such companies. These broad market influences and fluctuations may adversely affect the price of our stock, and our
ability to remain listed on the Nasdaq National Market, regardless of our operating performance or other factors.



A decline in our stock price could result in securities class action litigation against us that could divert managements attention and harm our business.



We have been in the past and may in the future be subject to
shareholder lawsuits, including securities class action lawsuits. In the past, securities class action litigation has often been brought against a company after periods of volatility in the market price of securities. In the future, we may be a
target of similar litigation. Securities litigation could result in substantial costs and divert our managements attention and resources, which in turn could harm our ability to execute our business plan.



Our articles of incorporation and bylaws contain provisions that could delay or prevent
a change in control.



Our articles of incorporation and bylaws contain
provisions that could delay or prevent a change in control of our company. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. Some of these provisions:



| |  |  | authorize the issuance of preferred stock that can be created and issued by our board of directors without prior shareholder
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | approval, commonly referred to as blank check preferred stock, with rights senior to those of our common stock;
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | prohibit shareholder action by written consent; and
| | - |  | ---------------------------------------------------



| |  |  | establish advance notice requirements for submitting nominations for election to our board of directors and for proposing matters that can be acted upon by shareholders at a
meeting.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In March 2001, we adopted a shareholder rights plan or
poison pill. This plan could cause the acquisition of our company by a party not approved by our board of directors to be prohibitively expensive.



In addition, the General Atlantic Investors and the Cheung Kong Investors own a sufficient amount of our securities to be able to control the outcome of matters
submitted to a vote of our shareholders, which could have the effect of discouraging or impeding an acquisition proposal.



Changes in accounting rules for employee stock options could significantly impact our GAAP financial results.



Accounting policies affecting many aspects of our business, including rules relating to
employee stock option grants, have recently been revised or are under review. The FASB and other agencies have finalized changes to U.S. generally accepted accounting principles that will require us, starting in the first



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quarter of 2006, to record a charge to earnings for employee stock option grants and other equity incentives although we may elect to become subject to these
accounting principles before we are required to. We may have significant and ongoing accounting charges resulting from option grant and other equity incentive expensing that could reduce our overall net income. In addition, since we historically
have used equity-related compensation as a component of our total employee compensation program, the accounting change could make the use of equity-related compensation less attractive to us and therefore make it more difficult to attract and retain
employees.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET



The following table presents the hypothetical changes in fair value in
the 13.9% Notes at June 30, 2005. The value of the instrument is sensitive to changes in interest rates. The modeling technique used measures the change in fair values arising from hypothetical parallel shifts in the yield curve of plus or minus 50
basis points (bps), 100 bps and 150 bps over a twelve-month time horizon. The base value represents the estimated traded fair market value of the notes.



|            |  |                                                                        |       |                         |   |                                                                        |  |   |        |  |         |       |         |   |       |  |   |       |  |   |      
|----------- |  | ---------------------------------------------------------------------- | ----- | ----------------------- | - | ---------------------------------------------------------------------- |  | - | ------ |  | ------- | ----- | ------- | - | ----- |  | - | ----- |  | - | -----
|            |  | Valuation of borrowing given aninterest rate decrease of X basispoints |       | Nochange ininterestrate |   | Valuation of borrowing given aninterest rate increase of X basispoints
|            |  | 150 bps                                                                |       | 100 bps                 |   | 50 bps                                                                 |  |   | 50 bps |  | 100 bps |       | 150 bps
|            |  | (in thousands)                                                        
|13.9% Notes |  | $                                                                      | 4,817 |                         | $ | 4,811                                                                  |  | $ | 4,806  |  | $       | 4,800 |         | $ | 4,794 |  | $ | 4,789 |  | $ | 4,783



As of June 30, 2005, we had cash and
cash equivalents of $17.0 million and no investments in marketable securities and our long-term obligations consisted of our $18.0 million three year, 13.9% Notes due December 2008 and certain fixed rate capital leases. Accordingly, an immediate 10%
change in interest rates would not affect our long-term obligations or our results of operations.



A significant portion of our international operations has a functional currency other than the United States dollar. Accordingly, we are exposed to foreign currency exchange rate risk inherent in our sales
commitments, anticipated sales, and assets and liabilities of these operations. Fluctuations in exchange rates may harm our results of operations and could also result in exchange losses. The impact of future exchange rate fluctuations cannot be
predicted with any certainty; however, our exposure to foreign currency exchange rate risk is primarily associated with fluctuations in the Euro. We realized a net gain on foreign exchange of $1.3 million during the six months ended June 30, 2005.
To date, we have not sought to hedge the risks associated with fluctuations in exchange rates.



ITEM 4. CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures



We maintain
disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the Exchange Act), that are designed to ensure that information required to be disclosed by
us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in United States Securities and Exchange Commission 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.



As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our
disclosure committee and management, including the chief executive officer and the chief financial officer, of the effectiveness of the design and operation of our disclosure controls



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and procedures pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b). Based upon, and as of the date of this evaluation, the chief executive officer and the
chief financial officer concluded that our disclosure controls and procedures were not effective because we have not yet remediated the material weaknesses discussed in our Annual Report on Form 10-K/A as filed on May 2, 2005 for the year ended
December 31, 2004. Specifically, as of December 31, 2004, we did not maintain effective controls over (i) lack of expertise and resources to analyze and apply generally accepted accounting principles to significant non-routine transactions, (ii)
inadequate controls over period-end financial reporting processes, (iii) inadequate segregation of duties and (iv) inadequate controls over access to financial applications and data, based on criteria established inInternal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In light of these material weaknesses described more fully in our Form 10-K/A, we performed additional analysis and other
post-closing procedures to ensure our consolidated financial statements are prepared in accordance with generally accepted accounting principles (GAAP). Accordingly, management believes that the financial statements included in this report fairly
present in all material respects our financial condition, results of operations and cash flows for the periods presented.



The certifications of our principal executive officer and principal financial officer required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 are
attached as exhibits to this Quarterly Report on Form 10-Q. The disclosures set forth in this Item 4 contain information concerning the evaluation of our disclosure controls and procedures, internal control over financial reporting and changes in
internal control over financial reporting referred to in those certifications. Those certifications should be read in conjunction with this Item 4 for a more complete understanding of the matters covered by the certifications.



Changes in Internal Control Over Financial Reporting



Our management has discussed the material weaknesses as previously disclosed in Item 9A in
our Annual Report on Form 10-K/A for the year ended December 31, 2004 and other deficiencies with our audit committee. In an effort to remediate the identified material weaknesses and other deficiencies, we intend to implement remedial measures,
including, but not limited to the following:



| |  |  | engaging expert resources to assist with worldwide tax planning and compliance and to review our overall corporate structure;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | engaging consultants to assist in the application of GAAP to complex issues on a quarterly basis;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | hiring additional accounting personnel to focus on our ongoing remediation initiatives and compliance efforts;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | implementing consistent accounting and professional services time reporting systems worldwide;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | improving our documentation and training related to policies and procedures for the controls related to our significant accounts and processes;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | improving our documentation and training regarding revenue recognition procedures and reviews;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | improving control and monitoring over access to data and information systems;
| | - |  | -----------------------------------------------------------------------------



| |  |  | re-allocating and/or relocating duties of finance personnel to enhance segregation of duties; and
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | implementing consistent purchasing systems worldwide.
| | - |  | -----------------------------------------------------



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During the first quarter of 2005, we began requiring passwords, which are changed every 90 days, to access critical
systems and financial applications. However, there was no significant change in our internal control over financial reporting that occurred during the fiscal quarter ended June 30, 2005 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting. While we believe that the remedial actions will result in correcting the material weaknesses in our internal controls, the exact timing of when the conditions will be corrected is
dependent upon future events, which may or may not occur.



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PART II - OTHER INFORMATION



ITEM 1. LEGAL PROCEEDINGS



None.



ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS



(a) Sales of Unregistered Equity Securities



None.



(c) Issuer Purchases of Equity
Securities



None.



ITEM 3. DEFAULTS UPON SENIOR SECURITIES



None.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



None.



ITEM 5. OTHER INFORMATION



We have made a change to our financial statements for the three and six months ended June 30, 2005, which were previously released via press release and
furnished on a Form 8-K with the Securities and Exchange Commission on July 28, 2005. The previously reported amounts and the corrected amounts are as follows:



|                                                    |  |                                 |          |   |                                |   |          |             |  |   |           |   |  |   |          |  
|--------------------------------------------------- |  | ------------------------------- | -------- | - | ------------------------------ | - | -------- | ----------- |  | - | --------- | - |  | - | -------- | -
|                                                    |  | Three months endedJune 30, 2005 |          |   | Six months ended June 30, 2005 |  
|                                                    |  | As reported                     |          |   | Corrected                      |   |          | As reported |  |   | Corrected |  
|Cash and cash equivalents:                          |  | $                               | 16,993   |   |                                | $ | 16,857   |             |  | $ | 16,993    |   |  | $ | 16,857   |  
|Total current assets                                |  |                                 | 40,421   |   |                                |   | 40,285   |             |  |   | 40,421    |   |  |   | 40,285   |  
|Total assets                                        |  |                                 | 56,285   |   |                                |   | 56,149   |             |  |   | 56,285    |   |  |   | 56,149   |  
|Total shareholders deficit                         |  |                                 | (115,589 | ) |                                |   | (115,725 | )           |  |   | (115,589  | ) |  |   | (115,725 | )
|Total liabilities and shareholders deficit         |  |                                 | 56,285   |   |                                |   | 56,149   |             |  |   | 56,285    |   |  |   | 56,149   |  
|Other income (expense), net                         |  |                                 | 2,531    |   |                                |   | 2,395    |             |  |   | 4,377     |   |  |   | 4,241    |  
|Loss before provision for income taxes              |  |                                 | (1,285   | ) |                                |   | (1,421   | )           |  |   | (8,346    | ) |  |   | (8,482   | )
|Net loss                                            |  |                                 | (1,401   | ) |                                |   | (1,537   | )           |  |   | (8,770    | ) |  |   | (8,906   | )
|Accretion on mandatorily redeemable preferred stock |  |                                 | (6,515   | ) |                                |   | (6,516   | )           |  |   | (11,792   | ) |  |   | (11,793  | )
|Net loss attributable to common shareholders       |  |                                 | (7,916   | ) |                                |   | (8,053   | )           |  |   | (20,562   | ) |  |   | (20,699  | )
|Shares used in the per share calculations           |  |                                 | 29,358   |   |                                |   | 29,369   |             |  |   | 28,356    |   |  |   | 28,361   |  



ITEM 6. EXHIBITS



(a) Exhibits



|      |  |                                                                                                                                                           
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1  |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
|      | 
|31.2  |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
|      | 
|32.1* |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002         
|      | 
|32.2* |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002         

---

|* | In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Managements Reports on Internal Control Over Financial
Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed filed for purpose of Section 18 of
the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURE



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.



CRITICAL PATH, INC.By:

/s/ James A. ClarkJames A. ClarkExecutive Vice President and Chief
Financial Officer (Duly Authorized Officer and Principal
Financial and Accounting Officer)




Date: August 9, 2005



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Exhibit Index



|      |  |                                                                                                                                                           
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1  |  | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
|      | 
|31.2  |  | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002
|      | 
|32.1* |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002         
|      | 
|32.2* |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002         

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|* | In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Managements Reports on Internal Control Over Financial
Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Form 10-Q and will not be deemed filed for purpose of Section 18 of
the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.
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