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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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(Mark One)

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



For the fiscal year ended: December 31, 2004



OR



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



For the transition period from             
to            .



Commission File Number 000-25331



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CRITICAL PATH, INC.

(Exact name of Registrant as specified in its charter)



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|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|California                                                     |  | 911788300                              
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)
|                                                               | 
|350 The Embarcadero San Francisco, California                  |  | 94105                                  
|(address of principal executive offices)                       |  | (zip code)                             



(415) 541-2500

(Registrants telephone number, including area code)



None

(Securities registered pursuant to Section 12(b) of the Act)



Common Stock, Series C

Participating Preferred Stock Purchase Rights

(Securities registered pursuant to Section 12(g) of the Act and Title of Class)



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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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x



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



The aggregate market value of voting and non-voting common stock held by
non-affiliates of the Registrant was approximately $28,189,916 as of June 30, 2004, based on the closing price of the Common Stock as reported on the Nasdaq National Market for that date. Shares of common stock held as of June 30, 2004 by each
director and executive officer of the Registrant, as well as shares held by each holder of more than 10% of the common stock known to the Registrant, have been excluded for purposes of the foregoing calculation. This determination of affiliate
status is not a conclusive determination for other purposes.



There were 29,784,123 shares of the Registrants Common Stock issued and outstanding on March 1, 2005.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the Registrants definitive proxy statement (the Proxy Statement) to be mailed to shareholders in connection with its 2005
annual meeting of shareholders are incorporated by reference into Part III of this report. Except as expressly incorporated by reference, the Registrants Proxy Statement shall not be deemed to be part of this report.



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##### Table of Contents

Critical Path, Inc.



Index to Annual
Report on Form 10-K



|                                                             |  |                                                                                                              |  |     
|------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|                                                             |  |                                                                                                              |  | Page
|                                                             |  |                                                                                                              |  |     
|                                                             |  | Part I                                                                                                       |  |     
|Item 1.                                                      |  | Business                                                                                                     |  | 4   
|Item 2.                                                      |  | Properties                                                                                                   |  | 14  
|Item 3.                                                      |  | Legal Proceedings                                                                                            |  | 15  
|Item 4.                                                      |  | Submission of Matters to a Vote of Security Holders                                                          |  | 16  
|                                                             | 
|Executive Officers and other Key Employees of the Registrant |  | 17                                                                                                          
|                                                             |  |                                                                                                             
|                                                             |  | Part II                                                                                                      |  |     
|Item 5.                                                      |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 19  
|Item 6.                                                      |  | Selected Consolidated Financial Data                                                                         |  | 20  
|Item 7.                                                      |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 22  
|Item 7A.                                                     |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 57  
|Item 8.                                                      |  | Financial Statements and Supplementary Data                                                                  |  | 57  
|Item 9.                                                      |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure                         |  | 59  
|Item 9A.                                                     |  | Controls and Procedures                                                                                      |  | 59  
|Item 9B.                                                     |  | Other Information                                                                                            |  | 62  
|                                                             |  |                                                                                                             
|                                                             |  | Part III                                                                                                     |  |     
|Item 10.                                                     |  | Directors and Executive Officers of the Registrant                                                           |  | 64  
|Item 11.                                                     |  | Executive Compensation                                                                                       |  | 64  
|Item 12.                                                     |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters              |  | 64  
|Item 13.                                                     |  | Certain Relationships and Related Transactions                                                               |  | 65  
|Item 14.                                                     |  | Principal Accountant Fees and Services                                                                       |  | 65  
|                                                             |  |                                                                                                             
|                                                             |  | Part IV                                                                                                      |  |     
|Item 15.                                                     |  | Exhibits and Financial Statement Schedules                                                                   |  | 66  
|                                                             |  | Report of Independent Registered Public Accounting Firm                                                      |  | 72  
|Signatures                                                   |  | 122                                                                                                         
|Exhibit Index                                                |  |                                                                                                             



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This Annual Report and the following disclosure 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 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 Managements Discussion and Analysis of Financial Condition and Results of Operations and
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 Annual Report on Form 10-K includes numerous trademarks and
registered trademarks of Critical Path. Products or service names of other companies mentioned in this Annual Report on Form 10-K may be trademarks or registered trademarks of their respective owners.



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##### Table of Contents

PART I



ITEM 1. BUSINESS



Overview



We deliver software and services
that enable the rapid deployment of highly scalable valued-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.



Messaging. Our messaging applications are typically licensed by telecommunications carriers, service providers and government agencies, and some
highly distributed enterprises for deployment in their data centers. These licenses 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. We also offer our
messaging solutions as hosted services, where we provide access to and host email, personal information management such as calendar and contacts, resource scheduling, and newsgroups over the Internet and wireless networks for
enterprises, telecommunications operators, and, for certain services, consumers. Unlike with licensed software, customers of these services do not need to install or maintain their own copies of the software. Instead, customers pay initial setup
fees and regular monthly, quarterly or annual subscriptions for the services they would like to be able to access.



Identity management. Our identity management software is typically licensed by large enterprises, government agencies, and telecommunications
carriers and is deployed on site in their data centers. 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.



Professional services. We
offer a range of professional services designed to help our customers make more effective use of our products and services. Our licensed messaging and identity management software often require installation, migration and integration with
customers existing infrastructure or customization to provide special features or capabilities. In addition, our consultants offer expertise and experience in designing and delivering new services that our customers can use to supplement their
own resources.



Maintenance and support. 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.



Critical Paths Products and Services



Our messaging solutions are designed to provide integrated access to a broad range of communication and collaboration applications from wireless devices, web browsers, desktop clients and voice systems. Our messaging solutions can integrate
with third-party applications and systems, enabling customers to protect existing investments and maintain flexibility to adapt to future needs. Our target markets for our messaging solutions include fixed line, broadband and wireless providers as
well as some enterprises and government agencies.



In 2004, we
began to focus our marketing and product development efforts in the messaging market on consumer messaging solutions for service providers. In order to communicate this focus to the marketplace, we



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introduced a new brand of solutions and new brand image in February 2005. The new brandMemova will be used with our messaging solutions, including Memova Messaging, Memova Mobile and Memova Anti-Abuse. The new Memova brand is intended to bring with it a more innovative,
consumer-oriented image for us, better differentiating ourselves from our competitors and strengthening the markets perception of the company as a provider of mobile and broadband messaging solutions for the consumer mass market.



Our identity management solutions are designed to extend these benefits of
lower helpdesk costs, increased security and easier implementation of regulatory compliance to an organizations applications, databases, directories and systems. Identity data, such as names, user ids, passwords, email addresses, phone
numbers, group affiliations, roles and access rights, that are scattered throughout disparate data systems in an organization are consolidated according to highly customizable business rules into a consistent, accurate profile of each user. Then,
using customer-specified policies, appropriate portions of this clean identity data are automatically distributed to all applications and systems that depend upon having accurate, up-to-date information about each user. This reduces the need for
manual processes, reducing errors and delays that can add costs and make organizations less secure. Our target markets for our identity management solutions include enterprises, governments, carriers and service providers.



Messaging Solutions



Our messaging solutions include:



| |  |  | Memova MessagingProvides email solutions and other value-added services that are accessible via wireless devices, the web, and desktop email clients such as Microsoft® Outlook®. Also provides scalability and reliability, advanced functionality and integrated anti-virus/anti-spam protection.
Allows premium services to be delivered over SMS and WAP Push, including rich content, weather, sports, games and high-volume interactive voting.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Memova MobileAllows delivery of low-cost push email to simple, inexpensive mobile telephones that support MMS. Consumers can choose to have selected email from any POP-enabled email account pushed to
their mobile phone and select which senders to allow on the device. The Memova Mobile service is simple to configure, using simple text messages from the users mobile phone with no software required on the device. Memova Mobile is currently in a number of customer evaluations and market
trials and is not yet in commercial release.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Memova Anti-AbuseProvides protection against spam, viruses and other malicious attacks before they can enter or exit the end-customers mail system. The product is built on our SMTP Relay Server and
intelligently combines mail traffic analysis with third-party content analysis to deliver a high overall abuse capture rate at a low total cost of ownership. Additionally, we offer premium third-party services to further enhance layers of
protection.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Personal Information ManagementAllows delivery of an integrated suite of personal information services including email, calendar, address book, alerts and file sharing
via wireless, voice, web and desktop clients. Centralizes and synchronizes personal data across applications and devices to help accelerate and simplify deployments, drive usage and consumption of data traffic, increase loyalty and reduce customer
churn.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our messaging solutions are comprised of
integrated messaging application products that work together to share data in order to deliver an improved user experience and provide intelligent processing of messages. For example, a meeting in someones calendar can automatically trigger an
alert that is dynamically routed to the user via email, wireless, or instant message, depending upon the time of day, subject, or other user-configured attributes. After reading the alert, the user can send messages to co-workers listed in his or
her personal address book, the same one used by our other messaging applications. Providing these capabilities on an integrated basis can reduce the complexity of deployments, simplifies on-going support and reduces the total cost of ownership.



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Our messaging application products include:



| |  |  | Critical Path Messaging ServerHighly scalable messaging server which enables the delivery of services from email and multimedia messaging services to unified messaging
and next generation voicemail services. Can be deployed in many different configurations, from single-server deployments up through redundant, globally-distributed installations. We have proven scalability with customers that have developed our
messaging server with installations of over 15 million users.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical Path Personal Information Management SuiteOur Personal Information Management suite, or PIM suite, includes the following products:
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical Path Personal Address Book ServerProvides centralized storage of contact information used by our messaging applications. This enables customers to consolidate
multiple address books into a single service with continuous access to private and shared address information, allowing important phone numbers or email addresses to be quickly obtained from desktop email clients in the office, web browsers at home,
or from wireless phones while on the road. Includes support for integrating with third-party applications such as voice dialing.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical Path Calendar ServerOffers sophisticated collaboration features such as group scheduling and availability lookup and shared access to calendars and task lists.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical Path Internet File ServerProvides global sharing of files, both for enterprise collaboration and for extending MMS multimedia files to the web for easy storage
and sharing. Provides web, wireless or voice interfaces as well as access via WebDAV-compliant desktop clients such as Microsoft Windows clients.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical Path Notification ServerAutomatically generates alerts based on user-specified events in Critical Path and third-party applications. Routes and delivers alert
messages via SMS, WAP Push, email, or instant messaging over AOL®, Yahoo!® or MSN® Instant Messaging.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our messaging solutions are built upon an integrated technology base called
the Critical Path Communications Platform. This platform is designed for high scalability and reliability as well as easy integration, deployment and flexibility. The Critical Path Communications Platform provides a wide range of functions that
manage connectivity of web, wireless, and voice devices to applications. The following are the key components of the Critical Path Communications Platform:



| |  |  | Critical Path Presentation ServerStandards-based, carrier-class application server that enables the delivery of tightly integrated collaborative applications into a
highly customized and personalized interface. This approach can help service providers differentiate offerings, stimulate usage and provide extensibility for future services. The Presentation Server is designed to provide single sign-on, an
integrated user interface, dynamic tailoring according to classes of service selected, and access via web, wireless and voice devices for our applications. In addition, it enables the integration of third-party applications, providing a common
interface for centrally configuring access to virtually any communications service that can be presented on a web or wireless device.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical Path Short Message Service (SMS) Access ServerProvides a bridge that connects the various incompatible SMS operator systems to create a single, common
environment for delivering enhanced services to help drive traffic and create new revenue opportunities. Provides access to our email and address book applications from SMS phones and enables third-party applications to send and receive text
messages for offering premium content and services such as weather, sports, games, and high-volume online voting.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical Path SyncML ServerOpen, standards-based software server that enables the synchronization of contacts, events and tasks between wireless devices and the
services provided by the Critical Path Personal Information Management, or PIM, solution. The SyncML Server is integrated with Critical Paths carrier-grade PIM servers, the Critical Path Personal Address Book Server and Critical Path Calendar
Server, to provide plug-and-play functionality.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Our messaging solutions are available as both licensed software for on-premise deployment, and as hosted
services. Our licensed software and professional consultants help customers integrate our products into their other applications and systems and offer a wide range of options for customization. Our hosted services are designed to enable customers to
outsource implementation and operation of advanced messaging services. These services also offer standards-based email service for carriers and service providers, Web hosting companies, Web portals and corporate enterprises providing accounts to
their end-users for activities such as trading securities, shopping or participating in online communities. Specifically, our hosted messaging services include an extensive suite of messaging services, including email, calendaring, centralized
address books, shared files, dynamic alerts and synchronization, that co-exist and interoperate with existing messaging systems. The benefits of this service includes predictable monthly costs, consistent reliability and professional billing,
provisioning and reporting are designed to minimize the hassles of operations and to scale smoothly as the number and needs of users grow. Our hosted services can also be used as a backup for internal mail systems, enabling rapid restoration of
mission-critical email connectivity in the event of a failure of a primary mail system.



Identity Management Solutions



Our identity
management solutions include:



| |  |  | Data & Directory IntegrationAssists organizations to reduce costs and improve the accuracy of information by consolidating critical data that are typically
scattered throughout various business data systems into centralized profiles of each user. In addition, it allows business rules for updating this data to be established and enforced so that accurate, current information can be synchronized and
distributed to all appropriate applications and systems. This enables applications such as whitepages directories to be deployed easily and reliably and for operating system infrastructure such as Microsofts Active Directory to be integrated
with services from other vendors.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Profile ManagementAssists organizations to reduce costs and decrease deployment time for new applications and services by centralizing the administration of user
profiles containing identity information. Such accurate user data is crucial for security infrastructure such as single sign-on, public key infrastructure, or PKI, web access control, and consistent personalization of applications.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | User ProvisioningAssists organizations to reduce costs of administering user accounts and to increase information security by consolidating user profiles and
centralizing processes for provisioning and de-provisioning user accounts across applications and systems. Allows employees, contractors, partners and customers to be granted access to crucial information resources, or have access removed, quickly
and accurately.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Password ManagementAssists organizations to improve security and reduce helpdesk calls by automating and providing self-service interfaces for deploying passwords for
each user across multiple applications and systems. Administrators can update passwords for all of a users applications, databases and operating systems from a central location. Users can take advantage of self-service interfaces to change
passwords or reset forgotten passwords without requiring assistance from helpdesk or IT personnel. Automating such labor-intensive tasks reduces errors and frees up helpdesk staff for other activities, leading to a variety of potential benefits such
as cost savings, increased user productivity and reduced security vulnerabilities.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our identity management solutions are comprised of identity management application products that organize and manage user identity information, such as
names, user ids, passwords, email addresses, telephone numbers, group affiliations, roles and access rights, for applications, databases, directories and operating systems. They offer high scalability, capable of supporting millions of entries with
a single deployment.



Our identity management products include:



| |  |  | Critical Path Directory ServerProvides a highly scalable, central repository for user profile information and other data shared by multiple systems and
applications. This high volume LDAP directory is deployed in numerous critical environments, including security infrastructure for enterprise
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | intranets and extranets, online banking services, Internet postal services, telecommunications carriers and government services. Optional hot-standby support
provides automatic failover and disaster recovery.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical Path Meta-Directory ServerConsolidates user identity information that is scattered among disparate data systems and integrates it according to highly
customizable business rules into a consistent, accurate profile for each user. Then, using customer-specified policies, appropriate portions of this clean identity data are automatically distributed to all applications and systems that depend upon
having accurate, up-to-date information about each user. This can reduce errors and delays that drive up helpdesk costs.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Critical Path Password ManagementProvides centralized management and self-service administration of passwords for multiple applications and systems. Designed to help
customers reduce burdens on helpdesks, increase user satisfaction and productivity as well as reduce vulnerability to out-of-date passwords.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Target Markets, Customers and Strategic Alliances



Customers and Target Markets



We offer messaging and identity management solutions to enterprises, wireless carriers and telecommunications providers, broadband companies and service
providers, and government agencies and postal authorities.



| |  |  | Wireless Carriers and Telecommunications ProvidersWe believe that wireless carriers are looking for ways to deliver differentiated services that will spur consumption
of data and voice traffic, enable new premiums to be charged, attract new subscribers and retain subscribers longer. We offer a broad range of rich, integrated messaging and collaboration applications, available as licensed software and hosted
services, as well as identity management infrastructure that work together to share and process data. With a proven ability to scale up to millions of subscribers per installation and a dedication to open standards that provides extensibility and
investment protection, our software enables carriers to deliver a wide range of customized services, such as email, personal information management, premium MMS and SMS services, and unified communications, to both consumers and business users from
a single platform.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Broadband Companies and Service ProvidersWe believe that broadband providers such as cable, satellite and DSL operators are continually looking to offer differentiated
services that can take advantage of the high bandwidth they are providing to their subscribers. Our flexible messaging solutions, available both as licensed software and as hosted services, enable multimedia content to be integrated with rich
messaging and collaboration applications designed to create premium services that attract new subscribers, increase loyalty and retain subscribers longer. We believe flexibility and ease of deployment of our software enables providers to reliably
and incrementally roll out new services as their business expands. Our scalability handles growing subscriber bases smoothly, and our ability to offer the services either as licensed software or as hosted services gives providers the flexibility to
choose the delivery method that best suits their business.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Government Agencies and Postal AuthoritiesGovernments and postal authorities are increasingly becoming providers of digital services, both internally for employees,
contractors and suppliers as well as externally to citizens and residents. Delivering services on a national scale to highly distributed users depends upon having strongly-managed identities and robust communications. Our identity management
solutions enable agencies to create centralized repositories of identity information for keeping track of which users are allowed access to which services, particularly for Web-based infrastructure. Our messaging solutions are used worldwide,
particularly by postal authorities, to provide email for life. These messaging solutions, available as licensed software as well as hosted services, can enable agencies to significantly reduce the cost of providing email, personal
information management and collaboration services to users across the country and around the world.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | EnterprisesOur identity management solutions are designed to help enterprises reduce helpdesk costs and strengthen security infrastructure (particularly for single
sign-on and access control for Web-based portals) with solutions for data and directory integration, user profile management, user provisioning and password synchronization. In addition, our hosted messaging solutions help enterprises reduce the
cost of delivering new generations of messaging services while co-existing with Microsoft Exchange and other existing systems.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Strategic Alliances



A key element of our sales strategy is to expand distribution channels through strategic reseller or joint sales relationships. These alliances can
provide access to a greater range of markets and customers by increasing the breadth of offerings that incorporate our products and services:



| |  |  | Systems IntegratorsFor many large enterprises and telecommunications carriers, our offerings are part of a larger solution. To provide the level of service required to
bring together and implement such larger offerings, particularly for customers who require global coverage, we have allied with a number of systems integrators in the industry.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Solution ProvidersOur technology is embedded into the solutions sold by a variety of companies. We believe these relationships enable our products to address a wider
range of needs and, in many cases, provide access for follow-on sales of our other products.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Information regarding customers and sales by geographic area is included in Note 17Product and Geographic Information in the Notes to Consolidated
Financial Statements.



Sales and Marketing



Sales Strategies



Direct Sales. We maintain a direct sales force to introduce prospective customers and channel partners to our
products and services and to work in tandem with our business partners. Our worldwide direct sales team is organized around our target markets in each of our key geographic regions. Currently, we have sales staff located in domestic offices in or
near San Francisco, Dallas, Chicago, Atlanta and a variety of other cities that cover North America. Internationally we have members of our sales organization located in Brazil, Denmark, France, Germany, India, Ireland, Italy, the Netherlands,
Spain, Sweden, Switzerland, Indonesia, Australia and the United Kingdom that cover Southeast Asia, China, Europe, Africa and Latin America.



Channel Sales. We actively embrace sales alliances with specialized technology and service firms in a variety of channels in order to increase our
presence and share in our target markets. Our flexible, customizable solutions are well suited for these firms and channel delivery, offering numerous opportunities for adding value through consulting services and integration with complementary
products. We team with global system integrators, or SIs, independent software vendors, or ISVs, original equipment manufacturers, or OEMs, and hardware vendors.



Marketing Strategies. Our global marketing team is focused on product definition, lead generation, sales support and
public relations to better equip our sales force and companies with whom we have sales alliances and to educate our key markets about the business value of our messaging and identity management solutions. We intend to continue to focus on targeted
industry events, particularly in conjunction with our strategic alliances, to promote our brand presence and acquire customers.



Competition



Although we are not aware of any one company that directly competes with every one of our products and services, we face a different set of competitors in
each of our lines of business. Our messaging solutions compete against offerings from Openwave Systems Inc., Sun Microsystems Sun ONE software division (formerly iPlanet), Microsoft Corporation, Mirapoint Inc. and IronPort Systems, Inc., as
well as with a variety of smaller



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product suppliers. In the identity management market, we compete primarily with Sun Microsystems Sun ONE software division (formerly iPlanet), IBM
Corporation, Microsoft Corporation, Novell Corporation, Siemens Corporation and Computer Associates, as well as various small identity management application vendors. In the market for outsourced hosted email services, we compete with such
corporations as Outblaze Limited, BlueTie, Inc. and other smaller application service providers offering hosted Microsoft Exchange services.



While these competitors and others exist in each of our individual lines of business, we believe our overall solution of products and services serves as a
competitive advantage. Our products and services are designed to help customers easily integrate our broad range of products into their infrastructure, selecting multiple products and services from us as their requirements demand. In addition, our
ability to deliver our messaging solutions either as licensed software or as hosted solutions enables our customers to choose the most efficient model for different parts of their business.



We believe that competitive factors affecting the market for our
communications solutions include:



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



| |  |  | Solution orientation of messaging of offerings that allow deployment with limited customization;
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | breadth of platform features and functionality;
| | - |  | -----------------------------------------------



| |  |  | ease of integration and deployment into customers existing applications and systems;
| | - |  | -------------------------------------------------------------------------------------



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



| |  |  | ability to extensively customize, personalize and tailor solutions to different classes of users across multiple markets;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | 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; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | perceived long-term stability of the vendor.
| | - |  | --------------------------------------------



The relative importance of each of these factors depends upon the specific customer environment. Although we believe that our products and services
currently compete favorably with respect to such factors, we may not be able to maintain our competitive position against current and potential competitors.



We believe competition will increase as current competitors increase the sophistication of their offerings, as new participants enter the market and as
the market continues to grow, becoming increasingly attractive. Many 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 the development or introduction of products or services or updates, would also allow additional
time for our competitors to improve their service or product offerings, and for new competitors to develop messaging and identity management products and services for our target markets. Increased competition could result in pricing pressures,
reduced operating margins and loss of market share, any of which could cause our business to suffer.



Technology



Messaging



The Critical Path Communications Platform includes a
range of tools and software development kits, or SDKs, that provide extensive customization and easy integration with third-party technologies. These components can be used on a standalone basis or together in many combinations, enabling us to
deliver flexible solutions. The Critical Path Communications Platform operates on Sun Microsystems Solaris, Red Hats distribution of the Linux operating systems and HPs HP-UX operating systems, with additional support for various
components on IBMs AIX and Microsofts Windows NT/2000.



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We separate the construction and presentation of user interfaces for each application into a separate,
highly extensible application server framework called Presentation Server. This approach enables the creation of customized, personalized application user interfaces to the Critical Path Communications Platform components and third party
technologies through a powerful SDK. It offers mixed mode communications, so that services can be accessed from a multitude of devices ranging from the desktop, laptop, PDA, mobile handset or telephone using text, voice, and video. The Presentation
Server is based on Java 2 Enterprise Edition, or J2EE, and Java Server Pages, or JSP, technologies, and supports Hypertext Markup Language, or HTML, Wireless Markup Language, or WML, VoiceXML and a range of other interface markup languages.



Our SyncML Server is a flexible engine for synchronizing
information between server-based applications such as our messaging applications and client devices such as wireless phones. Our Short Message Service Access Server is a powerful application framework that enables the development of premium text
messaging applications that send Short Message Service, or SMS, messages. The SMS Access Server includes an application development SDK, or SMASI, that applications can use to drive SMS traffic through all of the major SMS Center, or SMSC,
operations software systems. Our SMS Access Server also includes WAP Push support to enable next generation wireless applications like premium Multimedia Messaging Service, or MMS, services.



Our Messaging Server is a scalable, standards-based, messaging server with a
powerful native IMAP mail store and SMTP relay. Its advanced architecture allows single or multiple domains to be split over multiple servers, distributed geographically as well as setup as clusters. It also has support for security features
including secure-socket-layer, or SSL as well as anti-virus and anti-spam filtering.



Our hosted messaging service is comprised of multiple groups of servers and routers acting as a single, virtual point of contact to customers for messaging services. All aspects of our hosted messaging service are, in
turn, deployed in a redundant configuration with the goal that if any process or system goes down, another will be available to handle customer traffic seamlessly. This behavior is called transparent failover and is designed to increase
the availability of messaging services to the customer. Our hosted messaging service also includes a dynamic load-balancing system that acts as proxy servers for firewall safety. The load balancers are configured in parallel so that if one goes
down, the load is transferred to the remaining systems. We have created a proprietary account provisioning protocol for account creation and maintenance. This enables account transitioning from other services or legacy systems to be bulk-loaded,
tested, replicated and deployed on our service automatically. This protocol addresses a critical time to market issue by helping organizations to quickly transition to new email systems based on standards promulgated by the Internet Engineering Task
Force, including Internet Message Access Protocol, or IMAP, Post Office Protocol version 3, or POP3, and Simple Mail Transfer Protocol, or SMTP.



Our data centers provide high-speed connections to diverse backbone providers and robust network architecture and feature redundant systems for power;
raised floors; seismically braced racks; fire protection; and physical security and surveillance 24 hours a day, seven days a week. In addition, we have a diverse set of firewall solutions that are specifically tailored for each of our hosted
services. To enhance security for our network, we monitor the network hardware 24 hours a day, seven days a week. One of the important features of our messaging service is sophisticated spam blocking to help guard against unsolicited commercial
email and virus scanning to help prevent the spread of Internet viruses and worms.



Identity Management



The Critical Path
Directory Server provides a common store of user or resource information that can be accessed via standard LDAP and X.500 protocols. The Directory can be used to store user profiles, digital certificates from PKI software and eBusiness systems. The
Directory can be distributed over multiple systems to provide improved performance and ease of replication and updates.



At the core of our Meta-Directory technology is an engine for gathering data about users from a variety of business systems, including the various
components of the Critical Path Communications Platform. Our Meta-Directory comes with plug-in connectors for a wide range of systems including Sybases SQL Server,



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Microsofts Exchange, Lotus Notes, and products from Oracle Corporation, Peoplesoft Corporation, Siebel Systems and mainframe applications. It also
connects to all of the major directory systems on the market, including Critical Paths Directory Server, Microsofts Active Directory, Novells eDirectory and iPlanets Directory Server. Meta-Directory also includes a powerful
SDK that enables the development of custom connectors using Perl, Java, XML and SOAP, freeing customers from having to learn proprietary scripting languages. Critical Paths Directory and Meta-Directory both incorporate security technology like
SSL for secure transport and authentication.



We also offer a
layered application called Critical Path Password Management. This software provides easy-to-use graphical interfaces for managing multiple passwords from a centralized location.



Research and Development



Our products and services are primarily based on systems that were internally developed or acquired through acquisitions.



We invested $19.6 million, $19.0 million and $21.0 million in research and
development in 2002, 2003, and 2004, respectively. In addition, we incurred stock-based compensation expense of $1.2 million, $15,000 and $37,000 related to research and development during 2002, 2003, and 2004, respectively. We anticipate that we
will continue to devote significant resources to product development in the future as we add new features and functionality to our products and services. The market in which we compete is characterized by rapidly changing technology, evolving
industry standards, frequent new service and product announcements, introductions and enhancements and changing customer demands. Accordingly, our future success will depend on our ability to adapt to rapidly changing technologies, to adapt our
services to evolving industry standards and to continually improve the performance, features and reliability of our products and services. The failure to adapt to such changes would harm our business. In addition, the widespread adoption of new
Internet, networking or telecommunications technologies or other technological changes could require us to undertake substantial expenditures to modify or adapt our services or infrastructure.



Intellectual Property



We regard the protection of our trade secrets, patents, patent applications, copyrights and trademarks as critical to our
success. We rely on a combination of statute, common law and contractual restrictions to establish and protect our proprietary rights and developed intellectual property in our product and service offerings. We have entered into proprietary
information and invention assignment agreements with our employees, contractors and consultants, and nondisclosure agreements with customers, partners and third parties to whom we disclose confidential and proprietary information. Despite our
efforts in this regard, former employees or third parties may infringe or misappropriate our proprietary rights that could harm our business. The validity, enforceability and scope of protection of our intellectual property can be tested and in some
areas is still evolving.



We have registered Critical
Path as a trademark and applied for registration of Memova in the United States. We have also registered and used Critical Path and are using and in the process of registering Memova in a variety of foreign
countries where we have operations or do business. We plan to continue to enforce those marks and other trademarks in both the United States and internationally, although protection of the marks cannot be assured.



We license our software and proprietary service offerings and despite all
efforts to protect that property and ensure the quality of our brand and patented or copyrighted products or processes, current or future licensees could take actions that might harm the value of our intellectual property portfolio, our brand or
reputation.



We have been involved in claims by third parties
of patent, copyright and trademark infringement against us in the past. Any claim like this, regardless of the merits, could be time consuming to defend, result in costly and



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distracting litigation, cause delays in rollouts of services, products or updates or require us to enter into licensing agreements with third parties. Such
licensing agreements may include payment of significant royalties or may not be available to us on commercially reasonable terms. Additionally, enforcing our intellectual property rights could entail significant expense, with such costs also
potentially harming our results of operations.



Employees



At December 31, 2004, we had 355 employees, including 150 in services and
operations, 57 in sales and marketing, 94 in research and development and 54 in general corporate and administration. Our future success depends, in significant part, upon the continued service of our key technical and senior management personnel
and our continuing ability to attract and retain highly qualified and experienced technical, sales and managerial personnel. Competition for such personnel can be intense, and we cannot guarantee that we can retain our key technical and managerial
employees or that we will be able to attract, assimilate or retain other highly qualified technical, sales and managerial personnel in the future. None of our employees are represented by a labor union. We have not experienced any work stoppages and
consider our relations with our employees to be good.



Government Regulation



Although there are currently a limited number of laws and
regulations directly applicable to the Internet and the operation of commercial messaging services, it is probable that laws and regulations will continue to be adopted with respect to the Internet or commercial email services covering issues such
as user privacy, pricing, content, copyrights, distribution, antitrust and characteristics and quality of products and services. Further, the growth and development of the market for online email may prompt calls for more stringent consumer and
copyright protection and privacy laws that may impose additional burdens on those companies conducting business online. The adoption of any additional laws or regulations may impair the growth of the Internet or commercial online services, which
could, in turn, decrease the demand for our products and services and increase our cost of doing business, or otherwise harm our business, operating results and financial condition. Moreover, the applicability to the Internet of existing laws in
various jurisdictions governing issues such as property ownership, sales and other taxes, libel and personal privacy is uncertain and may take years to resolve. Any such new legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to our business or the application of existing laws and regulations to the Internet could harm our business, operating results and financial condition.



Certain of our service offerings include operations subject to the Digital
Millenium Copyright Act of 1998. We have expended resources and implemented processes and controls in order to remain in compliance with DMCA, but there can be no assurance that our efforts will be sufficient and/or new legislation and case law will
not affect the operation of and liability associated with a portion of our services.



Geographic Information



A summary of domestic
and international financial data is set forth in Note 17Product and Geographic Information in the Notes to the Consolidated Financial Statements in Item. 8 of this Annual Report on Form 10-K, which is incorporated herein by reference. A
discussion of factors potentially affecting our domestic and international operations is set forth in Managements Discussion and Analysis of Financial Condition and Results of OperationsAdditional Factors that May Affect Future
Operating Results, in Item. 7 of this Annual Report on Form 10-K, which is incorporated herein by reference.



SEC Filings and Other Available Information



We were incorporated in California in 1997. We file reports with the United States Securities and Exchange Commission, or SEC, including without
limitation annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The public may read and
copy any materials we file with the SEC



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at the SECs Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public
Reference Room by calling the SEC at 1-800-SEC-0330. In addition, we are an electronic filer. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, including us, that
file electronically with the SEC at the website address located at http://www.sec.gov.



Our telephone number is 415-541-2500 and our website address is located at http://criticalpath.net. The information contained in our website does not form any part of this Annual Report on Form 10-K. However,
we make available free of charge through our website our Annual Report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. In addition, we also make available on http://criticalpath.net our Code of Ethics and Business
Conduct for Employees, Officers and Directors. This Code is also available in print without charge to any person who requests it by writing to:



Critical Path, Inc.

Corporate Secretary

350 The Embarcadero

San
Francisco, CA 94105



ITEM 2. PROPERTIES



The following table sets forth the materially important facilities that we currently lease:



|                          |  |            |  |                   |  |                       |  |                |  |                                                                                                                
|------------------------- |  | ---------- |  | ----------------- |  | --------------------- |  | -------------- |  | ---------------------------------------------------------------------------------------------------------------
|Location                  |  | Squarefeet |  | Leaseterm         |  | Lease expiration      |  | Option torenew |  | Primary use                                                                                                    
|San Francisco, California |  | 63,467     |  | 4 years, 9 months |  | December 31, 2006 (a) |  | No             |  | Corporate headquarters: selling, marketing, research and development, operations and general and administrative
|                          |  |            |  |                   | 
|Toronto, Canada           |  | 16,166     |  | 3 years           |  | June 30, 2007         |  | No             |  | Marketing, research and development and operations                                                             
|                          |  |            |  |                   | 
|Dublin, Ireland           |  | 28,397     |  | 15 years          |  | July 4, 2014          |  | No             |  | Selling, marketing, research and development, general and administrative                                       
|                          |  |            |  |                   | 
|Turin, Italy              |  | 5,382      |  | 6 years           |  | October 1, 2006       |  | No             |  | Selling, marketing and general and administrative                                                              

---

|(a) | In September 2004, we received a courtesy notice from the landlord notifying us that the landlord had found a new tenant for our headquarters facility per the
landlords substitution right in the First Amendment to Lease between SRI Hills Plaza Venture, LLC and Critical Path,, Inc. On March 15, 2005, we received the Substitution Notice from the landlord as required per the Amendment. In accordance
with the Substitution Notice, we expect to relocate our headquarters facilities and move into new office space provided for us at 2 Harrison Street, Suite #200 by no later than June 29, 2005. The new facility to which we would relocate is
approximately 23,000 square feet and would be leased for a term of one year and six months commencing July 1, 2005 and ending on December 31, 2006. In connection with the landlords substitution right and our relocation, we will be required to
make a lease termination payment totaling approximately $1.3 million on June 1, 2005, however, the annual rent, on a cash basis, for our headquarters facility will decline from approximately $2.5 million per year to an amount that, although still
under negotiation, we expect to be less than $0.6 million per year. Additionally, we will incur costs related to the physical move and build out of
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | the new facility; however, we cannot currently estimate these costs as we have not yet engaged a moving company nor completed a detailed leasehold
improvement plan. We currently believe that the $1.3 million lease termination payment will be accrued as a charge to our statement of operations during the three months ended March 31, 2005.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In addition to the facilities listed above, we also lease other facilities in
the United States and Europe. In the United States we lease other facilities in the states of California, New Jersey, Georgia, Utah and Washington D.C. which are used primarily for selling, marketing and general and administrative purposes. In
Europe, we lease other facilities in Britain, France, Germany, Italy, Spain and Sweden which are used primarily for selling, marketing, research and development and general and administrative purposes.



ITEM 3. LEGAL PROCEEDINGS



From time to time, we have been subject to litigation including the pending litigation described below. Our current estimated range of liability related
to some of the pending litigation below is based on claims for which we can estimate the amount and range of loss. We have recorded the minimum estimated liability related to those claims, where there is a range of loss. Because of the uncertainties
related to both the amount and range of loss on the remaining pending litigation, we are unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. As additional information becomes available, we will assess
our potential liability and revise our estimates. Pending or future litigation could be costly, could cause the diversion of managements attention and could upon resolution, have a material adverse effect on our business, results of
operations, financial condition and cash flow. Moreover, the results of complex legal proceedings are difficult to predict. Other than as described below, we are not a party to any other material legal proceedings.



Action in the Superior Court of San Diego. In December 2003, we were
named in a lawsuit filed by former shareholders of Remedy Corporation against current and former officers and directors of Peregrine Systems, Inc., Peregrines former accountants, some of Peregrines customers, including us, and various
other unnamed defendants. The operative complaint alleges that we, as Peregrines customer, engaged in a fraudulent transaction with Peregrine that was not accounted for by Peregrine in conformity with generally accepted accounting principles
(GAAP) and that this substantially inflated the value of Peregrine securities issued as consideration in Remedys merger with Peregrine approximately one year later in August 2001. The operative complaint alleges causes of action against us for
fraud and deceit, violations of California Corporations Code provisions regarding aiding and abetting securities fraud, common law conspiracy to commit fraud, and common law aiding and abetting the commission of fraud. The complaint seeks an
unspecified amount of compensatory and punitive damages, along with rescission of the Peregrine securities purchased in the Remedy merger, interest and attorneys fees. Effective as of January 2005, the Company entered into a settlement agreement
providing that the claims against us would be dismissed immediately without prejudice. Thereafter, upon our satisfaction of certain conditions, the plaintiffs are obligated to dismiss the claims with prejudice. Such conditions consist principally of
informal discovery such as, for example, providing access to employees and consultants who may have knowledge relevant to the plaintiffs continuing case against the remaining defendants and providing documents which may be relevant to such
case. The settlement involved no cash or other financial consideration. We had not recorded a liability against this claim as of December 31, 2004.



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



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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 by us and no admission of liability. However, the settlement is subject to approval by the Court. We had not recorded a liability against this claim as of December 31, 2004.



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 a preferential payment to us of approximately $1.1 million within the 90-day preference
period before Cable & Wireless filed for bankruptcy protection. 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, we intend to defend ourselves vigorously if the Trust pursues this claim. We had not recorded a liability against this claim as of December 31, 2004.



The uncertainty associated with these and other unresolved or threatened
lawsuits could seriously harm our business and financial condition. In particular, the lawsuits or the lingering effects of previous lawsuits and the now completed SEC investigation could harm relationships with existing customers and our ability to
obtain new customers and partners. The continued defense of lawsuits could also result in the diversion of managements time and attention away from business operations, which could harm our business. Negative developments with respect to the
settlements or the lawsuits could cause the price of our common stock to further decline significantly. In addition, although we are unable to determine the amount, if any, that we may be required to pay in connection with the resolution of these
lawsuits, and although we maintain adequate and customary insurance, the size of any such payments could seriously harm our financial condition.



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



On November 16, 2004, we held our Annual Meeting of Shareholders to vote
upon the following proposals:



(1) Elect six
directors to serve until the next Annual Meeting or until their successors have been duly elected and qualified;



(2) Approve (a) a capital restructuring proposal to permit the Board of Directors, in its sole discretion, to amend our Amended and
Restated Articles of Incorporation to effect a reverse stock spit of Common Stock at a specific ratio to be determined by the Board of Directors within a range from 1-for-2 to 1-for-20; and (b) the form of the Certificate of Amendment to the Amended
and Restated Articles of Incorporation by which the Board of Directors may consummate such action;



(3) Ratify the audit committees appointment of PricewaterhouseCoopers LLP as our independent registered public accounting firm for
the 2004 fiscal year; and



Each of the proposals listed above
passed with the following votes as set forth in the tables below:



|             |  |                          |  |            |  |           
|------------ |  | ------------------------ |  | ---------- |  | ----------
|Proposal     |  | For                      |  | Withhold  
|Proposal (1) |  | William E. McGlashan Jr. |  | 54,669,257 |  | 11,649,431
|             |  | Mark J. Ferrer           |  | 66,206,925 |  | 111,763   
|             |  | Peter L.S. Currie        |  | 66,155,591 |  | 163,097   
|             |  | Ross Dove                |  | 65,968,725 |  | 349,963   
|             |  | Frost R.R. Prioleau      |  | 65,922,304 |  | 396,384   
|             |  | Michael J. Shannahan     |  | 66,192,078 |  | 126,610   



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Mr. Tom Tinsleys term as a director continued after the meeting as the designee of the Series D
Cumulative Redeemable Convertible Preferred Stock (Series D preferred stock).



|             |  |            |  |         |  |        
|------------ |  | ---------- |  | ------- |  | -------
|Proposal     |  | For        |  | Against |  | Abstain
|Proposal (2) |  | 65,953,277 |  | 317,936 |  | 47,475 
|Proposal (3) |  | 66,249,891 |  | 60,451  |  | 8,346  



There were no broker
non-votes for any of the proposals.



Executive Officers and Other Key Employees



The executive officers and other key employees of Critical Path and their ages as of March 15, 2005 are as follows:



|                            |  |     |  |                                                                
|--------------------------- |  | --- |  | ---------------------------------------------------------------
|Name                        |  | Age |  | Position                                                       
|Mark J. Ferrer              |  | 45  |  | Chief Executive Officer and Chairman                           
|James A. Clark              |  | 48  |  | Executive Vice President and Chief Financial Officer           
|Michael J. Zukerman         |  | 45  |  | Executive Vice President, General Counsel and Secretary        
|Menelaos (Michael) Serbinis |  | 31  |  | Chief Technology Officer and EVP of Marketing                  
|Barry Twohig                |  | 37  |  | Executive Vice President, Engineering                          
|Mark Palomba                |  | 46  |  | Executive Vice President, WW Services, Support and Asia Pacific



Mark J. Ferrerhas served as Chief Executive Officer since the end of March 2004, as a director since May 2004 and as Chairman since February 2005. Prior to joining Critical Path, Mr. Ferrer served as president and chief executive officer of Vastera, Inc. from
February 2002 to November 2003 and prior to that as its president and chief operating officer from December 1999 to November 2003. From April 1998 to December 1999, Mr. Ferrer held various management positions with the Baan Company, serving as
president of Baan Americas and as chief operating officer of Aurum Software. From June 1982 to April 1998, Mr. Ferrer served in various roles at IBM Corporation. Mr. Ferrer serves on the board of directors of Plateau Systems, a private company, and
as chairman for Teach for America, DC, a not-for-profit corporation.



James A. Clarkhas served as Executive Vice President and Chief Financial Officer since February 2004. Prior to joining Critical Path, from January 2002 to October 2003, he was the chief financial officer at Diversified Healthcare
Services, Inc., which was acquired by Fair Isaac Corporation. Before that, he was the chief financial officer at several software and services businesses, including StellarNet, Inc. from February 2001 to January 2002, Netopia, Inc. from November
1994 to February 2001 and Integral Systems, Inc from November 1985 to November 1994. He is a certified public accountant.



Michael J. Zukermanhas served as Executive Vice President, General Counsel and Secretary since June 2001. From July 1999 to June 2001, he was vice
president of business development for Driveway Corporation, a provider of web-based file storage services. Prior to that, Mr. Zukerman was senior vice president of business development, general counsel and secretary at Sega.com, Inc., from October
1996 to June 1999. From 1989 to October 1996, Mr. Zukerman was vice president and general counsel at Netopia, Inc. Prior to that, Mr. Zukerman was an attorney with Brobeck, Phleger & Harrison LLP.



Menelaos (Michael) Serbinishas served as Chief Technology Officer
since February 2001. Mr. Serbinis joined Critical Path as its Chief Security Officer in March 2000 and served in this capacity until February 2001. From November 1997 to March 2000, Mr. Serbinis was the chief technology officer of The docSpace
Company, which he co-founded in November 1997. From September 1996 to October 1997, Mr. Serbinis was a software engineer for Total Control, a subsidiary of General Electric. From April 1996 to August 1996, Mr. Serbinis was responsible for search
engine engineering at Zip2 Corporation.



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Barry Twohighas served as Executive Vice President, Engineering since October, 2002 and as Vice
President, Messaging since November 2000, after joining the Company as a result of the acquisition of ISOCOR Corporation, where he held Director of Engineering and other engineering management positions, since February 1995. From August 1988 to
January 1995, Mr. Twohig served in various roles at Retix Corporation.



Mark Palombajoined Critical Path in May 2004 as Executive Vice President, Worldwide Services, Support and Asia Pacific. Prior to joining Critical Path, Mr. Palomba served as Senior Vice President, Global Operations at Vastera, Inc.
from February 2000 to December 2003. Prior to joining Vastera, Mr. Palomba served as Senior Vice President of Consulting for Baan Americas, a software company from January 1999 to February 2000 and as Vice President of Consulting, Client Services
for Aurum Software from July 1998 to January 1999. From 1982 to July 1998, Mr. Palomba held numerous positions with the IBM Corporation.



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PART II



ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES



Market Information



Our common stock has been traded on the Nasdaq National Market under the symbol CPTH since March 1999. For the periods indicated, the
following table presents the high and low sale price per share of our common stock (as adjusted to reflect the reverse stock split of our authorized and outstanding common stock in August 2003) as reported on the Nasdaq National Market.



|                                        |  |                  |      |                  |   |      |  |     |      |  |   |     
|--------------------------------------- |  | ---------------- | ---- | ---------------- | - | ---- |  | --- | ---- |  | - | ----
|                                        |  | Fiscal year 2003 |      | Fiscal year 2004
|                                        |  | High             |      | Low              |   | High |  | Low
|First fiscal quarter ended March 31     |  | $                | 3.92 |                  | $ | 1.96 |  | $   | 2.66 |  | $ | 1.21
|Second fiscal quarter ended June 30     |  |                  | 4.76 |                  |   | 2.80 |  |     | 5.46 |  |   | 1.25
|Third fiscal quarter ended September 30 |  |                  | 6.96 |                  |   | 2.38 |  |     | 1.44 |  |   | 0.59
|Fourth fiscal quarter ended December 31 |  |                  | 3.30 |                  |   | 1.10 |  |     | 1.54 |  |   | 0.60



Holders



We have only one class of common stock and
as of March 1, 2005, there were approximately 1,162 holders of record of our common stock. Most shares of our common stock are held by brokers and other institutions on behalf of our shareholders.



Dividend Policy



We have never declared or paid any dividends on our common stock nor do we
anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to finance the operations and any expansion of our business. Currently, our credit facility with Silicon Valley Bank prohibits the
declaration of dividends absent their consent and an affirmative vote of the holders of a majority of the outstanding Series D preferred stock and holders of a majority of the outstanding Series E Redeemable Convertible Preferred Stock (Series E
preferred stock) shall be a prerequisite for the payment of dividends on our common stock. In addition, we are required to pay all accrued and unpaid dividends of our Series D preferred stock and Series E preferred stock before declaring or paying
dividends on our common stock. Any future determination to pay cash dividends will be at the discretion of our Board of Directors and will depend upon our financial condition, operating results, capital requirements and other factors our Board of
Directors deems relevant.



Sales of
Unregistered Securities and Purchases of Equity Securities



During the three months ended December 31, 2004, we did not sell any equity securities that were not registered under the Securities Act nor did we repurchase any of our equity securities. However, during the fiscal year ended December 31,
2004, the period covered by this report, we had sales of unregistered equity securities and made repurchases of our equity securities. These transactions are disclosed in our quarterly reports on Form 10-Q as filed with the SEC.



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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA



The selected consolidated statement of operations data during the five fiscal years ended December 31, 2000, 2001, 2002, 2003 and 2004 and selected
consolidated balance sheet data at December 31, 2000, 2001, 2002, 2003 and 2004 have been derived from our audited consolidated financial statements. The 2003 and 2004 consolidated balance sheet data and the 2002, 2003 and 2004 consolidated
statement of operations data are derived from the audited consolidated financial statements presented herein. The data set forth below should be read in conjunction with the audited consolidated financial statements and notes thereto included
elsewhere in this Annual Report on Form 10-K.



|                                                         |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|-------------------------------------------------------- |  | ---------------------------------------- | ---------- | - | ---- | - | -------- | ---- |  | - | -------- | - |  | ---- | ------- | - |  | - | -------- | -
|                                                         |  | Fiscal years ended December 31,          |           
|                                                         |  | 2000                                     |            |   | 2001 |   |          | 2002 |  |   | 2003     |   |  | 2004 |        
|                                                         |  | (in thousands, except per share amounts) |           
|Consolidated statement of operations data:               |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|Net revenues                                             |  | $                                        | 135,653    |   |      | $ | 104,173  |      |  | $ | 87,133   |   |  | $    | 72,297  |   |  | $ | 71,072   |  
|Cost of net revenues                                     |  |                                          | 121,921    |   |      |   | 123,041  |      |  |   | 70,422   |   |  |      | 48,284  |   |  |   | 48,552   |  
|                                                         |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|Gross profit                                             |  |                                          | 13,732     |   |      |   | (18,868  | )    |  |   | 16,711   |   |  |      | 24,013  |   |  |   | 22,520   |  
|Operating expenses (a)                                   |  |                                          | 1,831,449  |   |      |   | 222,830  |      |  |   | 122,105  |   |  |      | 74,884  |   |  |   | 63,924   |  
|                                                         |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|Operating income (loss)                                  |  |                                          | (1,817,717 | ) |      |   | (241,698 | )    |  |   | (105,394 | ) |  |      | (50,871 | ) |  |   | (41,404  | )
|Interest and other income (expense) (b)                  |  |                                          | (28,235    | ) |      |   | 169,440  |      |  |   | (11,538  | ) |  |      | (10,406 | ) |  |   | (9,481   | )
|                                                         |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|Loss before provision for income taxes                   |  |                                          | (1,845,952 | ) |      |   | (72,258  | )    |  |   | (116,932 | ) |  |      | (61,277 | ) |  |   | (50,885  | )
|Provision for income taxes                               |  |                                          | (6,513     | ) |      |   | (7,206   | )    |  |   | (979     | ) |  |      | (856    | ) |  |   | (1,112   | )
|                                                         |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|Net loss                                                 |  |                                          | (1,852,465 | ) |      |   | (79,464  | )    |  |   | (117,911 | ) |  |      | (62,133 | ) |  |   | (51,997  | )
|Accretion on mandatorily redeemable preferred stock (c)  |  |                                          |           |   |      |   | (356     | )    |  |   | (13,904  | ) |  |      | (12,446 | ) |  |   | (14,565  | )
|                                                         |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|Net loss attributable to common shares                   |  | $                                        | (1,852,465 | ) |      | $ | (79,820  | )    |  | $ | (131,815 | ) |  | $    | (74,579 | ) |  | $ | (66,562  | )
|                                                         |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|Basic and diluted net loss attributable to common shares |  | $                                        | (122.68    | ) |      | $ | (4.32    | )    |  | $ | (6.78    | ) |  | $    | (3.73   | ) |  | $ | (3.15    | )
|                                                         |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|Basic and diluted weighted average shares outstanding    |  |                                          | 15,100     |   |      |   | 18,495   |      |  |   | 19,445   |   |  |      | 20,020  |   |  |   | 21,123   |  
|                                                         |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|                                                         | 
|                                                         |  | At December 31,                          |           
|                                                         |  | 2000                                     |            |   | 2001 |   |          | 2002 |  |   | 2003     |   |  | 2004 |        
|                                                         |  | (in thousands)                           |           
|Consolidated balance sheet data:                         |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|Cash, cash equivalents and marketablesecurities (d)      |  | $                                        | 216,452    |   |      | $ | 69,165   |      |  | $ | 43,071   |   |  | $    | 18,984  |   |  | $ | 23,239   |  
|Working capital (d)                                      |  |                                          | 186,777    |   |      |   | 57,983   |      |  |   | 19,961   |   |  |      | 1,876   |   |  |   | 2,683    |  
|Goodwill and other intangible assets (e)                 |  |                                          | 124,094    |   |      |   | 48,641   |      |  |   | 6,613    |   |  |      | 6,613   |   |  |   | 6,613    |  
|Total assets                                             |  |                                          | 497,610    |   |      |   | 199,952  |      |  |   | 104,006  |   |  |      | 67,725  |   |  |   | 69,199   |  
|Current liabilities                                      |  |                                          |            |   |      |   |          |      |  |   |          |   |  |      |         |   |  |   |          |  
|Convertible subordinated notes payable (f)               |  |                                          | 300,000    |   |      |   | 38,360   |      |  |   | 38,360   |   |  |      | 38,360  |   |  |   | 5,565    |  
|Capital lease obligations, long-term portion             |  |                                          | 4,687      |   |      |   | 1,149    |      |  |   | 1,332    |   |  |      | 1,295   |   |  |   |         |  
|Mandatorily redeemable preferred stock (c)               |  |                                          |           |   |      |   | 306      |      |  |   | 14,210   |   |  |      | 30,411  |   |  |   | 122,377  |  
|Shareholders equity (deficit)                           |  |                                          | 113,104    |   |      |   | 108,972  |      |  |   | (8,554   | ) |  |      | (77,242 | ) |  |   | (112,189 | )

---

|(a) | For the year ended December 31, 2000, operating expenses include a $1.3 billion charge related to impairment of intangible assets including the deferred costs associated with our
ICQ and Qwest relationships and amortization of goodwill totaling $341.7 million. On January 1, 2002, in accordance with SFAS No. 142, Goodwill and Other Intangible Assets,we ceased amortizing goodwill.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| | For the year ended December 31, 2001, operating expenses include a $26.6 million charge related to impairment of certain long-lived assets, an $18.3 million charge related to costs
incurred in connection with strategic restructuring activities (see also Note 3Strategic Restructuring in the Notes to Consolidated Financial Statements) and amortization of goodwill totaling $0.6 million.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | For the year ended December 31, 2002, operating expenses include a $3.2 million charge related to costs incurred in connection with strategic restructuring activities (see also Note
3Strategic Restructuring 4 in the Notes to Consolidated Financial Statements).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | For the year ended December 31, 2003, operating expenses include a net $8.1 million charge related to costs incurred in connection with strategic restructuring activities. This
charge was partially offset by the reversal of $1.2 million in restructuring expenses recorded in the years ended December 31, 2001 and 2002 because it was determined that these amounts would not be paid in the future (see also Note
3]Strategic Restructuring 4 in the Notes to Consolidated Financial Statements). Additionally, operating expenses include a charge for the settlement of litigation totaling $5.1 million (see Note 12Commitments and Contingencies in the
Notes to Consolidated Financial Statements).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | For the year ended December 31, 2004, operating expenses include a net $3.4 million charge related to costs incurred with strategic restructuring activities, stock-based expenses of
$1.8 million primarily related to the severance agreement with our former chief executive officer and a $2.0 million charge to fully reserve a note receivable with a former officer that we have deemed uncollectible. The restructuring charge was
partially offset by the reversal of $2.3 million in restructuring expenses recorded in the year ended December 31, 2001 related to the anticipated disposition of certain capital assets (see also Note 3Strategic Restructuring in the Notes to
Consolidated Financial Statements).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) | For the year ended December 31, 2001, interest and other income (expense) include a gain of $179.3 million, net of applicable taxes and write downs of related debt issuance costs,
recognized on the retirement of $261.4 million of face value of convertible subordinated notes.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | For the year ended December 31, 2003, interest and other income (expense) include a gain of $3.8 million related to the early release of escrow funds related to the acquisition of
The docSpace Company (see also Note 7Related Party Transactions in the Notes to Consolidated Financial Statements).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | For the year ended December 31, 2004, interest and other income (expense) include a $12.8 million charge for loss on extinguishment of debt taken in connection with the conversion
of approximately $32.8 million of convertible notes payable into 21.9 million shares of Series E preferred stock (see also Note 13Mandatorily Redeemable Preferred Stock in the Notes to Consolidated Financial Statements).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(c) | During the years ended December 31, 2001 and 2003 we issued in aggregate, a total of approximately 4.2 million shares of Series D preferred stock in connection with certain
financing activities and a litigation settlement and in the year ended December 31, 2004 we issued approximately 55.9 million shares of Series E preferred stock in connection with the conversion of certain of our outstanding notes payable and the
rights offering. The accretion on mandatorily redeemable preferred stock represents the dividends accrued and accretion of the beneficial conversion feature during such periods.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | The mandatorily redeemable preferred stock represents the value of the outstanding Series D and E preferred stock at the years ended December 31, 2001 to 2004 (see also Note
13Mandatorily Redeemable Preferred Stock in the Notes to Consolidated Financial Statements). The embedded derivative liability has been reclassed for the years ended December 31, 2001, 2002 and 2003 to conform to the December 31, 2004
presentation.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(d) | See the discussion of Liquidity and Capital resources in Part II, Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



|(e) | See Note 7Goodwill and Other Intangible Assets in the Notes to Consolidated Financial Statements).
|--- | ---------------------------------------------------------------------------------------------------



|(f) | During the year ended December 31, 2001, we retired $261.4 million of face value of convertible subordinated notes and during the year ended December 31, 2004, $32.8 million of the
convertible subordinated notes converted to shares of Series E preferred stock (see also Note 13Mandatorily Redeemable Preferred Stock in the Notes to Consolidated Financial Statements).
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

ITEM7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS



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 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 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.



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. Our licensed messaging and identity management software often require integration with
customers existing infrastructure or customization to provide special features or capabilities. In addition, our consultants offer expertise and experience in designing and delivering new services that our customers can use to supplement their
own resources.



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.



22



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##### Table of Contents

Restructuring Initiatives



We have operated at a loss since our inception and as of December 31, 2004, we had an accumulated deficit of approximately
$2.3 billion, inclusive of 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 in an effort to achieve profitability 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.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 the first quarter of 2005. In 2004, we recorded a net restructuring charge of $3.6
million related to these activities. Included in this charge is a credit of approximately $2.3 million related to the adjustment of a restructure charge accrued in 2001 for the disposal of certain capital assets (see also Note 3Strategic
Restructuring in the Notes to Consolidated Financial Statements for additional information with respect to our restructuring activities). At December 31, 2004, we had a $0.8 million liability related to our restructure activities, the majority of
which we expect will be paid during 2005.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In
September 2004, we received a notice from the landlord of our headquarters facility in San Francisco, California notifying us 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 expect to vacate our facilities at 350 The Embarcadero and move into new office space provided for us at 2 Harrison Street, Suite #200 by no later than June 29, 2005. In connection with the landlords substitution right
and our relocation, we will be required to make a lease termination payment totaling approximately $1.3 million on June 1, 2005; however, the annual rent, on a cash basis, for our headquarters facility will decline from approximately $2.5 million
per year to an amount that, although still under negotiation, we expect to be less than $0.6 million per year. Additionally, we will incur costs related to the physical move and build out of the new facility; however, we cannot currently estimate
these costs as we have not yet engaged a moving company nor completed a detailed leasehold improvement plan. We currently believe that the $1.3 million lease termination payment will be accrued as a charge to our statement of operations during the
three months ended March 31, 2005.



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.



23



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##### Table of Contents

Critical Accounting Policies



The following discussion and analysis of our financial condition and results of operations are based upon our consolidated
financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the
reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or
conditions. Our significant accounting policies are described in Note 1The Company and Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements as of and for the year ended December 31, 2004. We believe our
most critical accounting policies and estimates include:



Revenue recognition. Our revenues are derived from four primary sources: software license sales, hosted messaging services, professional services and maintenance and support services. Revenues are recognized once the related products
or services have been delivered and collection of the associated fees is considered probable.



| |  |  | Software license revenues are generated from the sale of our messaging and identity management products as well as the resale of third-party software under perpetual and term
licenses. Software license revenues are recognized when persuasive evidence of an arrangement exists, delivery of the licensed software to the customer has occurred and the collection of a fixed or determinable license fee is considered probable. We
generally recognize license revenue from the sale of perpetual licenses upfront after the preceding criteria have been met while we recognize license revenue from the sale of term licenses ratably over the term of such licenses. Our revenue
recognition policies require that revenues recognized from software arrangements be allocated to each undelivered element of the arrangement based on the fair values of the elements, such as post contract customer support, installation, training or
other services.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We also sell our license
software products through resellers. Revenues from reseller agreements may include a nonrefundable, advance royalty which is payable upon the signing of the contract and license fees based on the contracted value of our products purchased by the
reseller. Additionally, revenues from reseller agreements may include nonrefundable fees related to software license products and related services for an identified customer of the reseller. Guaranteed license fees from resellers, where no right of
return exists, are recognized when persuasive evidence of an arrangement exists, delivery of the licensed software has occurred and the collection of a fixed or determinable license fee is considered probable. Non-guaranteed per-copy license fees
from resellers are initially deferred and are recognized when they are reported as sold to end-users by the reseller.



| |  |  | Hosted messaging revenues are generated from fees for hosting services we offer related to our messaging and collaboration solutions, including but not limited to email, calendar,
reserve and news groups. These are primarily based upon monthly contractual per unit rates for the services involved, which are recognized on a monthly basis over the term of the contract normally beginning with the month in which service delivery
starts. Amounts billed or received in advance of service delivery, including branding and set-up fees, are initially deferred and subsequently recognized on a ratable basis over the expected term of the relationship normally beginning with the month
in which service delivery starts.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Professional service revenues are generated from fees primarily related to training, installation and configuration services associated with implementing and maintaining our license
software products for our customers. Professional service revenues are recognized in the period in which the services are performed.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Maintenance and support service revenues are generated from fees for post-contract customer support agreements associated primarily with our software license products. Maintenance
services typically include rights to future update and upgrade product releases and dial-up phone services and the associated fees are typically paid up-front by the customer, deferred and recognized ratably over the term of the support contract,
which is generally one year.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



24



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##### Table of Contents

We also enter into arrangements that include multiple products and services where the services are deemed
essential to the functionality of a delivered element, under such circumstances we normally recognize the entire arrangement fee using the percentage of completion method. Under this method, individual contract revenues are recorded based on the
percentage relationship of the contract input hours incurred as compared to managements estimate of the total input hours to complete the contract.



Estimating allowance for doubtful accounts and contingencies. The preparation of financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and contingencies at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. For this reason, actual results could differ
from those estimates. Management must make estimates surrounding their ability to collect revenues and related accounts receivable. Management specifically analyzes accounts receivable, historical and current economic trends, previous bad debts,
customer concentrations, credit worthiness of customers, and payment terms of customer accounts, when evaluating adequacy of the allowance for doubtful accounts.



Management estimates liabilities and contingencies at the end of each period. The current financial statement presentation
reflects managements best estimates of liabilities and pending litigation which are probable and where the amount and range of loss can be estimated. We record the minimum liability related to those claims where there is a range of loss.
Because of the uncertainties related to the probability of loss and the amount and range of loss on the pending litigation, management may not be able to make an accurate estimate of the liability that could result from an unfavorable outcome. As
additional information becomes available, we will continue to assess the potential exposure related to our pending litigation and update our estimates and related disclosures. Such future revisions in our estimates could materially impact our
financial results.



Valuation and impairment of long-lived
assets and identifiable intangible assets. Finite-lived intangible assets are presented at cost, net of accumulated amortization. Amortization is calculated using the straight-line method over estimated useful lives of the assets, which
has historically been between 3 and 5 years. We will record an impairment charge on finite-lived intangibles or long-lived assets when we determine that the carrying value of intangibles and long-lived assets may not be recoverable. Factors
considered important which could trigger impairment, include, but are not limited to:



| |  |  | significant under performance relative to expected historical or projected future operating results;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | significant negative industry or economic trends;
| | - |  | -------------------------------------------------



| |  |  | significant decline in our stock price for a sustained period; and
| | - |  | ------------------------------------------------------------------



| |  |  | our market capitalization relative to net book value.
| | - |  | -----------------------------------------------------



Based upon the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cash flow method
using a discount rate determined by our management to be commensurate with the risk inherent in our current business model.



Stock-based compensation. We have historically applied the intrinsic value method of accounting provided under Accounting Principles Board (APB)
Opinion No. 25 and related interpretations. Under APB 25, issuing stock options to employees generally resulted in recognition of no compensation cost. Our stock-based employee compensation plans are described more fully in
Note 14Shareholders Equity (Deficit) in the Notes to Consolidated Financial Statements.



Stock-based employee compensation cost is reflected in net loss, as some options granted under those plans had an exercise price less than the fair value
of the underlying common stock on the date of grant and the shares of restricted stock granted under such plans have no exercise price. Such stock-based compensation is amortized using the straight-line method over the remaining vesting periods of
the related restricted stock and options, which is generally two to four years.



25



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##### Table of Contents

Pro forma information regarding net loss and net loss per share can be found in Note 1The Company
and Summary of Significant Accounting Policies Stock Based Compensation in the Notes to Consolidated Financial Statements.



Beginning on July 1, 2005, we are required to adopt the provisions of SFAS No. 123R which eliminates the alternative to use APB 25s intrinsic value
method of accounting that was provided in Statement 123 as originally issued. SFAS 123R will require entities to measure and recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair
value of those awards. That cost will be recognized over the period during which an employee is required to provide service in exchange for the awardthe requisite service period. See section captioned Recent Accounting
Pronouncements below.



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 the fourth quarter of 2003 and first quarter of 2004 we secured additional funds through several rounds of financing that involved the sale of senior secured notes, in the third quarter we completed a rights offering and in the
fourth quarter of 2004 we drew $11.0 million from an $18.0 million round of debt financing. In March 2005, we drew down the remaining $7.0 million from the $18.0 million round of debt financing. 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 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. We do not believe equity financing on terms reasonably acceptable to us 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 recent
periods indicated:



|                                             |  |                                |          |   |      |   |         |      |  |   |         |  
|-------------------------------------------- |  | ------------------------------ | -------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                             |  | Fiscal year ended December 31, |         
|                                             |  | 2002                           |          |   | 2003 |   |         | 2004 | 
|                                             |  | (in thousands)                 |         
|Net loss attributable to common shareholders |  | $                              | (131,815 | ) |      | $ | (74,579 | )    |  | $ | (66,562 | )
|Net cash used by operating activities        |  |                                | (25,065  | ) |      |   | (34,885 | )    |  |   | (32,327 | )



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 December 31, 2004, we had cash and cash equivalents available for operations totaling $23.2 million, of which $6.7 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 December 31, 2004 were $16.5 million, which included $11.0 million we drew from an $18.0 million round of debt financing
completed in December 2004. As of December 31, 2004, we had cash collateralized letters of credit totaling approximately $2.7 million. This cash is recorded as restricted cash on our balance sheet and is not readily available for our operations;
however, we believe that we will be able to reduce our letters of credit upon relocating our headquarters facility.



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Based on our financing activities in the fourth quarter of 2004 and the draw in March 2005 of the
remaining $7.0 million of the $18.0 million debt financing, we believe that we have sufficient cash to meet our cash operating requirements for the next 12 months, including the $1.3 million lease termination payment discussed above in the section
captioned Restructuring Initiatives along with the $5.6 million repayment of our outstanding 53/4% Convertible Subordinated Notes (the 53/4% Notes) due on April 1, 2005 as well as the
investments in capital equipment to support the transition our hosted messaging environment from an out-sourced model to one that we perform in-house and to support our on-going research and development efforts. 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 December 31, 2004 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 our letters of credit, totaling approximately $2.7 million. For additional information with respect to the credit facility, see Note 9Credit Facility in the Notes to Consolidated Financial Statements.



Cash and cash equivalents



The following table sets forth a summary of our primary sources and uses of
cash along with our cash and cash equivalents balance as of the dates indicated:



|                                                      |  |                                |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                      |  | Fiscal year ended December 31, |        
|                                                      |  | 2002                           |         |   | 2003 |   |         | 2004 | 
|                                                      |  | (in thousands)                 |        
|Beginning cash and cash equivalents                   |  | $                              | 59,463  |   |      | $ | 33,498  |      |  | $ | 18,984  |  
|Net cash used by operating activities                 |  |                                | (25,065 | ) |      |   | (34,885 | )    |  |   | (32,327 | )
|Net cash provided (used) by investing activities      |  |                                | (1,797  | ) |      |   | 6,332   |      |  |   | (6,617  | )
|Net cash provided (used) by financing activities      |  |                                | (781    | ) |      |   | 12,605  |      |  |   | 42,605  |  
|                                                      |  |                                |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents  |  |                                | (27,643 | ) |      |   | (15,948 | )    |  |   | 3,661   |  
|Effect of exchange rates on cash and cash equivalents |  |                                | 1,678   |   |      |   | 1,434   |      |  |   | 594     |  
|                                                      |  |                                |         |   |      |   |         |      |  |   |         |  
|Ending cash and cash equivalents                      |  | $                              | 33,498  |   |      | $ | 18,984  |      |  | $ | 23,239  |  
|                                                      |  |                                |         |   |      |   |         |      |  |   |         |  



Total cash and cash
equivalents increased from 2003 to 2004 primarily as a result of our financing activities, partially offset by cash used to support our operating and investing activities.



Net cash used by operating activities. Our operating activities used $32.3 million of cash during fiscal year 2004.
This cash was used to support our net loss of $52.0 million, adjusted for non-cash items such as: a $12.8 million loss on the extinguishment of debt, depreciation and amortization of $10.3 million, decreases in the fair value of a preferred stock
instrument of $(4.3) million, stock-based expenses of $1.9 million, a charge of $2.0 million to fully reserve a former officers note receivable and a ($1.6) million reduction in our restructure accrual; which totaled $31.1 million. Our net loss
attributable to common shareholders was primarily a result of our operating costs, including both cost of revenues and operating expenses which are primarily comprised of employee costs, third party contractor costs and restructuring costs, being
greater than our revenues.



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:



|                         |  |                                |        |      |   |        |  |   |       
|------------------------ |  | ------------------------------ | ------ | ---- | - | ------ |  | - | ------
|                         |  | Fiscal year ended December 31,
|                         |  | 2002                           |        | 2003 |   | 2004  
|                         |  | (in thousands, except DSOs)   
|Accounts receivable, net |  | $                              | 22,818 |      | $ | 16,880 |  | $ | 19,667
|DSOs                     |  |                                | 94     |      |   | 76     |  |   | 91    



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DSOs increased from 2003 to 2004 primarily due to customers deferring payment as a result of their
year-end cash management efforts as well as an increasing proportion of revenue from customers outside the United States to whom we generally offer payment terms customary to the region in which the customers are located. While these payment terms
are normal within the region in which they are provided, they are generally longer than the terms offered to customers in the United States. We believe that our DSOs are within industry norms, given the regions in which we operate. However, to the
extent our international revenues increase as a proportion of total revenues, our DSOs may also increase which would negatively impact our liquidity and capital resources.



A number of non-cash items, such as: depreciation and amortization, changes in the value of a preferred stock instrument,
stock-based expenses, accretion related to our preferred stock, loss on extinguishment of debt and certain restructuring charges, have been charged to expense and impacted our net losses during the fiscal year ended December 31, 2004. 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 this subsidiary may result in certain tax liabilities and 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 provided (used) by investing activities. Our investing
activities used $6.6 million of cash during the fiscal year ended December 31, 2004 primarily due to purchases of equipment totaling $4.2 million primarily used to support hosted messaging operations infrastructure and the $2.7 million cash used to
collateralize our letters of credit for certain facility leases. We will be required to continue to make investments in capital equipment during 2005 as we transition our hosted messaging environment from an out-sourced model to one that we perform
in-house and to support our on-going research and development efforts. We expect to fund these purchases through the use of our available cash resources or through leasing arrangements if available on terms we find acceptable. Additionally, we
intend to fund through the use of our available cash resources leasehold improvements for the new office space into which we will be moving our headquarters facility in 2005.



Cash provided by financing activities. Our financing activities provided $42.6 million of cash during the fiscal year
ended December 31, 2004 primarily as a result of gross proceeds totaling $45.0 million from a combination of proceeds we received from the issuance of convertible notes and our rights offering and $1.0 million of proceeds from the issuance of
our common stock through a combination of employee stock option exercises and activities under our employee stock purchase plan (ESPP) partially offset by $2.3 million of payments on our credit facility, $7.3 million of costs incurred in connection
with our financing activities and $1.1 million of payments on our capital equipment leases.



We receive cash from the exercise of stock options and the sale of stock under our ESPP. While we expect to continue to receive these proceeds in future
periods, the timing and amount of such proceeds is difficult to



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predict and is contingent on a number of factors including the price of our common stock, the number of employees participating in the stock option plans and
our employee stock purchase plan and general market conditions.



During the fiscal year ended December 31, 2004, we raised gross proceeds of approximately $48.5 million of cash in connection with the following financing transactions:



| |  |  | 10% Senior Convertible Notes (the Senior Notes)
| | - |  | -----------------------------------------------



In January 2004, we issued $15.0 million in principal amount of the Senior Notes to Permal U.S. Opportunities Limited, Zaxis Equity Neutral, L.P., Zaxis
Institutional Partners, L.P., Zaxis Offshore Limited, Zaxis Partners, L.P. and Passport Master Fund, L.P.



In March 2004, we issued $18.5 million in principal amount of the Senior Notes to investment entities affiliated with Crosslink Capital, Criterion Capital
Management, Heights Capital Management and Apex Capital.



At a
special meeting of shareholders in July 2004, we received approval from our shareholders to convert the Senior Notes plus all accrued and unpaid interest, into Series E preferred stock at $1.50 per share. As a result of the conversion, there was no
outstanding principal or interest outstanding related to the Senior Notes at December 31, 2004.



| |  |  | Rights Offering
| | - |  | ---------------



In August 2004, we consummated a rights offering pursuant to which we issued 2.6 million shares of Series E preferred stock with a purchase price of $1.50
per share, representing approximately $4.0 million in gross proceeds excluding underwriter discounts and commissions and other costs incurred in connection with the rights offering.



| |  |  | 13.9% Notes Payable (the 13.9% Notes)
| | - |  | -------------------------------------



In December 2004, we issued $11.0 million in principal amount of the 13.9% Notes, out of a total of $18.0 million, 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. In March 2005, we issued the remaining
$7.0 million of these notes. The 13.9% Notes accrue interest at a rate of 13.9% per annum, however; we are not obligated to make interest payments on these notes prior to the maturity date of December 2007.



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, under the terms of the Series D preferred stock and Series E preferred stock, we must seek the consent of the holders of a majority of our Series D preferred stock and the
holders of a majority of our Series E preferred stock 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.



29



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Contractual Obligations and Commitments



The table below sets forth our significant cash obligations and commitments as of December 31, 2004.



|                                                       |  |                |         |                                |   |        |      |  |      |       |      |   |        |  |            |         |  |   |       |  |   |      
|------------------------------------------------------ |  | -------------- | ------- | ------------------------------ | - | ------ | ---- |  | ---- | ----- | ---- | - | ------ |  | ---------- | ------- |  | - | ----- |  | - | -----
|                                                       |  |                |         | Fiscal year ended December 31,
|                                                       |  | Total          |         | 2005                           |   |        | 2006 |  | 2007 |       | 2008 |   | 2009   |  | Thereafter
|                                                       |  | (in thousands)
|Convertible subordinated notes, including interest (a) |  | $              | 5,725   |                                | $ | 5,725  |      |  | $    |      |      | $ |       |  | $          |        |  | $ |      |  | $ |     
|Mandatorily redeemable preferred stock                 |  |                | 187,581 |                                |   |       |      |  |      |      |      |   |       |  |            | 187,581 |  |   |      |  |   |     
|13.9% Notes (b)                                        |  |                | 16,586  |                                |   |       |      |  |      |      |      |   | 16,586 |  |            |        |  |   |      |  |   |     
|Operating lease obligations                            |  |                | 18,147  |                                |   | 5,593  | (d)  |  |      | 3,284 |      |   | 1,973  |  |            | 1,311   |  |   | 1,104 |  |   | 4,882
|Capital lease obligations                              |  |                | 1,084   |                                |   | 960    |      |  |      | 105   |      |   | 19     |  |            |        |  |   |      |  |   |     
|Other purchase obligations (c)                         |  |                | 4,390   |                                |   | 3,064  |      |  |      | 1,136 |      |   | 190    |  |            |        |  |   |      |  |   |     
|                                                       |  |                |         |                                |   |        |      |  |      |       |      |   |        |  |            |         |  |   |       |  |   |      
|                                                       |  | $              | 233,513 |                                | $ | 15,342 |      |  | $    | 4,525 |      | $ | 18,768 |  | $          | 188,892 |  | $ | 1,104 |  | $ | 4,882
|                                                       |  |                |         |                                |   |        |      |  |      |       |      |   |        |  |            |         |  |   |       |  |   |      

---

|(a) | Includes the 53/4% Notes due April 2005 and related interest amounts. At a special meeting in July 2004, our shareholders approved
the conversion of the majority of these and other notes into shares of Series E preferred stock, eliminating approximately $76.4 million of debt that existed at June 30, 2004.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | Includes the principal and related interest amounts.
|--- | ----------------------------------------------------

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

|(d) | Included is a $1.3 million lease termination payment and expected future rent related to the relocation of our headquarters facility. In September 2004, we received a notice from
the landlord of our headquarters facility in San Francisco, California notifying us 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 expect to vacate our
facilities at 350 The Embarcadero and move into new office space provided for us at 2 Harrison Street, Suite #200 by no later than June 29, 2005. In connection with the landlords substitution right and our relocation, we will be required to
make a lease termination payment totaling approximately $1.3 million on June 1, 2005; however, the annual rent, on a cash basis, for our headquarters facility will decline from approximately $2.5 million per year to an amount that, although still
under negotiation, we expect to be less than $0.6 million per year. Additionally, we will incur costs related to the physical move and build out of the new facility; however, we cannot currently estimate these costs as we have not yet engaged a
moving company nor completed a detailed leasehold improvement plan. We currently believe that the $1.3 million lease termination payment will be accrued as a charge to our statement of operations during the three months ended March 31, 2005.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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.



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The following table sets forth our results of operations for the fiscal years ended December 31, 2002,
2003 and 2004.



|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|---------------------------------------------------------------- |  | --------------------------------------------------- | ------------ | - | ------ | ------------ | ------- | ---- |  | - | ------- | - |  | - | ------- | - | - | ---- | - | - | - | ------- | - |  | ---- | -
|                                                                 |  | Fiscal year ended December 31,                      |              |   | Change |             
|                                                                 |  |                                                     | 2002 to 2003 |   |        | 2003 to 2004 |        
|                                                                 |  | 2002                                                |              |   | 2003   |              |         | 2004 |  |   | $       |   |  | % |         |   | $ |      |   | % |  
|                                                                 |  | (in thousands, except per share amounts; unaudited) |             
|NET REVENUE                                                      |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|Software licensing                                               |  | $                                                   | 35,176       |   |        | $            | 22,104  |      |  | $ | 19,326  |   |  | $ | (13,072 | ) |   | -37  | % |   | $ | (2,778  | ) |  | -13  | %
|Hosted messaging                                                 |  |                                                     | 24,893       |   |        |              | 19,444  |      |  |   | 17,842  |   |  |   | (5,449  | ) |   | -22  | % |   |   | (1,602  | ) |  | -8   | %
|Professional services                                            |  |                                                     | 11,593       |   |        |              | 12,315  |      |  |   | 12,829  |   |  |   | 722     |   |   | 6    | % |   |   | 514     |   |  | 4    | %
|Maintenance and support                                          |  |                                                     | 15,471       |   |        |              | 18,434  |      |  |   | 21,075  |   |  |   | 2,963   |   |   | 19   | % |   |   | 2,641   |   |  | 14   | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|Total net revenue                                                |  |                                                     | 87,133       |   |        |              | 72,297  |      |  |   | 71,072  |   |  |   | (14,836 | ) |   | -17  | % |   |   | (1,225  | ) |  | -2   | %
|                                                                 |  |                                                     |              |   |        |              |        
|COST OF NET REVENUE                                              |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|Software licensing                                               |  |                                                     | 2,682        |   |        |              | 4,068   |      |  |   | 5,463   |   |  |   | 1,386   |   |   | 52   | % |   |   | 1,395   |   |  | 34   | %
|Hosted messaging                                                 |  |                                                     | 29,303       |   |        |              | 26,193  |      |  |   | 25,404  |   |  |   | (3,110  | ) |   | -11  | % |   |   | (789    | ) |  | -3   | %
|Professional services                                            |  |                                                     | 10,020       |   |        |              | 12,203  |      |  |   | 11,939  |   |  |   | 2,183   |   |   | 22   | % |   |   | (264    | ) |  | -2   | %
|Maintenance and support                                          |  |                                                     | 8,670        |   |        |              | 5,803   |      |  |   | 5,495   |   |  |   | (2,867  | ) |   | -33  | % |   |   | (308    | ) |  | -5   | %
|Amortization of purchased technology                             |  |                                                     | 18,522       |   |        |              |        |      |  |   |        |   |  |   | (18,522 | ) |   | -100 | % |   |   |        |   |  | 0    | %
|Stock-based expense                                              |  |                                                     | 1,225        |   |        |              | 17      |      |  |   | 76      |   |  |   | (1,208  | ) |   | -99  | % |   |   | 59      |   |  | 347  | %
|Restructuring expense                                            |  |                                                     |             |   |        |              |        |      |  |   | 175     |   |  |   |        |   |   | 0    | % |   |   | 175     |   |  | 0    | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|Total cost of net revenue                                        |  |                                                     | 70,422       |   |        |              | 48,284  |      |  |   | 48,552  |   |  |   | (22,138 | ) |   | -31  | % |   |   | 268     |   |  | 1    | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|GROSS PROFIT                                                     |  |                                                     | 16,711       |   |        |              | 24,013  |      |  |   | 22,520  |   |  |   | 7,302   |   |   | 44   | % |   |   | (1,493  | ) |  | -6   | %
|                                                                 |  |                                                     |              |   |        |              |        
|OPERATING EXPENSES                                               |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|Selling and marketing                                            |  |                                                     | 43,604       |   |        |              | 31,224  |      |  |   | 22,703  |   |  |   | (12,380 | ) |   | -28  | % |   |   | (8,521  | ) |  | -27  | %
|Research and development                                         |  |                                                     | 19,649       |   |        |              | 19,047  |      |  |   | 20,973  |   |  |   | (602    | ) |   | -3   | % |   |   | 1,926   |   |  | 10   | %
|General and administrative                                       |  |                                                     | 22,128       |   |        |              | 12,603  |      |  |   | 15,005  |   |  |   | (9,525  | ) |   | -43  | % |   |   | 2,402   |   |  | 19   | %
|Amortization of intangible assets                                |  |                                                     | 24,773       |   |        |              |        |      |  |   |        |   |  |   | (24,773 | ) |   | -100 | % |   |   |        |   |  | 0    | %
|Acquisition-related retention bonuses                            |  |                                                     | 11           |   |        |              |        |      |  |   |        |   |  |   | (11     | ) |   | -100 | % |   |   |        |   |  | 0    | %
|Stock-based expense                                              |  |                                                     | 8,772        |   |        |              | 5,124   |      |  |   | 1,839   |   |  |   | (3,648  | ) |   | -42  | % |   |   | (3,285  | ) |  | -64  | %
|Restructuring expense                                            |  |                                                     | 3,168        |   |        |              | 6,886   |      |  |   | 3,404   |   |  |   | 3,718   |   |   | 117  | % |   |   | (3,482  | ) |  | -51  | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|Total operating expenses                                         |  |                                                     | 122,105      |   |        |              | 74,884  |      |  |   | 63,924  |   |  |   | (47,221 | ) |   | -39  | % |   |   | (10,960 | ) |  | -15  | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|LOSS FROM OPERATIONS                                             |  |                                                     | (105,394     | ) |        |              | (50,871 | )    |  |   | (41,404 | ) |  |   | 54,523  |   |   | -52  | % |   |   | 9,467   |   |  | -19  | %
|                                                                 |  |                                                     |              |   |        |              |        
|Other income (expense), net                                      |  |                                                     | (7,358       | ) |        |              | (8,026  | )    |  |   | 7,281   |   |  |   | (668    | ) |   | 9    | % |   |   | 15,307  |   |  | -191 | %
|Interest income                                                  |  |                                                     | 1,506        |   |        |              | 407     |      |  |   | 405     |   |  |   | (1,099  | ) |   | -73  | % |   |   | (2      | ) |  | 0    | %
|Interest expense                                                 |  |                                                     | (2,748       | ) |        |              | (3,336  | )    |  |   | (4,384  | ) |  |   | (588    | ) |   | 21   | % |   |   | (1,048  | ) |  | 31   | %
|Loss on extinguishment of debt                                   |  |                                                     |             |   |        |              |        |      |  |   | (12,783 | ) |  |   |        |   |   | 0    | % |   |   | (12,783 | ) |  | 0    | %
|Equity in net loss of joint venture                              |  |                                                     | (1,408       | ) |        |              |        |      |  |   |        |   |  |   | 1,408   |   |   | -100 | % |   |   |        |   |  | 0    | %
|Gain (loss) on investments                                       |  |                                                     | (1,530       | ) |        |              | 549     |      |  |   |        |   |  |   | 2,079   |   |   | -136 | % |   |   | (549    | ) |  | -100 | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|Loss before income taxes                                         |  |                                                     | (116,932     | ) |        |              | (61,277 | )    |  |   | (50,885 | ) |  |   | 55,655  |   |   | -48  | % |   |   | 10,392  |   |  | -17  | %
|                                                                 |  |                                                     |              |   |        |              |        
|Provision for income taxes                                       |  |                                                     | (979         | ) |        |              | (856    | )    |  |   | (1,112  | ) |  |   | 123     |   |   | -13  | % |   |   | (256    | ) |  | 30   | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|NET LOSS                                                         |  |                                                     | (117,911     | ) |        |              | (62,133 | )    |  |   | (51,997 | ) |  |   | 55,778  |   |   | -47  | % |   |   | 10,136  |   |  | -16  | %
|                                                                 |  |                                                     |              |   |        |              |        
|Dividend and accretion on mandatorily redeemable preferred stock |  |                                                     | (13,904      | ) |        |              | (12,446 | )    |  |   | (14,565 | ) |  |   | 1,458   |   |   | -10  | % |   |   | (2,119  | ) |  | 17   | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS                     |  | $                                                   | (131,815     | ) |        | $            | (74,579 | )    |  | $ | (66,562 | ) |  | $ | 57,236  |   |   | -43  | % |   | $ | 8,017   |   |  | -11  | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|Net loss per share attributable to common shareholders           |  | $                                                   | (6.78        | ) |        | $            | (3.73   | )    |  | $ | (3.15   | ) |  | $ | 3.05    |   |   | -45  | % |   | $ | 0.57    |   |  | -15  | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  
|Shares used in the per share calculations                        |  |                                                     | 19,445       |   |        |              | 20,020  |      |  |   | 21,123  |   |  |   | 575     |   |   | -3   | % |   |   | 1,103   |   |  | 6    | %
|                                                                 |  |                                                     |              |   |        |              |         |      |  |   |         |   |  |   |         |   |   |      |   |   |   |         |   |  |      |  



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NET REVENUES



Total net revenues decreased slightly from 2003 to 2004 and from 2002 to 2003 primarily as a result of decreased revenue
from the licensing of our messaging platform and the sale of our hosted messaging solutions partially offset by increased revenue from the sale of maintenance contracts and support services.



| |  |  | Software licensing.Software license revenues decreased in 2004 from 2003 primarily due to a $4.8 million decrease in license sales of our identity management software
partially offset by a $2.0 increase in license sales of certain third party software and our messaging server. License sales of our identity management software decreased due to decreased sales to ISP and enterprise customers primarily as a result
of increased competition and reduced sales focus on large enterprise opportunities in North America. License sales of the third party software we resell increased as a result of our customers searching for solutions that will protect their customers
from spam and viruses sent via email over the Internet and license sales of our messaging server increased as a result of growing demand from our European ISP customers as their subscriber bases grew. Software license revenues decreased in 2003 from
2002 primarily due to the closing of fewer transactions with customers in 2003 as compared to 2002 as a result of our restructuring initiatives undertaken in early 2003 which resulted in fewer sales executives and employees in the field, weak
economic conditions globally and political uncertainty in 2003 which caused customers to delay information technology spending, particularly in the telecommunications industry. The following table sets forth the components of our software license
revenues for the periods indicated:
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                              |  |                                |        |   |        |   |       |      |        |  |              |       |  |              |        |  |    |   |  |   |         |   |   |     |   |   |   |        |   |  |     |  
|----------------------------- |  | ------------------------------ | ------ | - | ------ | - | ----- | ---- | ------ |  | ------------ | ----- |  | ------------ | ------ |  | -- | - |  | - | ------- | - | - | --- | - | - | - | ------ | - |  | --- | -
|                              |  | Fiscal year ended December 31, |        |   | Change |  
|                              |  | 2002                           |        |   | 2003   |   |       | 2004 |        |  | 2002 to 2003 |       |  | 2003 to 2004 |       
|                              |  | Total                          |        | % |        |   | Total |      | %      |  |              | Total |  | %            |        |  | $  |   |  | % |         |   | $ |     |   | % |  
|                              |  | (in thousands)                 |       
|Messaging server              |  | $                              | 16,663 |   | 47     | % |       | $    | 6,932  |  | 31           | %     |  | $            | 7,837  |  | 41 | % |  | $ | (9,731  | ) |   | -58 | % |   | $ | 905    |   |  | 13  | %
|Identity management solutions |  |                                | 15,944 |   | 45     | % |       |      | 10,102 |  | 46           | %     |  |              | 5,291  |  | 27 | % |  |   | (5,842  | ) |   | -37 | % |   |   | (4,811 | ) |  | -48 | %
|Other                         |  |                                | 2,569  |   | 7      | % |       |      | 5,070  |  | 23           | %     |  |              | 6,198  |  | 32 | % |  |   | 2,501   |   |   | 97  | % |   |   | 1,128  |   |  | 22  | %
|                              |  |                                |        |   |        |   |       |      |        |  |              |       |  |              |        |  |    |   |  |   |         |   |   |     |   |   |   |        |   |  |     |  
|                              |  | $                              | 35,176 |   |        |   |       | $    | 22,104 |  |              |       |  | $            | 19,326 |  |    |   |  | $ | (13,072 | ) |   | -37 | % |   | $ | (2,778 | ) |  | -13 | %
|                              |  |                                |        |   |        |   |       |      |        |  |              |       |  |              |        |  |    |   |  |   |         |   |   |     |   |   |   |        |   |  |     |  



| |  |  | Hosted messaging.Hosted messaging revenues decreased in 2004 from 2003 primarily due to customers terminating or reducing their hosted messaging services with us as a result
of new competitors entering the market for hosted email services with lower cost, lower functionality products that may be more suited to our customers needs or customers terminating the email service offerings they sell to their end users.
Hosted messaging revenues decreased in 2003 from 2002 primarily due to the loss of customers as a result of a delay in the release of a new hosted messaging platform as well as reduced volumes from existing customers. We expect hosted revenues will
decline in 2005 as a result of the expiration of a certain customers contract at the end of our first fiscal quarter. The customer has decided not to renew the contract as a result of a change in their strategy with respect to their service
offering.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Professional services.Professional services revenues increased in 2004 from 2003 primarily due to increased revenues in Europe as a result of repeat delivery of some or all
of previously developed professional service solutions to our customers. Professional services revenues increased in 2003 from 2002 primarily due to improved utilization of existing internal professional services resources and additional projects
associated with software license sales.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Maintenance and support.Maintenance and support revenues increased in 2004 from 2003 primarily due to favorable renewal rates of existing customers, the
successful renewal of maintenance and support services with customers whose contracts had earlier expired, particularly in Europe, and the execution of new maintenance and support contracts associated with new license sales. Maintenance and support
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | revenues increased in 2003 from 2002 due primarily to renewals of existing maintenance and support agreements and increased revenues from maintenance and
support agreements with new and existing customers who were purchasing new software licenses.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The following table sets forth our total revenues by region for the fiscal years ended December 31, 2002, 2003 and 2004:



|                       |  |                                |        |   |        |   |       |      |        |  |              |       |  |              |        |  |    |   |  |   |         |   |   |     |   |   |   |        |   |  |     |  
|---------------------- |  | ------------------------------ | ------ | - | ------ | - | ----- | ---- | ------ |  | ------------ | ----- |  | ------------ | ------ |  | -- | - |  | - | ------- | - | - | --- | - | - | - | ------ | - |  | --- | -
|                       |  | Fiscal year ended December 31, |        |   | Change |  
|                       |  | 2002                           |        |   | 2003   |   |       | 2004 |        |  | 2002 to 2003 |       |  | 2003 to 2004 |       
|                       |  | Total                          |        | % |        |   | Total |      | %      |  |              | Total |  | %            |        |  | $  |   |  | % |         |   | $ |     |   | % |  
|                       |  | (in thousands)                 |       
|North America          |  | $                              | 40,461 |   | 46     | % |       | $    | 27,102 |  | 37           | %     |  | $            | 21,117 |  | 30 | % |  | $ | (13,359 | ) |   | -33 | % |   | $ | (5,985 | ) |  | -22 | %
|Europe                 |  |                                | 40,083 |   | 46     | % |       |      | 39,629 |  | 55           | %     |  |              | 46,795 |  | 66 | % |  |   | (454    | ) |   | -1  | % |   |   | 7,166  |   |  | 18  | %
|Latin America          |  |                                | 2,736  |   | 3      | % |       |      | 2,157  |  | 3            | %     |  |              | 1,529  |  | 2  | % |  |   | (579    | ) |   | -21 | % |   |   | (628   | ) |  | -29 | %
|Asia Pacific           |  |                                | 3,853  |   | 4      | % |       |      | 3,409  |  | 5            | %     |  |              | 1,631  |  | 2  | % |  |   | (444    | ) |   | -12 | % |   |   | (1,778 | ) |  | -52 | %
|                       |  |                                |        |   |        |   |       |      |        |  |              |       |  |              |        |  |    |   |  |   |         |   |   |     |   |   |   |        |   |  |     |  
|Subtotal international |  |                                | 46,672 |   | 54     | % |       |      | 45,195 |  | 63           | %     |  |              | 49,955 |  | 70 | % |  |   | (1,477  | ) |   | -3  | % |   |   | 4,760  |   |  | 11  | %
|                       |  |                                |        |   |        |   |       |      |        |  |              |       |  |              |        |  |    |   |  |   |         |   |   |     |   |   |   |        |   |  |     |  
|                       |  | $                              | 87,133 |   |        |   |       | $    | 72,297 |  |              |       |  | $            | 71,072 |  |    |   |  | $ | (14,836 | ) |   | -17 | % |   | $ | (1,225 | ) |  | -2  | %
|                       |  |                                |        |   |        |   |       |      |        |  |              |       |  |              |        |  |    |   |  |   |         |   |   |     |   |   |   |        |   |  |     |  



European revenues have
increased as a proportion of our total revenues and grew in 2004 from 2003 primarily due to growing demand within our existing European customer base, revenue from new customers and revenue recognized from our hosted messaging services with T-Mobile
and Virgin.net. Revenues in North America have decreased year-over-year and as a proportion of our total revenues primarily due to decreased license sales of our identity management software, as we have refocused our resources and efforts to our
messaging products, as well as customer concerns with respect to our viability.



We typically experience an increase in our revenues during the fourth quarter with a corresponding decrease in revenues during the first quarter of the new fiscal year, generally as a result of seasonality, and we
expect this trend to continue.



COST OF NET
REVENUES AND GROSS MARGIN



Total cost of net revenues
increased slightly in 2004 from 2003 primarily as a result of increased software licensing and restructuring costs partially offset by decreased costs for our hosted messaging, professional services and maintenance and support services.



| |  |  | Software licensing.Software license cost of revenues currently consist primarily of third-party royalty costs and historically had included product media duplication,
manuals and packaging materials, personnel and facility costs. Software license cost of revenues increased in 2004 from 2003 primarily due to a $1.1 million increase in sales of third party software that we resell and the related increase in royalty
costs associated with such sales. Software license costs increased in 2003 from 2002 due primarily to an increase in third party costs associated with certain license transactions that required us to purchase third party technology to integrate with
our offering.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Hosted messaging.Hosted messaging cost of revenues consists primarily of costs incurred in the delivery and support of hosted messaging services, including
equipment rental costs, depreciation and amortization expenses, employee related costs, Internet connection and co-location charges, maintenance costs as well as other direct and allocated indirect costs. Hosted messaging costs decreased in 2004
from 2003 primarily due to a $4.0 million decrease in depreciation and amortization expense as a result of the expiration of certain existing fixed assets as well as a $1.2 million decrease in co-location and connection fees as a result of the
outsourcing of our hosted services. These reductions were partially offset by a $2.7 million increase related to the outsource service provider utilized to host our service as well as a $1.0 million increase in employee expenses as our hosted
messaging staff increased to an average of 44 employees in 2004 from an average of 34 employees during 2003. Hosted messaging
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | costs decreased in 2003 from 2002 primarily due to cost savings generated through our 2002 and 2003 restructuring initiatives, including the reduction in
employees and related overhead and personnel costs of $0.9 million, the cancellation of certain outside consulting arrangements of $1.0 million, the sale or exit of several non-core services, the retirement of surplus network infrastructure
equipment and software and the consolidation of data centers.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Professional services.Professional services cost of revenues consist primarily of employee related and third party contractor costs providing installation, migration,
training services and custom engineering for both our hosted and licensed solutions as well as other direct and allocated indirect costs. Professional services costs decreased during 2004 from 2003 primarily due to offsetting variations in facility
and employee-related costs as a result of our restructuring efforts. Professional services costs increased in 2003 from 2002 primarily due to $2.3 million in incremental consulting and personnel costs associated with a significant European services
project partially offset by cost savings generated through our 2002 and 2003 restructuring initiatives, including the termination of employees and the reduction in related overhead and personnel costs.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 and licensed solutions as well as other direct and allocated indirect costs. Maintenance and support costs decreased in 2004 from 2003 primarily due to a $0.4 million decrease in facility and other overhead related
costs and a $0.3 million decrease in employee related costs partially offset by increased third party contractor costs. Maintenance and support staff decreased to an average of 28 employees in 2004 from an average of 33 employees in 2003.
Maintenance and support costs decreased in 2003 from 2002 due primarily to cost savings generated through our 2002 and 2003 restructuring initiatives, including the termination of employees and the reduction in related overhead and employee related
costs.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Amortization of purchased technology.Amortization of purchased technology represents the amortization of identifiable intangible assets related to existing technology in
2002 for some of our products acquired in fiscal year 2000. As of the end of 2002, these identifiable intangible assets had been fully amortized.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stock-based expense.Stock-based expenses represent 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 (see also Note 1The Company and Summary of Significant Accounting Policies Stock-Based
Compensation in the Notes to Consolidated Financial Statements). Stock-based expenses decreased in 2003 from 2002 primarily due to a reduction in the amount of stock options granted to non-employee contractors and reduced modifications made to
employees stock options.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Restructuring expense.Restructuring expense in 2004 is related to the write-off of certain purchased technology after we decided not to pursue development of the product
incorporating the licensed technology as a result of refocusing our operations on our core products and technology.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our total gross margin, which is our gross profit divided by our total net revenues, decreased to 32% in 2004 from 33% in 2003 primarily due to a decrease
in our software license and hosted messaging gross margins partially offset by increased gross margins in our professional services and maintenance and support services. Total gross margins increased to 33% in 2003 from 19% in 2002 primarily due to
the increase in maintenance and support services gross margins and the elimination of costs related to the amortization of purchased technology.



We expect our cost of revenues to decrease as a result of our restructure activities and in particular as a result of the transition of our hosted
messaging environment from an out-sourced model to one that we perform in-house.



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##### Table of Contents

OPERATING EXPENSES



Total operating expenses decreased in 2004 from 2003 primarily due to reduced selling and marketing costs as well as reduced
stock-based and restructuring expenses partially offset by increased research and development and general and administrative expenses. Total operating expenses decreased in 2003 from 2002 primarily due to reduced selling and marketing, research and
development, general and administrative expenses and stock-based expenses as well as the elimination of amortization of goodwill and other intangible assets in 2003 partially offset by increased restructuring expenses.



| |  |  | Sales and marketing. Sales and marketing expenses consist primarily of employee costs, including commissions, travel and entertainment, third party contractor costs,
advertising, public relations, other marketing related costs as well as other direct and allocated indirect costs. Sales and marketing expenses decreased in 2004 from 2003 primarily due to our continued restructuring activities in 2004. As a result
of these activities, employee-related costs decreased $4.2 million primarily as a result of termination of employees, facility related costs that were allocated to sales and marketing decreased $2.2 million primarily as a result of our continued
closure and consolidation of facilities and travel and entertainment expenses decreased $1.8 million primarily as a result of the reduced number of employees in sales and marketing. During 2004, our sales and marketing staff decreased to an average
of 71 employees in 2004 from an average of 110 employees in 2003. Sales and marketing expenses decreased in 2003 from 2002 due primarily to cost savings generated through our restructuring initiatives, including the termination of employees and
reduction in related overhead and personnel costs of approximately $7.0 million, the reduction in certain marketing program costs of approximately $2.3 million, and savings related to facilities consolidation of $3.2 million.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Research and development. Research and development expenses 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 indirect costs. Research and development expenses increased in 2004 from 2003 primarily due to a $1.7 million increase in
depreciation expenses as a result of the acceleration of depreciation on certain assets related to a newly developed messaging provisioning platform after it was determined the assets would be taken out of service before the end of their originally
estimated useful life and depreciation related to new capital expenditures as well as a $0.5 million increase in third-party contractor costs. These increases were partially offset by a $0.3 million decrease in employee-related and travel and
entertainment expenses allocated to research and development as a result of our continued restructuring activities. During 2004, our research and development staff decreased to an average of 120 employees in 2004 from an average of 131 employees in
2003. Research and development expenses decreased in 2003 from 2002 primarily due to cost savings generated through our 2002 and 2003 restructuring initiatives, including the termination of employees and the reduction in related overhead and
personnel costs of approximately $1.2 million and the consolidation of facilities of $1.0 million. These cost savings were partially offset by an increase in outside consulting expenses of approximately $0.6 million.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | General and administrative. General and administrative expenses consist primarily of employee-related costs, fees for outside professional services and other
direct and allocated indirect costs. General and administrative expenses increased in 2004 from 2003 primarily due to a $2.0 million charge to fully reserve a former officers note receivable as a result of the decline in the value of the
collateral securing the note and a $0.9 million charge recorded in connection with the severance agreement with our former chief executive officer, a $1.2 million increase in accounting professional services primarily as a result of our
Sarbanes-Oxley 404 compliance efforts and a $1.2 million increase in taxes and licenses primarily as a result of accruals for sales and use taxes and estimated Internal Revenue Service (IRS) penalty fees related to incomplete and delinquent
informational filings from previous years as well as payments on past-due property taxes. These charges and increased expenses were partially offset by a $1.0 million decrease in employee-related costs, a $0.6 million decrease in certain
telecommunications costs and a $0.5 million decrease in our facility related costs that was allocated to general and administrative primarily as a result of our restructuring activities. Additionally, our insurance costs
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| | decreased $0.5 million as a result of savings on our directors and officers insurance policy. During 2004, our general and administrative staff decreased to
an average of 56 employees in 2004 from an average of 71 employees in 2003. General and administrative expenses decreased in 2003 from 2002 primarily due to cost savings generated through our 2002 and 2003 restructuring initiatives, including the
termination of employees and the reduction in related overhead and personnel costs of approximately $2.9 million, the reduction in outside legal and litigation fees of $1.9 million, the reduction in bad debt expenses of $1.0 million, the reduction
in consulting expenses of $2.1 million and a reduction in accounting and audit fees of $0.2 million.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Amortization of intangible assets.Amortization of intangible assets represents the amortization of other intangible assets acquired in connection with our acquisitions in
1999 and 2000 and the amortization of intangible assets related to certain warrants issued to strategic partners. As of the end of 2002, these identifiable intangible assets had been fully amortized.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stock-based expense. Stock-based expenses represent 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 (see also Note 1The Company and Summary of Significant Accounting Policies Stock-Based
Compensation in the Notes to Consolidated Financial Statements). Stock-based expenses decreased in 2004 from 2003 primarily due to a court-approved settlement of litigation in 2003 related to which we issued 553,914 shares of common stock and
recorded a stock-based expense of $5.1 million for the fair value of such common stock and issued 188,587 shares of Series D preferred stock. Stock based-expense decreased in 2003 from 2002 primarily due to a reduction in the amount of stock options
granted to non-employee contractors and reduced modifications made to employees stock options as well as the decline in the price of our common stock which reduces the recorded value of our stock-based compensation.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Restructuring expense. Restructuring expenses consist primarily of employee severance costs as well as facility consolidation and lease termination costs incurred primarily
as a result of our restructuring actions. For the fiscal years ended December 31, 2002, 2003 and 2004 we recorded net charges $3.2 million, $6.9 million and $3.4 million, respectively, related to our restructuring activities. Included in our 2004
restructure activities is a credit of approximately $2.3 million related to the adjustment of a charge accrued in 2001 for the disposal of certain capital assets. The following table provides additional information with respect to the types of
restructuring charges included in our operating expenses for the periods indicated (see also Note 3Strategic Restructuring in the Notes to Consolidated Financial Statements for additional information with respect to our restructuring
activities).
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                       |  |                               |     |      |   |      |      |  |   |      |  
|-------------------------------------- |  | ----------------------------- | --- | ---- | - | ---- | ---- |  | - | ---- | -
|                                       |  | Fiscal year endedDecember 31, |    
|                                       |  | 2002                          |     | 2003 |   |      | 2004 | 
|                                       |  | (in millions)                 |    
|Employee severance benefits            |  | $                             | 2.1 |      | $ | 6.0  |      |  | $ | 4.4  |  
|Facility and operations consolidations |  |                               | 1.1 |      |   | 1.8  |      |  |   | 0.9  |  
|Non-core product divestitures          |  |                               |    |      |   | 0.3  |      |  |   | 0.4  |  
|Adjustments of previous charges        |  |                               |    |      |   | (1.2 | )    |  |   | (2.3 | )
|                                       |  |                               |     |      |   |      |      |  |   |      |  
|                                       |  | $                             | 3.2 |      | $ | 6.9  |      |  | $ | 3.4  |  
|                                       |  |                               |     |      |   |      |      |  |   |      |  



During 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, 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 the first quarter of 2005. At December 31, 2004, we had a $0.8 million liability related to our restructure activities, the majority of which we expect will be paid during 2005.



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##### Table of Contents

Our operating expenses have decreased during 2003 and 2004 primarily due to our restructure activities
undertaken during those years and efforts to control our costs. We expect that our operating expenses will decline in 2005 primarily as a result of the restructure activities undertaken in 2004.



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 embedded derivative in the Series D preferred stock that we issued in connection with a financing transaction in December 2001. In accordance with the provisions of SFAS No. 133,
Accounting for Derivative Instruments, we are required to adjust the carrying value of the derivative 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 or
expense. The following table sets forth the components of other income (expense), net for the periods indicated.



|                                                                      |  |                                |        |   |              |   |        |              |  |   |        |   |  |   |        |   |   |      |   |   |   |        |   |  |      |  
|--------------------------------------------------------------------- |  | ------------------------------ | ------ | - | ------------ | - | ------ | ------------ |  | - | ------ | - |  | - | ------ | - | - | ---- | - | - | - | ------ | - |  | ---- | -
|                                                                      |  |                                |        |   |              |   |        |              |  |   | Change |  
|                                                                      |  | Fiscal year ended December 31, |        |   | 2002 to 2003 |   |        | 2003 to 2004 | 
|                                                                      |  | 2002                           |        |   | 2003         |   |        | 2004         |  |   | $      |   |  | % |        |   | $ |      |   | % |  
|                                                                      |  | (in thousands)                 |       
|Foreign exchange gain (loss)                                          |  | $                              | 817    |   |              | $ | (437   | )            |  | $ | 3,055  |   |  | $ | (1,254 | ) |   | -153 | % |   | $ | 3,492  |   |  | -799 | %
|Gain (loss) from changes in the fair value of the embedded derivative |  |                                | (3,120 | ) |              |   | (8,090 | )            |  |   | 4,343  |   |  |   | (4,970 | ) |   | 159  | % |   |   | 12,433 |   |  | -154 | %
|Other                                                                 |  |                                | (5,055 | ) |              |   | 501    |              |  |   | (117   | ) |  |   | 5,556  |   |   | -110 | % |   |   | (618   | ) |  | -123 | %
|                                                                      |  |                                |        |   |              |   |        |              |  |   |        |   |  |   |        |   |   |      |   |   |   |        |   |  |      |  
|                                                                      |  | $                              | (7,358 | ) |              | $ | (8,026 | )            |  | $ | 7,281  |   |  | $ | (668   | ) |   | 9    | % |   | $ | 15,307 |   |  | -191 | %
|                                                                      |  |                                |        |   |              |   |        |              |  |   |        |   |  |   |        |   |   |      |   |   |   |        |   |  |      |  



Foreign exchange gain
(loss) will change primarily based upon fluctuations in the foreign currency rates between the U.S. dollar and the Euro. During 2004, the Euro strengthened considerably against the dollar which generated a gain from foreign currency transactions
associated with our international operations.



In connection
with issuing our Series D preferred stock in a financing transaction closed in 2001, the Series D preferred stock was deemed to have an embedded derivative instrument. In accordance with the provisions of SFAS No. 133, Accounting for Derivative
Instruments, we are 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 or expense. The estimated fair
value of the embedded derivative for the fiscal years ended December 31, 2002, 2003 and 2004 was $12.6 million, $24.9 million and $3.0 million, respectively.



Interest income



Interest income consists primarily of interest earnings on cash, cash equivalents and short-term investments. Interest income remained relatively
unchanged in 2004 from 2003 primarily as a result of our cash balances remaining relatively consistent during 2004 and 2003. Interest income decreased in 2003 from 2002 primarily due to the significant amount of cash used to support our operating
activities during 2002 and 2003.



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Interest expense



Interest expense consists primarily of the interest expense and amortization of issuance costs related to our Senior Notes issued in 2003 and 2004 and the
53/4% Notes issued in 2000 as well as interest and fees on our line of credit facility with Silicon Valley Bank and interest on certain capital leases and other long-term obligations. The following table sets forth the
components of interest expense for the periods indicated.



|                                               |  |                                |       |              |   |       |              |        |       |  |   |     |   |   |    |   |   |   |       |   |  |      |  
|---------------------------------------------- |  | ------------------------------ | ----- | ------------ | - | ----- | ------------ | ------ | ----- |  | - | --- | - | - | -- | - | - | - | ----- | - |  | ---- | -
|                                               |  |                                |       |              |   |       |              | Change |      
|                                               |  | Fiscal year ended December 31, |       | 2002 to 2003 |   |       | 2003 to 2004 |       
|                                               |  | 2002                           |       | 2003         |   | 2004  |              | $      |       |  | % |     |   | $ |    |   | % |  
|                                               |  | (in thousands)                 |      
|Senior Notes                                   |  | $                              |      |              | $ | 116   |              | $      | 1,979 |  | $ | 116 |   |   | 0  | % |   | $ | 1,863 |   |  | 1606 | %
|53/4%
Notes                                    |  |                                | 2,211 |              |   | 2,206 |              |        | 1,305 |  |   | (5  | ) |   | 0  | % |   |   | (901  | ) |  | -41  | %
|13.9% Notes                                    |  |                                |      |              |   |      |              |        | 8     |  |   |    |   |   | 0  | % |   |   | 8     |   |  | 0    | %
|Amortization of debt issuance costs            |  |                                | 275   |              |   | 275   |              |        | 436   |  |   |    |   |   | 0  | % |   |   | 161   |   |  | 59   | %
|Line of credit facility                        |  |                                |      |              |   | 440   |              |        | 370   |  |   | 440 |   |   | 0  | % |   |   | (70   | ) |  | -16  | %
|Capital leases and other long-term obligations |  |                                | 262   |              |   | 299   |              |        | 286   |  |   | 37  |   |   | 14 | % |   |   | (13   | ) |  | -4   | %
|                                               |  |                                |       |              |   |       |              |        |       |  |   |     |   |   |    |   |   |   |       |   |  |      |  
|                                               |  | $                              | 2,748 |              | $ | 3,336 |              | $      | 4,384 |  | $ | 588 |   |   | 21 | % |   | $ | 1,048 |   |  | 31   | %
|                                               |  |                                |       |              |   |       |              |        |       |  |   |     |   |   |    |   |   |   |       |   |  |      |  



Interest expense
increased in 2004 from 2003 primarily due to the interest which had accrued on the Senior Notes which we issued in the latter half of 2003 and early in 2004 partially offset by a reduction in the interest expense related to our 53/4% Notes as a result of the conversion of $32.8 million of such notes into shares of Series E preferred stock. See
Note 10Notes Payable in the Notes to Consolidated Financial Statements for additional information with respect to the conversion of the majority of our outstanding debt into shares of Series E preferred stock.



Loss on extinguishment of debt



Loss on extinguishment of debt is a non-cash charge taken in connection with
the conversion of approximately $32.8 million of convertible notes payable into 21.9 million shares of Series E preferred stock. See Note 10Notes Payable in the Notes to Consolidated Financial Statements for additional information with respect
to our loss on extinguishment of debt.



Equity in net loss of joint venture



Equity in net loss of joint venture represents our
portion of the 2002 losses of Critical Path Pacific, Inc., a joint venture we established in 2000 with Mitsui and Co., Ltd., NTT Communications Corporation and NEC Corporation to deliver advanced Internet messaging solutions to businesses in Asia.



In establishing this joint venture we invested $7.5 million
and held a 40% ownership interest, which we accounted for using the equity method. In 2002, we acquired the remaining 60% ownership interest in Critical Path Pacific, Inc. for $3.0 million in cash and the assumption of $2.6 million in business
restructuring and capital lease obligations and changed the name to Critical Path Japan, Inc. As a result of our acquisition of the remaining ownership interest, we began including the financial results of Critical Path Japan, Inc. in our own
consolidated financial result after the date of acquisition therefore there are no amounts charged to equity in net loss of joint venture for 2003 and 2004. Additionally, the excess of the purchase price we paid for the remaining ownership interest
of $5.6 million over the fair value of the acquired net assets, primarily working capital and fixed assets, of $4.6 million was recorded as goodwill. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets,the goodwill asset of
approximately $1.0 million was not amortized; however, it is tested for impairment on an annual basis, or more frequently if events or circumstances indicate that the asset might be impaired.



Gain (loss) on investments



The loss on investment in 2002 represents the other than temporary decline
in our investments in public and private companies in such year. The gain on investments in 2003 represents the net gain we realized through the



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sale of our remaining investments in public and private companies in such year. As a result of these sales, we did not carry any investments on our balance
sheet at December 31, 2003 and therefore there are no gains or losses recorded in 2004. The sale of our investments during 2003 resulted in a net gain of $0.5 million, which was comprised of $2.4 million in aggregate cash proceeds, the recognition
of $1.5 million in unrealized losses and the elimination of $0.4 million in assets held as equity investments (see also Note 5Investments in the Notes to Consolidated Financial Statements).



Provision for income taxes



The provision for income taxes in 2002, 2003 and 2004 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 in 2002, 2003 or 2004 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.



Our Series D preferred stock was originally issued in
connection with a financing transaction completed in 2001 from which we received gross cash proceeds of approximately $30.0 million and retired approximately $65.0 million in face value of our outstanding convertible subordinated notes in exchange
for shares of our Series D preferred stock. As originally issued, the Series D preferred stock accrued dividends at a rate of 8% per year, compounded on a semi-annual basis. Additionally, the Series D preferred stock was deemed to have an embedded
derivative related to the beneficial conversion feature which was limited to the net proceeds allocable to the Series D preferred stock of approximately $42.0 million. The value of the beneficial conversion feature when the Series D preferred stock
was originally issues was recorded as a reduction of the carrying amount of the Series D preferred stock and has been accreting over the term of the Series D preferred stock. In July 2004, at a special meeting of shareholders, our 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%. Additionally, we also had to record as a reduction to the carrying value of the
Amended Series D, the dividends which had accrued on the old Series D preferred stock totaling approximately $12.2 million. 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.



Our Series E preferred stock was
issued in connection with the conversion of $45.5 million of principal and accrued interest on our Senior Notes and $32.8 million of our 53/4% Notes payable into shares of Series E preferred stock as approved by our shareholders at the special meeting in July 2004. The Series E preferred stock has an automatic redemption date of July 2008
and accrues dividends at 53/4%. At issuance, the Series E preferred stock issued in exchange for the Senior
Notes was deemed to have a beneficial conversion feature totaling $16.3 million which was recorded as a reduction of the carrying amount of Series E preferred stock and will accrete over the term of the Series E preferred stock.



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



|                                           |  |                                |        |              |   |        |              |   |        |  |   |        |   |   |     |   |   |   |        |   |  |     |  
|------------------------------------------ |  | ------------------------------ | ------ | ------------ | - | ------ | ------------ | - | ------ |  | - | ------ | - | - | --- | - | - | - | ------ | - |  | --- | -
|                                           |  |                                |        | Change       |  
|                                           |  | Fiscal year ended December 31, |        | 2002 to 2003 |   |        | 2003 to 2004 |  
|                                           |  | 2002                           |        | 2003         |   | 2004   |              | $ |        |  | % |        |   | $ |     |   | % |  
|                                           |  | (in thousands)                 |       
|Accrued dividends                          |  | $                              | 4,427  |              | $ | 4,935  |              | $ | 7,315  |  | $ | 508    |   |   | 11  | % |   | $ | 2,380  |   |  | 48  | %
|Accretion of beneficial conversion feature |  |                                | 9,477  |              |   | 7,511  |              |   | 5,349  |  |   | (1,966 | ) |   | -21 | % |   |   | (2,162 | ) |  | -29 | %
|Accretion to redemption value              |  |                                |       |              |   |       |              |   | 1,901  |  |   |       |   |   | 0   | % |   |   | 1,901  |   |  | 0   | %
|                                           |  |                                |        |              |   |        |              |   |        |  |   |        |   |   |     |   |   |   |        |   |  |     |  
|                                           |  | $                              | 13,904 |              | $ | 12,446 |              | $ | 14,565 |  | $ | (1,458 | ) |   | -10 | % |   | $ | 2,119  |   |  | 17  | %
|                                           |  |                                |        |              |   |        |              |   |        |  |   |        |   |   |     |   |   |   |        |   |  |     |  



Recent Accounting Pronouncements



In March 2004, the Financial Accounting Standards Board
(FASB) approved the consensus reached on the Emerging Issues Task Force Issue (EITF) No. 03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-01 provides guidance on determining when an
investment is considered impaired, whether that impairment is other than temporary and the measurement of an impairment loss. EITF 03-01 also provides new disclosure requirements for other-than-temporary impairments on debt and equity investments.
In September 2004, the FASB delayed until further notice the effective date of the measurement and recognition guidance contained in EITF 03-01, however the disclosure requirements of EITF 03-01 are currently effective. The adoption of EITF 03-01 is
not expected to have a material impact on our financial position or results of operations.



In April 2004, the EITF issued EITF 03-06, Participating Securities and the Two-Class Method under SFAS No. 128, Earnings per Share. EITF 03-06 addresses a number of questions regarding the computation of earnings per
share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides
further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is
participating, including how to allocate undistributed earnings to such a security. EITF 03-06 is effective for fiscal periods beginning after March 15, 2004. The adoption of EITF 03-06 did not have a material impact on our results of operations and
financial position.



In December 2004, the FASB issued SFAS No.
123R, Share-Based Payment. The statement replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. This statement focuses primarily on accounting
for transactions in which an entity obtains employee services in share-based payment transactions. The adoption of the statement will result in the expensing of the fair value of stock options granted to employees in the financial statements.
Previously, we elected to only disclose the impact of expensing the fair value of stock options in the notes to the financial statements (see Note 1The Company and Summary of Significant Accounting Policies Stock-Based Compensation
in the Notes to Consolidated Financial Statements). The statement is effective for the quarters commencing after June 15, 2005.



The statement applies to new equity awards and to equity awards modified, repurchased, or canceled after the effective date. Additionally, compensation
cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of the effective date shall be recognized as the requisite service is rendered on or after the effective date. The compensation cost for
that portion of awards shall be based on the grant-date fair value of those awards as calculated from the pro forma disclosures under Statement No. 123. Changes to the grant-date fair value of equity awards granted before the effective date of this
statement are precluded. The compensation cost for those earlier awards shall be attributed to periods beginning on or after the effective date of this statement using the attribution method that was used under Statement No. 123, except that the
method of recognizing forfeitures only as they occur shall not be continued. Any unearned or deferred



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compensation related to those earlier awards shall be eliminated against the appropriate equity accounts. Additionally, common stock purchased pursuant to
stock options granted under our employee stock purchase plan will be expensed based upon the fair market value of the stock option.



The statement also allows for a modified version of retrospective application to periods before the effective date. Modified retrospective application may
be applied either (a) to all prior years for which Statement No. 123 was effective or (b) only to prior interim periods in the year of initial adoption. An entity that chooses to apply the modified retrospective method to all prior years for which
Statement No. 123 was effective shall adjust financial statements for prior periods to give effect to the fair-value-based method of accounting for awards granted, modified, or settled in cash in fiscal years beginning after December 15, 1994, on a
basis consistent with the pro forma disclosures required for those periods by Statement No. 123. Accordingly, compensation cost and the related tax effects will be recognized in those financial statements as though they had been accounted for under
Statement No. 123. Changes to amounts as originally measured on a pro forma basis are precluded.



The adoption of SFAS No. 123R will have a material impact on our results of operations, increasing cost of revenues, sales and marketing expenses,
research and development expenses and general and administrative expenses. The future results will be impacted by the number and value of additional stock option grants as well as the value of existing unvested stock options.



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 our financial position or results of operations.



In October 2004, the AJCA was passed. The AJCA provides a deduction for income from qualified domestic production activities which will be phased in from
2005 through 2010. In return, the AJCA also provides for a two-year phase-out of the existing extra-territorial income exclusion for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. In
December 2004, the FASB issued FASB Staff Position (FSP) No. 109-1, Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities by the American Jobs Creation Act of 2004. FSP No.
109-1 treats the deduction as a special deduction as described in SFAS No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction will
be reported in the same period in which the deduction is claimed in our tax return. We are currently evaluating the impact the AJCA will have on our results of operations and financial position.



The AJCA also creates a temporary incentive for U.S. corporations to
repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations. We are currently evaluating the AJCA and
are not yet in a position to decide whether, or to what extent, we might repatriate foreign earnings that have not yet been remitted to the United States.



On March 29, 2005, the SEC issued Staff Accounting Bulletin (SAB) 107 which express the views of the SEC regarding the interaction between SFAS No. 123R
and certain SEC rules and regulations and provided the SECs views regarding the valuation of share-based payment arrangements for public companies. In particular, SAB 107 provides guidance related to share-based payment transactions with
nonemployees, the transition from nonpublic to public entity status, valuation methods (including assumptions such as expected volatility and expected term), the accounting for certain redeemable financial instruments issue under share-based payment



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arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS No. 123R in and interim period,
capitalization of compensation cost related to share-based payment arrangements. The accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to adoption
of SFAS No. 123R and disclosures in Managements Discussion and Analysis of Financial Condition and Results of Operations subsequent to adoption of SFAS No. 123R. We are currently evaluating the impact SAB 107 will have on our results of operations
and financial position.



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 and identity management 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 against our competitors. 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 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. Any failure to properly manage
these systems and procedural transitions 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 have recently moved portions of our previously outsourced data operations in-house and to other service providers in order to lower costs and improve service. If we encounter
unexpected difficulties in managing our data operations in-house or in working with new service providers, we may fail to fully realize any anticipated cost savings or efficiencies.



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



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overcome viability concerns held by our prospective customers given our recent capital needs, the amount of resources necessary to maintain worldwide
operations and continued sluggishness in technology spending. 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.



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. Having obtained shareholder approval
on July 2, 2004, we amended the terms of the Series D preferred stock, including the conversion ratio, to increase the number of shares of common stock issuable upon conversion of the Series D preferred stock. As of March 1, 2005, there were
3,520,537 shares of Series D preferred stock outstanding, which were convertible into approximately 40.7 million shares of common stock. In addition, during the three months ended September 30, 2004, upon conversion of our Senior Notes, the exchange
of some of our Series D preferred stock and at the closing of our rights offering, we issued approximately 55.9 million shares of Series E preferred stock, which are convertible as of March 1, 2005, at the option of the holders, into approximately
57.9 million shares of common stock. We have received a demand from holders of Series E preferred stock to register shares of common stock issuable upon conversion of their shares of Series E preferred stock. We are in the process of preparing a
registration statement, which when completed will register up to approximately 29 million shares. 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 share 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, the approximately 55.9 million shares of Series E preferred stock outstanding currently have an aggregate liquidation preference of approximately $86.9 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 share (which, as of March 1, 2005, would result in an aggregate liquidation preference of approximately $61.1 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 the 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.



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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 18 million shares to approximately 116.6 million shares of common stock.



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 September 9, 2004, The Nasdaq Stock Market Inc. issued us a letter that we were not in compliance with the minimum closing bid price requirement and, therefore, faced delisting proceedings, although the minimum closing
bid price share of our common stock has recently exceeded $1.00 for a sufficient number of days, enabling us to regain compliance with the closing bid price requirement for continued listing. We may nevertheless be unable to comply with this or the
other quantitative maintenance criteria or any of the 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. For example, the closing price
for a share of our common stock recently fell below $1.00 once again and was $0.68 on March 30, 2005. If we fail to maintain continued listing on the Nasdaq National Market and must move to a market with less liquidity, our stock price would likely
further decline. If we are delisted, it could have a material adverse effect on the market price of, and the liquidity of the trading market for, our 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. We may identify additional material weaknesses before presenting managements final report on our internal control over financial reporting. 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 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 remediaton 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



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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.



We have not completed our evaluation of our internal control over financial reporting,
and failure to complete our evaluation in a timely manner could harm our business.



We are in the process of evaluating our internal control over financial reporting for the year ended December 31, 2004 required by Section 404 of the Sarbanes-Oxley Act of 2002. This annual report on Form 10-K reports
managements preliminary findings to date with respect to the evaluation of our internal control over financial reporting. Our independent registered accounting firm is also undergoing a similar evaluation of our internal control over financial
reporting, which is not yet completed. If either our management or independent registered accounting firm are unable to complete the evaluation of our internal control over financial reporting in a timely manner, investors may lose confidence in our
internal controls or we may become subject to regulatory sanctions or investigations, which could harm our operating results and the market price of our common stock. An inability to timely file an annual report on Form 10-K that contains a final
report of our internal control over financial reporting from our management and from our independent registered accounting firm would also delay our ability to utilize certain registration forms in order to register our common stock. If we are
unable to register common stock that is issued upon conversion of our outstanding preferred stock, we may be in violation of certain covenants we have with our holders of preferred stock, which could give rise to litigation or increased costs in
attempting to register our common stock using alternative forms of registration.



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 December 31, 2004, approximately $6.7 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 $2.7
million of our cash must be available to support our line of credit with Silicon Valley Bank and related letters of credit by the line of credit and is therefore unavailable for our operating activities.



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.



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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
messaging and directory infrastructure market, 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 consumer 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 and 27% in 2004. 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;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | 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 three months and year ended December 31, 2004, we incurred stock-based compensation expense of $0.3
million and $1.9 million, respectively, 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 through termination, sale or other disposition. 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.



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If we fail to improve our sales and marketing results, we may be unable to grow our business, 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 services. Current and prospective customers, in turn, must 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 enterprise customers with more frequency. In addition, certain of our
competitors have longer and closer relationships with the senior management of enterprise 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 2002, 2003 and 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 2002, 2003, and 2004, and we may continue to make additional changes to our senior management team. Our chief executive office and chairman, Mark Ferrer, joined us at the end of March 2004 and our chief financial officer, James Clark,
joined us on February 4, 2004. Because of these recent changes, our management team has not worked together as a group for an extended period of time and may not work together as effectively to successfully execute on revenue goals, implement our
strategies and manage our operations as they would if they had worked together for a longer period of time. If our 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 and the loss of any key strategic relationships could reduce our ability to sell our products and
services and our revenues to decline.



We depend on
strategic relationships to expand distribution channels and opportunities and to undertake joint product development and marketing efforts. Our ability to increase revenues depends upon aggressively marketing our services through new and existing
strategic relationships. For example, we depend on a broad acceptance of our software and outsourced messaging services on the part of potential resellers and partners. We also depend on joint marketing and product development through strategic
relationships to achieve further market acceptance and brand recognition. Our agreements with strategic partners typically do not restrict them from introducing competing services. These agreements typically are for terms of one to three years, and
automatically



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renew for additional one-year periods unless either party gives prior notice of its intention to terminate the agreement. In addition, these agreements are
terminable by our partners without cause, and some agreements are terminable by us. Most of our hosted customer agreements also provide for the partial refund of fees paid or other monetary penalties in the event that our services fail to meet
defined minimum performance standards. Distribution partners may choose not to renew existing arrangements on commercially acceptable terms, or at all. In addition to strategic relationships, we also depend on the ability of our customers
aggressively to sell and market our services to their end-users. If we lose any strategic relationships, fail to renew these agreements or 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.



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 fourth quarter of 2004, our top ten customers accounted for approximately 40% 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. 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 three months ended December 31, 2004, accounted for approximately 54% 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. 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;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



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



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



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



| |  |  | 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 and identity management infrastructure industry.



The messaging and identity management infrastructure 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.



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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, which was renewed in March 2005, may not be adequate for the liabilities and expenses potentially incurred in connection with current and 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.



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 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 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. In recent quarters we have
also initiated reductions in our work force and job eliminations 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. 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 and to make such determinations prudently could affect our future operations. A
failure to execute successfully on such plans and to plan appropriately could cause or expenses to continue to outpace our revenues and our financial condition could significantly decline.



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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 our competitors. The effects of terrorist attacks 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



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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, 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 and cannot screen all of the content generated by our users, and we could be exposed to liability with respect to this content. Furthermore, some foreign governments, such as Germany,



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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.



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.



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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.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



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.



We derived 54%, 62% and 68% of our revenues from international sales in 2002, 2003 and 2004. We intend to continue to operate in international markets and
to spend significant financial and managerial resources to do so. In particular, in 2002 we purchased the remaining interests of our joint venture partners for our operations in Japan. We hope to expend revenues and plan to increase resources to
grow our operations in the Asian market. 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



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March 1, 2005, the General Atlantic Investors beneficially own approximately 28.9% of our outstanding securities (which represents approximately 17.8% of the
voting power) and the Cheung Kong Investors beneficially own approximately 20.3% of our outstanding securities (which represents approximately 19.1% 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 nominate one director. Currently, one of our directors is affiliated with General 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, will 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.



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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 fourth quarter of 2004, the closing sale prices of our common stock on
the Nasdaq National Market ranged from $0.62 on October 4, 2004 to $1.47 on December 31, 2004. Our stock price may further decline or fluctuate in response to any number of factors and events, 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.



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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
our third quarter of 2005, to record a charge to earnings for employee stock option grants and other equity incentives. 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. See Note 1The Company and Summary of Significant Accounting Policies Stock-Based Compensation in the Notes to Consolidated Financial Statements
for a discussion of the impact on our financial results if we were to use the fair value method.



ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



The following table presents the hypothetical changes in fair value in the
53/4% Notes and 13.9% Notes at December 31, 2004. 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 an interest rate decrease of X basis points |        | No changein interestrate |   | Valuation of borrowing given an interest rate increase of X basis points
|            |  | 150 bps                                                                  |        | 100 bps                  |   | 50 bps                                                                   |  |   | 50 bps |  | 100 bps |        | 150 bps
|            |  | (in thousands)                                                          
|53/4%
Notes |  |                                                                          | 4,437  |                          |   | 4,391                                                                    |  |   | 4,346  |  |         | 4,301  |         |   | 4,256  |  |   | 4,211  |  |   | 4,167 
|13.9% Notes |  |                                                                          | 9,072  |                          |   | 9,063                                                                    |  |   | 9,054  |  |         | 9,045  |         |   | 9,036  |  |   | 9,027  |  |   | 9,018 
|            |  |                                                                          |        |                          |   |                                                                          |  |   |        |  |         |        |         |   |        |  |   |        |  |   |       
|            |  | $                                                                        | 13,509 |                          | $ | 13,454                                                                   |  | $ | 13,400 |  | $       | 13,346 |         | $ | 13,292 |  | $ | 13,238 |  | $ | 13,185
|            |  |                                                                          |        |                          |   |                                                                          |  |   |        |  |         |        |         |   |        |  |   |        |  |   |       



As of December 31,
2004, we had cash and cash equivalents of $23.2 million and no investments in marketable securities and our long-term obligations consisted of our $5.6 million five-year, 53/4% Notes due April 1, 2005, our $11.0 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 $3.1 million during 2004. To date, we have not sought to
hedge the risks associated with fluctuations in exchange rates.



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



Financial Statements



Reference is made to the Index of Consolidated Financial Statements that appears in Item 15(a)(i) of this report. The Report of Independent Registered
Accounting Firm, Consolidated Financial Statements, Notes to Consolidated Financial Statements and Financial Statement Schedule which are listed in the Index of Consolidated Financial Statements and which appear beginning on page 72 of this report
are incorporated into this Item 8.



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Supplementary Data



The selected consolidated quarterly statement of operations data during the two fiscal years ended December 31, 2003 and
2004. The data set forth below should be read in conjunction with the audited consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.



|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------ |  | ---------------------------------------- | ------- | - | ------ | - | ------- | ------ |  | - | ------- | - |  | ------ | ------- | - | ------ | - | ------- | ------ |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                                         |  | Three months ended                       |        
|                                                                         |  | Mar-03                                   |         |   | Jun-03 |   |         | Sep-03 |  |   | Dec-03  |   |  | Mar-04 |         |   | Jun-04 |   |         | Sep-04 |  |   | Dec-04  |  
|                                                                         |  | (in thousands, except per share amounts) |        
|Net revenues                                                             |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Software licenses                                                        |  | $                                        | 5,047   |   |        | $ | 5,592   |        |  | $ | 4,264   |   |  | $      | 7,201   |   |        | $ | 4,251   |        |  | $ | 5,407   |   |  | $ | 4,744   |   |  | $ | 4,924   |  
|Hosted messaging                                                         |  |                                          | 5,386   |   |        |   | 4,856   |        |  |   | 4,583   |   |  |        | 4,619   |   |        |   | 4,343   |        |  |   | 3,711   |   |  |   | 4,621   |   |  |   | 5,167   |  
|Professional services                                                    |  |                                          | 3,220   |   |        |   | 3,155   |        |  |   | 2,574   |   |  |        | 3,366   |   |        |   | 2,659   |        |  |   | 2,936   |   |  |   | 3,092   |   |  |   | 4,142   |  
|Maintenance and support                                                  |  |                                          | 4,381   |   |        |   | 4,533   |        |  |   | 4,744   |   |  |        | 4,776   |   |        |   | 5,825   |        |  |   | 4,962   |   |  |   | 5,038   |   |  |   | 5,250   |  
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Total net revenues                                                       |  |                                          | 18,034  |   |        |   | 18,136  |        |  |   | 16,165  |   |  |        | 19,962  |   |        |   | 17,078  |        |  |   | 17,016  |   |  |   | 17,495  |   |  |   | 19,483  |  
|Cost of net revenues                                                     |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Software licenses                                                        |  |                                          | 1,797   |   |        |   | 722     |        |  |   | 541     |   |  |        | 1,008   |   |        |   | 911     |        |  |   | 1,708   |   |  |   | 1,322   |   |  |   | 1,522   |  
|Hosted messaging                                                         |  |                                          | 6,263   |   |        |   | 7,103   |        |  |   | 6,196   |   |  |        | 6,631   |   |        |   | 6,381   |        |  |   | 6,570   |   |  |   | 5,995   |   |  |   | 6,458   |  
|Professional services                                                    |  |                                          | 3,450   |   |        |   | 2,910   |        |  |   | 2,734   |   |  |        | 3,109   |   |        |   | 3,094   |        |  |   | 3,034   |   |  |   | 2,667   |   |  |   | 3,144   |  
|Maintenance and support                                                  |  |                                          | 1,929   |   |        |   | 1,387   |        |  |   | 1,263   |   |  |        | 1,224   |   |        |   | 1,449   |        |  |   | 1,322   |   |  |   | 1,422   |   |  |   | 1,302   |  
|Stock-based expense                                                      |  |                                          | 17      |   |        |   |        |        |  |   |        |   |  |        |        |   |        |   | 5       |        |  |   |        |   |  |   |        |   |  |   | 71      |  
|Restructuring and other expenses                                         |  |                                          |        |   |        |   |        |        |  |   |        |   |  |        |        |   |        |   |        |        |  |   | 175     |   |  |   |        |   |  |   |        |  
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Total cost of net revenues                                               |  |                                          | 13,456  |   |        |   | 12,122  |        |  |   | 10,734  |   |  |        | 11,972  |   |        |   | 11,840  |        |  |   | 12,809  |   |  |   | 11,406  |   |  |   | 12,497  |  
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Gross profit                                                             |  |                                          | 4,578   |   |        |   | 6,014   |        |  |   | 5,431   |   |  |        | 7,990   |   |        |   | 5,238   |        |  |   | 4,207   |   |  |   | 6,089   |   |  |   | 6,986   |  
|Operating expenses                                                       |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Sales and marketing                                                      |  |                                          | 9,309   |   |        |   | 7,931   |        |  |   | 7,150   |   |  |        | 6,834   |   |        |   | 6,939   |        |  |   | 6,035   |   |  |   | 5,242   |   |  |   | 4,487   |  
|Research and development                                                 |  |                                          | 4,623   |   |        |   | 4,813   |        |  |   | 4,608   |   |  |        | 5,003   |   |        |   | 5,779   |        |  |   | 5,344   |   |  |   | 5,260   |   |  |   | 4,590   |  
|General and administrative                                               |  |                                          | 3,226   |   |        |   | 3,320   |        |  |   | 3,228   |   |  |        | 2,829   |   |        |   | 3,122   |        |  |   | 3,771   |   |  |   | 2,854   |   |  |   | 5,258   |  
|Stock-based expense (a)                                                  |  |                                          | 42      |   |        |   |        |        |  |   |        |   |  |        | 5,082   |   |        |   | 41      |        |  |   | 1,212   |   |  |   | 308     |   |  |   | 278     |  
|Restructuring and other expenses                                         |  |                                          | 3,189   |   |        |   | 892     |        |  |   | 953     |   |  |        | 1,852   |   |        |   | 1,065   |        |  |   | 1,144   |   |  |   | 2,590   |   |  |   | (1,395  | )
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Total operating expenses                                                 |  |                                          | 20,389  |   |        |   | 16,956  |        |  |   | 15,939  |   |  |        | 21,600  |   |        |   | 16,946  |        |  |   | 17,506  |   |  |   | 16,254  |   |  |   | 13,218  |  
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Operating loss                                                           |  |                                          | (15,811 | ) |        |   | (10,942 | )      |  |   | (10,508 | ) |  |        | (13,610 | ) |        |   | (11,708 | )      |  |   | (13,299 | ) |  |   | (10,165 | ) |  |   | (6,232  | )
|Other income (expense), net                                              |  |                                          | (6,543  | ) |        |   | 3,441   |        |  |   | (4,049  | ) |  |        | (875    | ) |        |   | 3,517   |        |  |   | 6,711   |   |  |   | (2,781  | ) |  |   | (166    | )
|Interest income                                                          |  |                                          | 116     |   |        |   | 85      |        |  |   | 105     |   |  |        | 101     |   |        |   | 150     |        |  |   | 22      |   |  |   | 125     |   |  |   | 108     |  
|Interest expense                                                         |  |                                          | (769    | ) |        |   | (783    | )      |  |   | (852    | ) |  |        | (932    | ) |        |   | (1,580  | )      |  |   | (2,065  | ) |  |   | (467    | ) |  |   | (272    | )
|Loss on extinguishment of debt (b)                                       |  |                                          |        |   |        |   |        |        |  |   |        |   |  |        |        |   |        |   |        |        |  |   |        |   |  |   | (12,783 | ) |  |   |        |  
|Gain on investments, net                                                 |  |                                          |        |   |        |   | 349     |        |  |   |        |   |  |        | 200     |   |        |   |        |        |  |   |        |   |  |   |        |   |  |   |        |  
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Loss before income taxes                                                 |  |                                          | (23,007 | ) |        |   | (7,850  | )      |  |   | (15,304 | ) |  |        | (15,116 | ) |        |   | (9,621  | )      |  |   | (8,631  | ) |  |   | (26,071 | ) |  |   | (6,562  | )
|Provision for income taxes                                               |  |                                          | (194    | ) |        |   | (287    | )      |  |   | (273    | ) |  |        | (102    | ) |        |   | (366    | )      |  |   | (445    | ) |  |   | (88     | ) |  |   | (213    | )
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Net loss                                                                 |  |                                          | (23,201 | ) |        |   | (8,137  | )      |  |   | (15,577 | ) |  |        | (15,218 | ) |        |   | (9,987  | )      |  |   | (9,076  | ) |  |   | (26,159 | ) |  |   | (6,775  | )
|Accretion on mandatorily redeemable preferred stock                      |  |                                          | (3,665  | ) |        |   | (2,839  | )      |  |   | (3,025  | ) |  |        | (2,917  | ) |        |   | (3,147  | )      |  |   | (3,348  | ) |  |   | (4,193  | ) |  |   | (3,877  | )
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Net loss attributable to common shareholders                             |  | $                                        | (26,866 | ) |        | $ | (10,976 | )      |  | $ | (18,602 | ) |  | $      | (18,135 | ) |        | $ | (13,134 | )      |  | $ | (12,424 | ) |  | $ | (30,352 | ) |  | $ | (10,652 | )
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Basic and diluted net loss per share attributable to common shareholders |  | $                                        | (1.37   | ) |        | $ | (0.55   | )      |  | $ | (0.92   | ) |  | $      | (0.89   | ) |        | $ | (0.63   | )      |  | $ | (0.59   | ) |  | $ | (1.43   | ) |  | $ | (0.50   | )
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  
|Basic and diluted weighted average shares outstanding                    |  |                                          | 19,666  |   |        |   | 19,873  |        |  |   | 20,126  |   |  |        | 20,415  |   |        |   | 21,014  |        |  |   | 21,157  |   |  |   | 21,171  |   |  |   | 21,252  |  
|                                                                         |  |                                          |         |   |        |   |         |        |  |   |         |   |  |        |         |   |        |   |         |        |  |   |         |   |  |   |         |   |  |   |         |  

---

|(a) | For the three months ended December 31, 2003, stock-based expense primarily represents the value of stock issued in connection with a court-approved settlement of claims by certain
former shareholders of Peerlogic, Inc. We issued approximately 0.6 million shares of common stock and approximately 0.2 million shares of Series D preferred stock in connection with such settlement.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | For the three months ended September 30, 2004, loss on extinguishment of debt represents a non-cash charge taken in connection with the conversion of approximately $32.8 million of
convertible notes payable into 21.9 million shares of Series E preferred stock (see also Note 10Notes Payable in the Notes to Consolidated Financial Statements).
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE



None



ITEM 9A. 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 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 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 of the material weaknesses discussed below. In light of the material weaknesses described below, we performed additional analysis and other post-closing procedures to ensure our
consolidated financial statements are prepared in accordance with generally accepted accounting principles. 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 Annual Report on Form
10-K. The disclosures set forth in this Item 9A contain information concerning the evaluation of our disclosure controls and procedures and changes in internal control over financial reporting, referred to in paragraph 4 of the certifications. Those
certifications should be read in conjunction with this Item 9A for a more complete understanding of the matters covered by the certifications.



Status of Managements Report on Internal Control Over Financial Reporting



Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such
term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we are in the process of evaluating the effectiveness of the Companys internal control over financial reporting based on the framework in Internal ControlIntegrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. As of the filing of this Form 10-K, our evaluation has not been completed. In accordance with SEC Release No. 50754Order Under Section 36
of the Securities Exchange Act of 1934 Granting an Exemption From Specified Provisions of Exchange Act Rules 13a-1 and 15d-1, we intend to file our managements report on the effectiveness of the



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Companys internal control over financial reporting as of December 31, 2004, no later than 45 days from March 16, 2005. Although managements
assessment of the Companys internal control over financial reporting is not complete, management has identified certain control deficiencies which represent material weaknesses at December 31, 2004. These material weaknesses are discussed in
greater detail below. The existence of one or more material weaknesses at December 31, 2004 precludes management from concluding that the Companys internal control over financial reporting was effective as of December 31, 2004, based on the
criteria in the Internal ControlIntegrated Framework. Accordingly, our independent registered public accounting firm expects to issue an adverse opinion on the effectiveness of our internal control over financial reporting.



A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected. To date, we have identified the following material weaknesses in our internal control over
financial reporting for the period ending December 31, 2004:



| |  |  | Lack of resources to apply generally accepted accounting principles to significant non-routine transactions. At December 31, 2004, we lacked internal expertise and resources
to analyze and apply generally accepted accounting principles for non-routine transactions, such as (i) extinguishment of debt, (ii) recording of embedded derivatives, and (iii) recording of beneficial conversion features. This control deficiency
resulted in material audit adjustments to long-term debt, embedded derivative liabilities, mandatorily redeemable preferred stock, common stock, other income and loss on extinguishment of debt which was reflected in the interim and annual periods of
2004.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Inadequate controls over period-end financial reporting processes. At December 31, 2004, we had insufficient documentation of our controls over the period-end financial
reporting process which has resulted, in part, from our use of disparate accounting systems in our various geographical locations. Specifically, we identified deficiencies, principally related to the documentation and design of the following: (i)
independent and timely review of our consolidation, analyses and financial reporting processes; (ii) procurement controls which could result in liabilities not being reported in the proper period; (iii) license revenue recognition reviews; (iv)
professional services revenue recognition reviews; (v) reviews of allowances for bad debt and customer credit; (vi) review and approval of journal entries to the general ledger; (vii) internal reporting and analyses such as business performance
reviews and (viii) internal controls over accounting for income taxes and other taxes. This control deficiency resulted in material audit adjustments to accounts payable, deferred revenues, revenues and operating expenses which was reflected in the
interim and annual periods of 2004.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Inadequate segregation of duties and lack of adequate oversight. At December 31, 2004, we did not maintain proper segregation of duties and adequate review and oversight of
our personnel in several of our subsidiary offices as well as in our administrative centers in the United States and Ireland. The inadequate segregation of duties impacted our (i) financial reporting controls, (ii) revenue controls, (iii)
expenditure controls, (iv) payroll controls, (v) corporate treasury controls, (vi) governance controls and (vii) information technology controls. In addition, the inadequate segregation of duties is further impacted by the discussion
belowInadequate controls over access to financial applications and data. In several instances, we had the same personnel performing duties that were not compatible.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | In addition, management did not have adequate oversight of these personnel to compensate for the inadequate segregation of duties. We have identified deficiencies where the same
individual had authority for activities that should be segregated, such as (i) billing and collection; (ii) vendor or employee master file maintenance and transaction processing, such as payment or invoicing; (iii) customer master file maintenance
and transaction processing, such as ordering or collections; (iv) cash transfer and bank account reconciliations; (v) journal entry creation and posting and (vi) opening and closing accounting periods. This control deficiency did not result in an
adjustment to the 2004 annual or interim financial statements. However, this control deficiency could result in a material misstatement of our annual or interim consolidated financial statements due to unintentional error, improper reporting or
fraud.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Inadequate controls over access to financial applications and data At December 31, 2004, we did not maintain effective controls over access to financial applications and
data. Such deficiencies include inadequate design and documentation of internal access security policies and segregation of duties requirements and a lack of independent monitoring of IT staff and some users with financial, accounting and reporting
responsibilities that also have access to financial application programs and data. This control deficiency did not result in an adjustments to the 2004 annual or interim financial statements.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Each of the control deficiencies described above could result in
misstatements of the aforementioned accounts that would result in a material misstatement to the annual or interim financial statements that would not be prevented or detected.



Accordingly, management has determined that each of these control deficiencies individually represent material weaknesses.
The existence of one or more material weaknesses at December 31, 2004 precludes management from concluding that the Companys internal control over financial reporting was effective as of December 31, 2004, based on the criteria in the
Internal ControlIntegrated Framework.



The
Companys evaluation of its internal control over financial reporting as of December 31, 2004 is not complete. Further, there can be no assurance that as a result of the ongoing evaluation of internal control over financial reporting,
additional deficiencies will not be identified or that any deficiencies identified, either alone or in combination with others, will represent a material weakness.



Changes in Internal Control Over Financial Reporting



As discussed above, management has not completed its assessment of the Companys internal control over financial
reporting. However, management is aware of material weaknesses, that have resulted in changes in the Companys internal control over financial reporting during the quarter ended December 31, 2004 that have materially affected, or are reasonably
likely to materially affect, the Companys internal control over financial reporting. Our management has discussed the material weaknesses described above and other deficiencies with our audit committee. In an effort to remediate the identified
material weaknesses and other deficiencies, we have initiated a number of changes to our internal control over financial reporting including the following:



| |  |  | We established documentation policies and procedures for accounting review of month-end close, journal entries, payrolls, revenue contracts, write-offs, restructuring related
entries, impairment reviews and tax related entries;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We purchased an online accounting research tool and will train our accounting managers in its use to assist in consistent financial reporting and application of accounting policies
and procedures; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We have migrated record keeping for a foreign subsidiary to our Oracle accounting application.
| | - |  | ----------------------------------------------------------------------------------------------



Additionally, in response to the material weaknesses identified, we intend to implement additional 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;
| | - |  | ----------------------------------------------------------------------------------------------



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



| |  |  | requiring passwords, which are changed every 90 days, to access critical systems and financial applications;
| | - |  | ------------------------------------------------------------------------------------------------------------



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



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



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.



Prior to the filing of our managements report on the effectiveness of internal control over financial reporting, we may identify additional deficiencies, some of which may constitute material weaknesses either
individually or when taken into account with other identified deficiencies, in our internal control over financial reporting. We may also identify additional remedial actions necessary to address material weaknesses already identified or identified
prior to the filing of managements report on internal control over financial reporting.



ITEM 9B. OTHER INFORMATION



On March 28, 2005, the Compensation Committee of our Board of Directors approved the cash awards with respect to the bonus component for the fiscal period
ended on December 31, 2004 of our chief executive officer and other officers who are reporting persons under Section 16 of the Securities Exchange Act of 1934, our executive officers. The bonus awards were determined based on the actual performance
of the company during the fiscal year 2004 as measured against certain performance objectives. The following table sets forth the cash bonus awards for the fiscal period ending on December 31, 2004 to our executive officers:



|                       |  |                                                         |  |                  |       
|---------------------- |  | ------------------------------------------------------- |  | ---------------- | ------
|Executive Officer Name |  | Title                                                   |  | 2004 Bonus Award
|Mark J. Ferrer         |  | Chief Executive Officer and Chairman                    |  | $                | 25,000
|James A. Clark         |  | Executive Vice President and Chief Financial Officer    |  | $                | 15,000
|Michael J. Zukerman    |  | Executive Vice President, General Counsel and Secretary |  | $                | 15,000
|Menelaos Serbinis      |  | Chief Technology Officer and EVP of Marketing           |  | $                | 22,500
|Barry Twohig           |  | Executive Vice President, Engineering                   |  | $                | 15,000
|Mark Palomba           |  | Executive Vice President, WW Services, Support          |  | $                | 17,000



On March 28, 2005, our
Compensation Committee approved an additional payment of $18,000 to Mark J. Ferrer, our chief executive officer and chairman, to reimburse him for taxes he incurred as a result of our payment of approximately $27,000 to Mr. Ferrers legal
counsel in connection with the negotiation and execution of Mr. Ferrers employment agreement with us.



On October 27, 2004, our Compensation Committee approved the compensation of our non-employee directors for fiscal year 2005. Each non-employee director
shall receive an annual retainer of $5,000 for serving as a director. In addition, the following annual cash retainers will be paid for services on board committees:



|                                                                |  |   |       
|--------------------------------------------------------------- |  | - | ------
|Non-chair Member of Compensation Committee                      |  | $ | 2,500 
|Non-chair Member of Nominating & Corporate Governance Committee |  | $ | 2,500 
|Non-chair Member of Audit Committee                             |  | $ | 5,000 
|Chair of Compensation Committee                                 |  | $ | 5,000 
|Chair of Nominating & Corporate Governance Committee            |  | $ | 5,000 
|Chair of Audit Committee                                        |  | $ | 10,000



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All of these cash payments are paid incrementally on a quarterly basis. Each non-employee director shall
also be paid $2,000 for each full board meeting attended in person, $1,000 for each committee meeting attended in person and $500 for each meeting attended by telephone.



Upon appointment to the Board of Directors, non-employee directors will receive an initial grant of an option to purchase
75,000 shares of our common stock under the terms of our Amended and Restated 1998 Stock Incentive Plan (our 1998 Plan). These options will become exercisable over a four-year period, at a rate of 1/48thper month. Thereafter, following the conclusion of each regular annual meeting of shareholders, each non-employee director will receive a grant of an option
to purchase 15,000 shares of our common stock under the terms of our 1998 Plan, if, on such date, he or she will continue to serve on our Board of Directors. These annual option grants will become exercisable over a three-year period, at a rate of
1/36thper month.



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PART III



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT



The information required by Item 10 of Form 10-K regarding our directors is
incorporated herein by reference from the information contained in the section captioned Election of Directors in our definitive proxy statement for our 2005 annual meeting of shareholders (Proxy Statement) to be filed with
the United States Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 2004. Certain information required by this item concerning executive officers is set forth in Part I of this Report under the
caption Executive Officers of the Registrant.



The
information required by this Item 10 regarding our audit committee and audit committee financial expert is incorporated herein by reference from the information contained in the Proxy Statement.



The information required by this Item 10 regarding Section 16(a) Beneficial
Ownership Reporting Compliance is incorporated herein by reference from the information contained in the section captioned Section 16(a) Beneficial Ownership Reporting Compliance in the Proxy Statement.



We have adopted the Critical Path, Inc. Code of Ethics and Business Conduct
for Officers, Employees and Directors (the code of ethics). The code of ethics applies to our principal executive officer, principal financial officer and principal accounting officer and all our other employees and is publicly available
on our website at www.criticalpath.net. If we make any amendments to the code of ethics or grant any waiver, including any implicit waiver, from a provision of the code to our principal executive officer, principal financial officer and
principal accounting officer that requires disclosure under applicable SEC rules, we intend to disclose the nature of such amendment or waiver on our website.



ITEM 11. EXECUTIVE COMPENSATION



The information required by Item 11 of Form 10-K is incorporated herein by reference from the information contained in the sections captioned
Executive Compensation and Director Compensation in our Proxy Statement.



ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS



The information required by Item 12 of Form 10-K is incorporated herein by reference from the information contained in the section captioned
Security Ownership of Certain Beneficial Owners and Management in our Proxy Statement.



The following table provides information with respect to our compensation plans under which equity securities are authorized for issuance as of our fiscal
year ended December 31, 2004.



|                                                          |  |                                                                                          |     |  |                                                                          |       |                                                            |           |    
|--------------------------------------------------------- |  | ---------------------------------------------------------------------------------------- | --- |  | ------------------------------------------------------------------------ | ----- | ---------------------------------------------------------- | --------- | ---
|                                                          |  | Number of securities tobe issued upon exerciseof outstanding options,warrants and rights |     |  | Weighted averageexercise price ofoutstanding options, warrantsand rights |       | Number of securitiesremaining available forfuture issuance |          
|Equity compensation plan approved by shareholders         |  | 9,017,349                                                                                | (a) |  | $                                                                        | 16.41 |                                                            | 4,691,691 | (b)
|Equity compensation plan not approved by shareholders (c) |  | 6,073,809                                                                                |     |  |                                                                          | 2.85  |                                                            | 265,598   |    
|                                                          |  |                                                                                          |     |  |                                                                          |       |                                                            |           |    
|Total                                                     |  | 15,091,158                                                                               |     |  |                                                                          | 10.95 |                                                            | 4,957,289 |    
|                                                          |  |                                                                                          |     |  |                                                                          |       |                                                            |           |    

---

|(a) | As a result of our previous business acquisition activities, there are 48,519 shares of common stock to be issued upon the exercise of outstanding options at an average exercise
price of approximately $45.17 per share.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(b) | Includes 669,338 shares of common stock available for future issuance under our employee stock purchase plan (ESPP). The number of shares reserved for issuance under the ESPP is
subject to an annual increase on January 1 of each year by an amount equal to 1% of our issued and outstanding common stock on such date, not to exceed 1,000,000 additional shares each year.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | Additionally, the number of shares reserved for issuance under the 1998 Stock Option Plan (the 1998 Plan), our shareholder approved plan, is subject to an annual increase on January
1 of each year by an amount equal to 2% of the total number of our common stock authorized for issuance. As a result, we added 4 million options to the 1998 Plan for future issuance to purchase shares of our common stock in January 2005. The
aggregate number of shares of common stock which may be issued under the 1998 Plan shall at all times be subject to adjustment as a result of stock splits, dividends payable in shares, combinations or consolidations of outstanding stock,
recapitalizations, mergers or reorganizations. Stock options, restricted stock, restricted stock units or stock appreciation rights may be awarded under the 1998 Plan.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



See NoteShareholders Equity (Deficit) in the Notes to Consolidated Financial Statements for a brief summary of
the material features of the 1999 Nonstatutory Stock Option Plan, our non-shareholder approved equity compensation plan.



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS



The information required by Item 13 of Form 10-K is incorporated herein by reference from the information contained in the
sections captioned Certain Relationships and Related Transactions and Audit Committee Pre-Approval Policies and Procedures in our Proxy Statement.



ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES



The information required by Item 14 of Form 10-K is incorporated herein by reference from the information contained in the
section captioned Principal Accounting Fees and Services in our Proxy Statement.



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PART IV



ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES



(a)(1) Index to Consolidated Financial Statements



Please see the Index to Consolidated Financial Statements that appears below.



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                          |  |     
|--------------------------------------------------------- |  | ----
|                                                          |  | Page
|Report of Independent Registered Public Accounting Firm   |  | 72  
|Consolidated Balance Sheets                               |  | 73  
|Consolidated Statements of Operations                     |  | 74  
|Consolidated Statements of Shareholders Equity (Deficit) |  | 75  
|Consolidated Statements of Cash Flows                     |  | 76  
|Notes to Consolidated Financial Statements                |  | 77  
|Schedule IIValuation and Qualifying Accounts             |  | 92  



(a)(2) Financial
Statement Schedule



Schedule IIValuation and
Qualifying Accounts for the years ended December 31, 2002, 2003 and 2004 appears on page 92 of this report and should be read in conjunction with the consolidated financial statements and related notes thereto and report of independent registered
public accounting firm filed herewith.



Schedules not mentioned
above have been omitted because the information required to be set forth therein is not applicable or the information is otherwise included in the Financial Statements or notes thereto.



(a)(3) Exhibits



Exhibits



The following exhibits are filed as part of, or are incorporated by reference into, this Annual Report on Form 10-K:



|       |  |                                                                                                                                                                                                                                                                                                          
|------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3(i).1 |  | Amended and Restated Articles of Incorporation (Incorporated by reference to Exhibit 3(i)(b) to the Registrants Registration on Form S-1 (File No. 333-71499)).                                                                                                                                         
|       | 
|3(i).2 |  | Amendment to the Articles of Incorporation, dated January 5, 2001 (Incorporated by reference to Exhibit 3.2 to the Registrants Annual Report on Form 10-K for the fiscal year ended
December 31, 2000).                                                                                                 
|       | 
|3(i).3 |  | Certificate of the Powers, Designations, Preferences and Rights of the Series D Cumulative Redeemable Convertible Participating Preferred Stock dated November 6, 2001 (Incorporated by
reference to Exhibit 3(i).3 to the Registrants Annual Report on Form 10-K for the year ended December 31, 2001).
|       | 
|3(i).4 |  | Certificate of Amendment of Amended and Restated Articles of Incorporation (Incorporated by reference to Exhibit 3(i) to Registrants Quarterly Report on Form 10-Q for the quarter ended
June 30, 2003).                                                                                                
|       | 
|3(i).5 |  | Form of Amended and Restated Certificate of Determination of Preferences of Series D Redeemable Convertible Preferred Stock of the Company (Incorporated by reference to Exhibit 4.3 to the
Registrants Current Report on Form 8-K filed March 10, 2004).                                               



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|       |  |                                                                                                                                                                                                                                                                                                                                                                          
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|3(i).6 |  | Form of Certificate of Determination of Preferences of Series E Redeemable Convertible Preferred Stock of the Company (Incorporated by reference to Exhibit 4.4 to the Registrants
Current Report on Form 8-K filed March 10, 2004).                                                                                                                                    
|       | 
|3(i).7 |  | Certificate of Determination of Preferences of Series F Redeemable Convertible Preferred Stock (Incorporated by reference to Exhibit 3.1 to the Registrants Current Report on Form 8-K
filed on March 10, 2004).                                                                                                                                                        
|       | 
|3(ii)  |  | Amended and Restated Bylaws. (Incorporated by reference to Exhibit 3(ii)(b) to the Registrants Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).                                                                                                                                                                                                      
|       | 
|4.1    |  | Form of Common Stock Certificate. (Incorporated by reference to Exhibit 4.1 to the Registrants Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).                                                                                                                                                                                                      
|       | 
|4.2    |  | Preferred Stock Rights Agreement dated as of March 19, 2001 between Registrant and ComputerShare Trust Company, Inc., including the Certificate of Determination, the form of Rights
Certificate and the Summary of Rights attached thereto as Exhibits A, B and C respectively (Incorporated by reference to Exhibit 4.5 of Registrants Form 8-A filed on May 7, 2001).
|       | 
|4.3    |  | Amendment No. 1 to Preferred Stock Rights Agreement dated as of November 6, 2001 between the Registrant and Computershare Trust Company, Inc., as Rights Agent (Incorporated by reference to
Exhibit 4.2 to the Registrants Amendment No. 1 to the Companys Registration Statement on Form 8-A filed on January 21, 2004 (File No. 000-25331)).                        
|       | 
|4.4    |  | Amendment No. 2 to Preferred Stock Rights Agreement dated as of November 18, 2003 between the Registrant and Computershare Trust Company, Inc., as Rights Agent (Incorporated by reference to
Exhibit 4.3 to the Registrants Amendment No. 1 to the Companys Registration Statement on Form 8-A filed on January 21, 2004 (File No. 000-25331)).                       
|       | 
|4.5    |  | Amendment No. 3 to Preferred Stock Rights Agreement dated as of January 16, 2004 between Registrant and Computershare Trust Company, Inc., as Rights Agent (Incorporated by reference to
Exhibit 4.4 to the Registrants Amendment No. 1 to the Companys Registration Statement on Form 8-A filed on January 21, 2004 (File No. 000-25331)).                            
|       | 
|4.6    |  | Amendment No. 4 to Preferred Stock Rights Agreement dated as of March 9, 2004 between Critical Path, Inc. and Computershare Trust Company, Inc., as Rights Agent (Incorporated by reference to
Exhibit 4.5 to the Registrants Amendment No. 2 to the Companys Registration Statement on Form 8-A filed on March 10, 2004 (File No. 000-25331)).                        
|       | 
|4.7    |  | Amendment No. 5 to Preferred Stock Rights Agreement dated as of June 24, 2004 between Critical Path, Inc. and Computershare Trust Company, Inc., as Rights Agent (Incorporated by reference to
Exhibit 4.6 to Amendment No. 3 to the Companys Registration Statement on Form 8-A (File No. 000-25331)).                                                                 
|       | 
|4.8    |  | Amendment No. 6 to Preferred Stock Rights Agreement dated as of December 29, 2004, between the Company and Computershare Trust Company, Inc. (Incorporated by reference to Exhibit 4.9 to the
Registrants Current Report on Form 8-K filed January 3, 2004).                                                                                                            
|       | 
|4.9    |  | Amendment No. 7 to Preferred Stock Rights Agreement dated as of February 10, 2005 between the Company and Computershare Trust Company, Inc. (Incorporated by reference to Exhibit 4.8 to the
Registrants Current Report on Form 8-K filed February 24, 2005).                                                                                                           
|       | 
|4.10   |  | Indenture, dated March 31, 2000, by and between Registrant and State Street Bank and Trust Company of California, N.A., Trustee, relating to the $300 million five-year, 5.75% Convertible
Subordinated Notes due April 1, 2005 (Incorporated by reference to Exhibit 4.5 to the Registrants Quarterly Report on Form 10-Q for the quarter ended March 31, 2000).       



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|     |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     | 
|4.11 |  | Warrant to Purchase Common Stock dated March 29, 2001 issued by the Registrant to Vectis Group LLC (Incorporated by reference to Exhibit 4.3 to Registrants Quarterly Report on Form 10-Q
for the quarter ended September 30, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|     | 
|4.12 |  | Warrant to Purchase Common Stock dated January 29, 1999 issued by the Registrant to America Online, Inc. (Incorporated by reference to Exhibit 4.4 to the Registrants Registration
Statement on Form S-1 (File No. 333-71499)).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|     | 
|4.13 |  | Warrant to Purchase up to 25,000 Shares of Common Stock dated as of December 29, 1999 by and between Ecker Folsom Properties, LLC (Incorporated by reference to Exhibit 4.6 to the
Registrants Annual Report on Form 10-K for the year ended December 31, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|     | 
|4.14 |  | Warrant to Purchase up to 834,000 Shares of Common Stock dated as of June 2000 by and between Worldsport Networks Europe Ltd. (Incorporated by reference to Exhibit 4.7 to the
Registrants Annual Report on Form 10-K for the year ended December 31, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|     | 
|4.15 |  | Stock and Warrant Purchase and Exchange Agreement dated as of November 8, 2001 by and among Registrant and General Atlantic Partners 74, LP, GAP Coinvestment Partners II, LP, Gapstar, LLC,
Vectis CP Holdings, LLC, Cenwell Limited, Campina Enterprises Limited (Incorporated by reference to Exhibit 4.8 to the Registrants Annual Report on Form 10-K for the year ended December 31, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|     | 
|4.16 |  | Escrow Agreement dated as of November 8, 2001 by and among Registrant and General Atlantic Partners 74, L.P., GAP Coninvestment Partners II, LP, Gapstar, LLC, Vectis CP Holdings, LLC, Cenwell
Limited, Campina Enterprises Limited (Incorporated by reference to Exhibit 4.11 to the Registrants Annual Report on Form 10-K for the year ended December 31, 2001).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|     | 
|4.17 |  | Amended and Restated Stockholders Agreement, dated November 26, 2003, among Registrant, General Atlantic Partners 74, L.P., GAP Coinvestment Partners II, L.P., GapStar, LLC, GAP-W, LLC, GAPCO
GmbH & Co. KG, Cenwell Limited, Campina Enterprises Limited, Great Affluent Limited, Dragonfield Limited, Lion Cosmos Limited and Vectis CP Holdings, LLC (Incorporated by reference to Exhibit 4.20 to the Registrants Annual Report on Form
10-K for the year ended December 31, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                             
|     | 
|4.18 |  | Third Amended and Restated Registration Rights Agreement, dated March 9, 2004, among Registrant, General Atlantic Partners 74, L.P., GAP Coinvestment Partners II, L.P., GapStar, LLC, GAPCO
GmbH & Co. KG, Cenwell Limited, Campina Enterprises Limited, Great Affluent Limited, Dragonfield Limited, Lion Cosmos Limited, Vectis CP Holdings, LLC, Permal U.S. Opportunities Limited, Zaxis Equity Neutral, L.P., Zaxis Institutional Partners,
L.P., Zaxis Offshore Limited, Zaxis Partners, L.P., Guggenheim Portfolio Company XIII, Passport Master Fund, L.P., Crosslink Crossover Fund IV, L.P., Sagamore Hill Hub Fund, Ltd., Criterion Capital Partners, Ltd., Criterion Capital Partners,
Institutional, Criterion Capital Partners, L.P. and Capital Ventures International (Incorporated by reference to Exhibit 4.44 to the Registrants Annual Report on Form 10-K for the year ended December 31, 2003).
|     | 
|4.19 |  | Note Amendment Agreement dated March 12, 2004, by and among Registrant, Cenwell Limited, Campina Enterprises Limited, Great Affluent Limited, Dragonfield Limited and Lion Cosmos Limited
(Incorporated by reference to Exhibit 4.45 to the Registrants Annual Report on Form 10-K for the year ended December 31, 2003).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|     | 
|4.20 |  | Warrant to Purchase up to 100,000 Shares of Common Stock dated March 12, 2004 issued by the Registrant to Silicon Valley Bank (Incorporated by reference to Exhibit 4.47 to the
Registrants Annual Report on Form 10-Q for the year ended March 30, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|     | 
|4.21 |  | Form of Warrant to Purchase up to 100,000 shares of Common Stock, by and between Max Limited and the Registrant (Incorporated by reference to Exhibit 4.47 to the Registrants Quarterly
Report on Form 10-Q for the quarter ended March 31, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    



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|       |  |                                                                                                                                                                                                                                                                                            
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|4.22   |  | Form of Note dated as of December 30, 2004 (Incorporated by reference to Exhibit 4.1 of Registrants Current Report on Form 8-K filed on January 3, 2005).                                                                                                                                 
|       | 
|4.23   |  | Form of Warrant to Purchase Series F Redeemable Convertible Preferred Stock of the Company dated December 30, 2004 (Incorporated by reference to Exhibit 4.2 of Registrants Current
Report on Form 8-K filed on January 3, 2005).                                                         
|       | 
|10.1   |  | Hills Plaza I Office Lease dated as of November 16, 2001 by and between Registrant and SPI Hills Plaza Venture, LLC (Incorporated by reference to Exhibit 10.4 to the Registrants Annual
Report on Form 10-K for the year ended December 31, 2001).                                       
|       | 
|10.2   |  | First Amendment to Lease dated November 17, 2003 by and between the Registrant and Sri Hills Plaza Venture, LLC (Incorporated by reference to Exhibit 10.60 to the Registrants Annual
Report on Form 10-K for the year ended December 31, 2003).                                          
|       | 
|10.3#  |  | Employee Stock Purchase Plan. (Incorporated by reference to Exhibit 4.3 to the Registrants Registration Statement on Form S-8 filed on June 15, 2001 (File No.
333-63080)).                                                                                                               
|       | 
|10.4#  |  | Amended and Restated 1998 Stock Plan. (Incorporated by reference to Exhibit 4.1 to the Registrants Registration Statement on Form S-8 filed on June 15, 2001 (File No.
333-63080)).                                                                                                       
|       | 
|10.5#  |  | 1999 Stock Option Plan and forms of agreements thereunder (Incorporated by reference to Exhibit 10.5 to the Registrants Registration Statement on Form S-8 filed on September 22, 1999
(File No. 333-87553)).                                                                             
|       | 
|10.6#  |  | Critical Path, Inc. Amended and Restated 1998 Stock Plan Notice of Restricted Stock Award (Incorporated by reference to Exhibit 10.68 to the Registrants Quarterly Report on Form 10-Q
for the quarter ended March 31, 2004).                                                             
|       | 
|10.7#  |  | First Amended and Restated Employment Agreement dated as of January 7, 2002 by and between Registrant and William E. McGlashan, Jr. (Incorporated by reference to Exhibit 10.13 to the
Registrants Annual Report on Form 10-K for the year ended December 31, 2001).                      
|       | 
|10.8#  |  | Amendment No. 1 to First Amended and Restated Employment Agreement dated as of September 1, 2003 by and between the Registrant and William McGlashan, Jr. (Incorporated by reference to Exhibit
10.47 to the Registrants Annual Report on Form 10-K for the year ended December 31, 2003).
|       | 
|10.9#  |  | Separation Agreement and Mutual Release, dated as of April 14, 2004, by and between the Registrant and William McGlashan (Incorporated by reference to Exhibit 10.62 to the Registrants
Quarterly Report on Form 10-Q for the quarter ended March 31, 2004).                              
|       | 
|10.10# |  | Nonstatutory Stock Option Agreement dated as of August 1, 2001 by and between Registrant and William E. McGlashan, Jr. (Incorporated by reference to Exhibit 10.11 to the Registrants
Annual Report on Form 10-K for the year ended December 31, 2001).                                   
|       | 
|10.11# |  | Nonstatutory Stock Option Agreement dated as of November 8, 2001 by and between Registrant and William E. McGlashan, Jr. (Incorporated by reference to Exhibit 10.12 to the Registrants
Annual Report on Form 10-K for the year ended December 31, 2001).                                 
|       | 
|10.12# |  | Nonstatutory Stock Option Agreement dated as of December 21, 2001 by and between Registrant and William E. McGlashan, Jr. (Incorporated by reference to Exhibit 10.14 to the Registrants
Annual Report on Form 10-K for the year ended December 31, 2001).                                
|       | 
|10.13# |  | Employment Agreement dated as of November 4, 2002 by and between Registrant and Patrick Tracy Currie (Incorporated by reference to Exhibit 10.32 to the Registrants Annual Report on Form
10-K for the year ended December 31, 2002).                                                     



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|       |  |                                                                                                                                                                                                                                                                                       
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|10.14# |  | Severance Agreement and Release of Claims by and between the Registrant and Tracy Currie dated October 29, 2004. (Incorporated by reference to Exhibit 99.1 to the Registrants Quarterly
Report on Form 10-Q for the quarter ended September 30, 2004).                              
|       | 
|10.15# |  | Nonstatutory Stock Option Agreement dated as of November 6, 2002 by and between Registrant and Patrick Tracy Currie (Incorporated by reference to Exhibit 10.33 to the Registrants Annual
Report on Form 10-K for the year ended December 31, 2002).                                 
|       | 
|10.16# |  | Employment Agreement dated as of January 14, 2002 by and between Registrant and Bernard Harguindeguy (Incorporated by reference to Exhibit 10.23 to the Registrants Annual Report on Form
10-K for the year ended December 31, 2001).                                                
|       | 
|10.17# |  | Amendment to Employment Agreement and Release of Claims dated May 16, 2003 by and between the Registrant and Bernard Harguindeguy (Incorporated by reference to Exhibit 10.42 to the
Registrants Annual Report on Form 10-K for the year ended December 31, 2003).                   
|       | 
|10.18# |  | Incentive Bonus Agreement dated October 23, 2003 between the Registrant and Bernard Harguindeguy (Incorporated by reference to Exhibit 10.43 to the Registrants Annual Report on Form
10-K for the year ended December 31, 2003).                                                    
|       | 
|10.19# |  | Form of Indemnification Agreement by and between the Registrant and each of its directors and officers. (Incorporated by reference to Exhibit 10.32 to the Registrants Annual Report on
Form 10-K for the year ended December 31, 2000).                                             
|       | 
|10.20# |  | Employment Agreement dated February 4, 2004 by and between the Registrant and James Clark (Incorporated by reference to Exhibit 10.48 to the Registrants Annual Report on Form 10-K for
the year ended December 31, 2003).                                                           
|       | 
|10.21# |  | Employment Agreement, dated June 11, 2001 by and between the Registrant and Michael Zukerman                                                                                                                                                                                          
|       | 
|10.22# |  | Amendment to Employment Agreement, dated December 20, 2002, by and between the Registrant and Michael Zukerman (Incorporated by reference to Exhibit 10.63 to the Registrants Quarterly
Report on Form 10-Q for the quarter ended March 31, 2004).                                   
|       | 
|10.23# |  | Change of Control Severance Agreement, dated as of May 29, 2003, by and between the Registrant and Michael J. Zukerman (Incorporated by reference to Exhibit 10.64 to the Registrants
Quarterly Report on Form 10-Q for the quarter ended March 31, 2004).                           
|       | 
|10.24# |  | Waiver Agreement made and entered into as of December 23, 2003, by and between Registrant and Michael J. Zukerman (Incorporated by reference to Exhibit 10.66 to the Registrants
Quarterly Report on Form 10-Q for the quarter ended March 31, 2004).                                
|       | 
|10.25# |  | Amendment to Employment Agreement, dated December 23, 2003, by and between the Registrant and Michael J. Zukerman (Incorporated by reference to Exhibit 10.65 to the Registrants
Quarterly Report on Form 10-Q for the quarter ended March 31, 2004).                                
|       | 
|10.26  |  | Fourth Amendment to Amended and Restated Loan and Security Agreement dated as of April 15, 2004 by and between Registrant and Silicon Valley Bank (Incorporated by reference to Exhibit 10.68
to the Registrants Quarterly Report on Form 10-Q for the quarter ended March 31, 2004).
|       | 
|10.27# |  | Nonstatutory Stock Option Agreement by and between the Registrant and Mark Ferrer for grant effective March 29, 2004 (Incorporated by reference to Exhibit 10.70 to the Registrants
Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).                         
|       | 
|10.28# |  | Incentive Stock Option Agreement by and between the Registrant and Mark Ferrer for grant effective March 29, 2004 (Incorporated by reference to Exhibit 10.71 to the Registrants
Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).                            



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|       |  |                                                                                                                                                                                                                                                               
|------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|10.29# |  | Restricted Stock Agreement by and between the Registrant and Mark Ferrer for grant effective March 29, 2004 (Incorporated by reference to Exhibit 10.72 to the Registrants Quarterly
Report on Form 10-Q for the quarter ended September 30, 2004).          
|       | 
|10.30# |  | Nonstatutory Stock Option Agreement by and between the Registrant and Mark Ferrer for grant effective August 16, 2004 (Incorporated by reference to Exhibit 10.73 to the Registrants
Quarterly Report on Form 10-Q for the quarter ended September 30, 2004).
|       | 
|10.31# |  | Restricted Stock Agreement by and between the Registrant and Mark Ferrer for grant effective August 16, 2004 (Incorporated by reference to Exhibit 10.74 to the Registrants Quarterly
Report on Form 10-Q for the quarter ended September 30, 2004).         
|       | 
|10.32# |  | Employment Agreement dated as of March 29, 2004 by and between Registrant and Mark Ferrer. (Incorporated by reference to Exhibit 10.61 to the Registrants Annual Report on Form 10-K/A
for the year ended December 31, 2003).                                
|       | 
|10.33  |  | Note and Warrant Purchase Agreement dated as of December 29, 2004, between the Company and the Investors. (Incorporated by reference to Exhibit 10.1 to the Registrants Current Report on
Form 8-K filed on January 3, 2005).                                
|       | 
|10.34# |  | Employment Agreement dated as of May 17, 2004 by and between Registrant and Mark Palomba.                                                                                                                                                                     
|       | 
|10.35# |  | Employment Agreement dated as of March 6, 2000 by and between Registrant and Mike Serbinis.                                                                                                                                                                   
|       | 
|10.36# |  | Employment Agreement dated as of January 19, 2000 by and between Registrant and Barry Twohig.                                                                                                                                                                 
|       | 
|21.1   |  | List of Subsidiaries (Incorporated by reference to Exhibit 21.1 to the Registrants Annual Report on Form 10-K for the year ended December 31, 2003).                                                                                                         
|       | 
|23.1   |  | Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm.                                                                                                                                                                         
|       | 
|24.1   |  | Power of Attorney (see the signature page of the Registrants Annual Report on Form 10-K for the year ended December 31, 2003).                                                                                                                               
|       | 
|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.                                                                                                            

---

|# | Indicates management contract or compensatory plan or arrangement.
|- | ------------------------------------------------------------------



(b) Exhibits



The exhibits set forth in (a)(3) above are filed or incorporated by reference as part of this report on Form 10-K.



(c) Financial Statement Schedules



The Valuation and Qualifying Accounts Schedule in (a)(2) above is
incorporated herein by reference.



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Report of Independent Registered Public Accounting Firm

On Financial Statements



To the Board of Directors and Shareholders

of Critical Path, Inc.:



In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(i) present fairly, in all material respects, the
financial position of Critical Path, Inc. and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting
principles generally accepted in the United States of America. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.



/s/    PRICEWATERHOUSECOOPERS LLP



San Jose, California

March 31, 2005



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CRITICAL PATH, INC.



CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)



|                                                                                    |  |              |            |   |      |   |            |  
|----------------------------------------------------------------------------------- |  | ------------ | ---------- | - | ---- | - | ---------- | -
|                                                                                    |  | December 31, |           
|                                                                                    |  | 2003         |            |   | 2004 |  
|ASSETS                                                                              |  |              |            |   |      |   |            |  
|Current assets                                                                      |  |              |            |   |      |   |            |  
|Cash and cash equivalents                                                           |  | $            | 18,984     |   |      | $ | 23,239     |  
|Accounts receivable, net                                                            |  |              | 16,880     |   |      |   | 19,667     |  
|Prepaid and other current assets                                                    |  |              | 4,664      |   |      |   | 4,567      |  
|                                                                                    |  |              |            |   |      |   |            |  
|Total current assets                                                                |  |              | 40,528     |   |      |   | 47,473     |  
|Property and equipment, net                                                         |  |              | 14,821     |   |      |   | 11,379     |  
|Goodwill                                                                            |  |              | 6,613      |   |      |   | 6,613      |  
|Restricted cash                                                                     |  |              |           |   |      |   | 2,702      |  
|Other assets                                                                        |  |              | 5,763      |   |      |   | 1,032      |  
|                                                                                    |  |              |            |   |      |   |            |  
|Total assets                                                                        |  | $            | 67,725     |   |      | $ | 69,199     |  
|                                                                                    |  |              |            |   |      |   |            |  
|LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND SHAREHOLDERS DEFICIT       |  |              |            |   |      |   |            |  
|Current liabilities                                                                 |  |              |            |   |      |   |            |  
|Accounts payable                                                                    |  | $            | 5,022      |   |      | $ | 4,973      |  
|Accrued compensation and benefits                                                   |  |              | 2,749      |   |      |   | 4,926      |  
|Income and other tax liabilities                                                    |  |              | 4,010      |   |      |   | 5,063      |  
|Other accrued liabilities                                                           |  |              | 13,996     |   |      |   | 13,218     |  
|Deferred revenue                                                                    |  |              | 8,856      |   |      |   | 9,978      |  
|Line of credit facility                                                             |  |              | 2,298      |   |      |   |           |  
|Capital lease and other obligations, current                                        |  |              | 1,721      |   |      |   | 1,067      |  
|Notes payable, current                                                              |  |              |           |   |      |   | 5,565      |  
|                                                                                    |  |              |            |   |      |   |            |  
|Total current liabilities                                                           |  |              | 38,652     |   |      |   | 44,790     |  
|Deferred revenue, net of current portion                                            |  |              | 1,343      |   |      |   | 173        |  
|Notes payable, net of current portion                                               |  |              | 48,376     |   |      |   | 8,875      |  
|Embedded derivative liability                                                       |  |              | 24,890     |   |      |   | 5,173      |  
|Capital lease and other obligations, net of current portion                         |  |              | 1,295      |   |      |   |           |  
|                                                                                    |  |              |            |   |      |   |            |  
|Total liabilities                                                                   |  |              | 114,506    |   |      |   | 59,011     |  
|                                                                                    |  |              |            |   |      |   |            |  
|Commitments and contingencies (Note 12)                                             |  |              |            |   |      |   |            |  
|Mandatorily redeemable preferred stock, par value $0.001 (Note 13)                  |  |              |            |   |      |   |            |  
|Shares authorized: 75,000                                                           |  |              |            |   |      |   |            |  
|Shares issued and outstanding: 4,000 and 59,986                                     |  |              |            |   |      |   |            |  
|Liquidation value: $67,494 and $157,568                                             |  |              | 30,411     |   |      |   | 122,377    |  
|                                                                                    |  |              |            |   |      |   |            |  
|Shareholders deficit                                                               |  |              |            |   |      |   |            |  
|Common Stock and paid-in-capital, par value $0.001                                  |  |              |            |   |      |   |            |  
|Shares authorized: 200,000                                                          |  |              |            |   |      |   |            |  
|Shares issued and outstanding: 21,078 and 23,087                                    |  |              | 2,154,295  |   |      |   | 2,174,496  |  
|Common stock warrants                                                               |  |              | 5,947      |   |      |   | 5,947      |  
|Notes receivable from shareholders                                                  |  |              | (870       | ) |      |   |           |  
|Unearned stock-based compensation                                                   |  |              |           |   |      |   | (1,353     | )
|Accumulated deficit                                                                 |  |              | (2,238,728 | ) |      |   | (2,290,725 | )
|Accumulated other comprehensive income (loss)                                       |  |              | 2,114      |   |      |   | (554       | )
|                                                                                    |  |              |            |   |      |   |            |  
|Total shareholders deficit                                                         |  |              | (77,242    | ) |      |   | (112,189   | )
|                                                                                    |  |              |            |   |      |   |            |  
|Total liabilities, mandatorily redeemable preferred stock and shareholders deficit |  | $            | 67,725     |   |      | $ | 69,199     |  
|                                                                                    |  |              |            |   |      |   |            |  



The accompanying notes
are an integral part of these consolidated financial statements.



73



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CRITICAL PATH, INC.



CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)



|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                    |  | Year Ended December 31, |         
|                                                                    |  | 2002                    |          |   | 2003 |   |         | 2004 | 
|Net revenues                                                        |  |                         |          |   |      |   |         |      |  |   |         |  
|Software license                                                    |  | $                       | 35,176   |   |      | $ | 22,104  |      |  | $ | 19,326  |  
|Hosted messaging                                                    |  |                         | 24,893   |   |      |   | 19,444  |      |  |   | 17,842  |  
|Professional services                                               |  |                         | 11,593   |   |      |   | 12,315  |      |  |   | 12,829  |  
|Maintenance and support                                             |  |                         | 15,471   |   |      |   | 18,434  |      |  |   | 21,075  |  
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Total net revenues                                                  |  |                         | 87,133   |   |      |   | 72,297  |      |  |   | 71,072  |  
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Cost of net revenues                                                |  |                         |          |   |      |   |         |      |  |   |         |  
|Software license                                                    |  |                         | 2,682    |   |      |   | 4,068   |      |  |   | 5,463   |  
|Hosted messaging                                                    |  |                         | 29,303   |   |      |   | 26,193  |      |  |   | 25,404  |  
|Professional services                                               |  |                         | 10,020   |   |      |   | 12,203  |      |  |   | 11,939  |  
|Maintenance and support                                             |  |                         | 8,670    |   |      |   | 5,803   |      |  |   | 5,495   |  
|Amortization of purchased technology                                |  |                         | 18,522   |   |      |   |        |      |  |   |        |  
|Stock-based expense                                                 |  |                         | 1,225    |   |      |   | 17      |      |  |   | 76      |  
|Restructuring expense                                               |  |                         |         |   |      |   |        |      |  |   | 175     |  
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Total cost of net revenues                                          |  |                         | 70,422   |   |      |   | 48,284  |      |  |   | 48,552  |  
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Gross profit                                                        |  |                         | 16,711   |   |      |   | 24,013  |      |  |   | 22,520  |  
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Operating expenses                                                  |  |                         |          |   |      |   |         |      |  |   |         |  
|Sales and marketing                                                 |  |                         | 43,604   |   |      |   | 31,224  |      |  |   | 22,703  |  
|Research and development                                            |  |                         | 19,649   |   |      |   | 19,047  |      |  |   | 20,973  |  
|General and administrative                                          |  |                         | 22,128   |   |      |   | 12,603  |      |  |   | 15,005  |  
|Acquisition related retention bonuses                               |  |                         | 11       |   |      |   |        |      |  |   |        |  
|Amortization of intangible assets                                   |  |                         | 24,773   |   |      |   |        |      |  |   |        |  
|Stock-based expense                                                 |  |                         | 8,772    |   |      |   | 5,124   |      |  |   | 1,839   |  
|Restructuring and other expenses                                    |  |                         | 3,168    |   |      |   | 6,886   |      |  |   | 3,404   |  
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Total operating expenses                                            |  |                         | 122,105  |   |      |   | 74,884  |      |  |   | 63,924  |  
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Loss from operations                                                |  |                         | (105,394 | ) |      |   | (50,871 | )    |  |   | (41,404 | )
|Interest income                                                     |  |                         | 1,506    |   |      |   | 407     |      |  |   | 405     |  
|Interest expense                                                    |  |                         | (2,748   | ) |      |   | (3,336  | )    |  |   | (4,384  | )
|Equity in net loss of joint venture                                 |  |                         | (1,408   | ) |      |   |        |      |  |   |        |  
|Gain (loss) on investments, net                                     |  |                         | (1,530   | ) |      |   | 549     |      |  |   |        |  
|Loss on extinguishment of debt                                      |  |                         |         |   |      |   |        |      |  |   | (12,783 | )
|Other income (expense), net                                         |  |                         | (7,358   | ) |      |   | (8,026  | )    |  |   | 7,281   |  
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Loss before income taxes                                            |  |                         | (116,932 | ) |      |   | (61,277 | )    |  |   | (50,885 | )
|Provision for income taxes                                          |  |                         | (979     | ) |      |   | (856    | )    |  |   | (1,112  | )
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Net loss                                                            |  |                         | (117,911 | ) |      |   | (62,133 | )    |  |   | (51,997 | )
|Dividend and accretion on mandatorily redeemable preferred stock    |  |                         | (13,904  | ) |      |   | (12,446 | )    |  |   | (14,565 | )
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Net loss attributable to common shares                              |  | $                       | (131,815 | ) |      | $ | (74,579 | )    |  | $ | (66,562 | )
|                                                                    |  |                         |          |   |      |   |         |      |  |   |         |  
|Net loss per share attributable to common sharesbasic and diluted: |  |                         |          |   |      |   |         |      |  |   |         |  
|Net loss per share attributable to common shares                    |  | $                       | (6.78    | ) |      | $ | (3.73   | )    |  | $ | (3.15   | )
|Weighted average sharesbasic and diluted                           |  |                         | 19,445   |   |      |   | 20,020  |      |  |   | 21,123  |  



The accompanying notes
are an integral part of these consolidated financial statements.



74



---

##### Table of Contents

CRITICAL PATH, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS DEFICIT



|                                                                                                                  |  |                                        |                                           |                                |                 |                     |          |                                 |   |        |                      |   |           |                                                        |  |   |       |  |   |        |   |  |   |        |   |  |   |            |   |  |   |          |  
|----------------------------------------------------------------------------------------------------------------- |  | -------------------------------------- | ----------------------------------------- | ------------------------------ | --------------- | ------------------- | -------- | ------------------------------- | - | ------ | -------------------- | - | --------- | ------------------------------------------------------ |  | - | ----- |  | - | ------ | - |  | - | ------ | - |  | - | ---------- | - |  | - | -------- | -
|                                                                                                                  |  | Mandatorily redeemable preferred stock |                                           | Shareholders equity (deficit) |                
|                                                                                                                  |  |                                        | Common stockand additionalpaid in capital |                                |                 | Commonstockwarrants |          | Notesreceivablefromshareholders |   |        | Unearnedcompensation |   |           | Accumulateddeficit and othercomprehensiveincome (loss) |  |   | Total | 
|                                                                                                                  |  | Series D                               |                                           |                                | AmendedSeries D |                     | Series E |                                 |   |        |                      |   |          
|                                                                                                                  |  | (in thousands)                         |                                          
|Balance at December 31, 2001                                                                                      |  | $                                      | 306                                       |                                |                 | $                   |         |                                 | $ |       |                      | $ | 2,173,466 |                                                        |  | $ | 5,250 |  | $ | (1,222 | ) |  | $ | (7,050 | ) |  | $ | (2,061,472 | ) |  | $ | 108,972  |  
|Accretion of dividend on mandatorily redeemable preferred stock                                                   |  |                                        | 4,427                                     |                                |                 |                     |         |                                 |   |       |                      |   | (4,427    | )                                                      |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | (4,427   | )
|Accretion of beneficial conversion feature on mandatorily redeemable preferred stock                              |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | (125      | )                                                      |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | (125     | )
|Accretion to redemption value for mandatorily redeemable preferred stock                                          |  |                                        | 9,477                                     |                                |                 |                     |         |                                 |   |       |                      |   | (9,477    | )                                                      |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | (9,477   | )
|Common stock issued under Employee Stock Purchase Plan                                                            |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 511       |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 511      |  
|Exercise of stock options and warrants                                                                            |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 1,268     |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 1,268    |  
|Issuance of warrants to purchase common stock                                                                     |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   | 697   |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 697      |  
|Stock-based compensation related to stock options                                                                 |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 1,980     |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 1,980    |  
|Interest on shareholder note                                                                                      |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   | (8     | ) |  |   |       |   |  |   |           |   |  |   | (8       | )
|Repayment of shareholder note                                                                                     |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   | 1,230  |   |  |   |       |   |  |   |           |   |  |   | 1,230    |  
|Amortization of unearned compensation                                                                             |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   | 6,991  |   |  |   |           |   |  |   | 6,991    |  
|Unrealized investment gain (loss)                                                                                 |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |        |   |  |   |       |   |  |   | (671       | ) |  |   | (671     | )
|Foreign currency translation adjustments                                                                          |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   | 2,416      |   |  |   | 2,416    |  
|Net loss                                                                                                          |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   | (117,911   | ) |  |   | (117,911 | )
|                                                                                                                  |  |                                        |                                           |                                |                 |                     |          |                                 |   |        |                      |   |           |                                                        |  |   |       |  |   |        |   |  |   |        |   |  |   |            |   |  |   |          |  
|Balance at December 31, 2002                                                                                      |  |                                        | 14,210                                    |                                |                 |                     |         |                                 |   |       |                      |   | 2,163,196 |                                                        |  |   | 5,947 |  |   |       |   |  |   | (59    | ) |  |   | (2,177,638 | ) |  |   | (8,554   | )
|Accretion of dividend on mandatorily redeemable preferred stock                                                   |  |                                        | 4,935                                     |                                |                 |                     |         |                                 |   |       |                      |   | (4,935    | )                                                      |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | (4,935   | )
|Accretion to redemption value for mandatorily redeemable preferred stock                                          |  |                                        | 7,511                                     |                                |                 |                     |         |                                 |   |       |                      |   | (7,511    | )                                                      |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | (7,511   | )
|Issuance of preferred stock in litigation settlement                                                              |  |                                        | 3,755                                     |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   |         |  
|Common stock issued under Employee Stock Purchase Plan                                                            |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 275       |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 275      |  
|Exercise of stock options and warrants                                                                            |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 846       |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 846      |  
|Issuance of common stock in litigation settlement                                                                 |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 1,300     |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 1,300    |  
|Issuance of warrants to purchase common stock                                                                     |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 48        |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 48       |  
|Stock-based compensation related to stock options                                                                 |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 206       |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 206      |  
|Lapse of early exercise repurchase rights                                                                         |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 870       |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 870      |  
|Reclassification of vested portion of shareholder notes                                                           |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   | (870   | ) |  |   |       |   |  |   |           |   |  |   | (870     | )
|Amortization of unearned compensation                                                                             |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   | 59     |   |  |   |           |   |  |   | 59       |  
|Unrealized investment gain (loss)                                                                                 |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   | 1,461      |   |  |   | 1,461    |  
|Foreign currency translation adjustments                                                                          |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   | 1,696      |   |  |   | 1,696    |  
|Net loss                                                                                                          |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   | (62,133    | ) |  |   | (62,133  | )
|                                                                                                                  |  |                                        |                                           |                                |                 |                     |          |                                 |   |        |                      |   |           |                                                        |  |   |       |  |   |        |   |  |   |        |   |  |   |            |   |  |   |          |  
|Balance at December 31, 2003                                                                                      |  |                                        | 30,411                                    |                                |                 |                     |         |                                 |   |       |                      |   | 2,154,295 |                                                        |  |   | 5,947 |  |   | (870   | ) |  |   |       |   |  |   | (2,236,614 | ) |  |   | (77,242  | )
|Conversion of Series D Preferred Stock to Amended Series D and Series Preferred Stock                             |  |                                        | (37,277                                   | )                              |                 |                     | 56,355   |                                 |   | 1,244  |                      |   | (2,490    | )                                                      |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | (2,490   | )
|Accretion of dividend on mandatorily redeemable preferred stock                                                   |  |                                        | 3,174                                     |                                |                 |                     | 1,876    |                                 |   | 2,266  |                      |   | (7,315    | )                                                      |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | (7,315   | )
|Accretion of beneficial conversion feature on mandatorily redeemable preferred stock                              |  |                                        | 3,917                                     |                                |                 |                     |         |                                 |   | 1,431  |                      |   | (5,349    | )                                                      |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | (5,349   | )
|Accretion to redemption value for mandatorily redeemable preferred stock                                          |  |                                        |                                          |                                |                 |                     | 1,344    |                                 |   | 557    |                      |   | (1,901    | )                                                      |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | (1,901   | )
|Issuance of Series E preferred stock upon conversion of notes payable and accrued interest, net of issuance costs |  |                                        |                                          |                                |                 |                     |         |                                 |   | 57,304 |                      |   | 28,798    |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 28,798   |  
|Revaluation of amended Series D warrant                                                                           |  |                                        | (225                                      | )                              |                 |                     |         |                                 |   |       |                      |   | 225       |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 225      |  
|Common stock issued under Employee Stock Purchase Plan                                                            |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 242       |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 242      |  
|Exercise of stock options and warrants                                                                            |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 780       |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 780      |  
|Proceeds from issuance of Series E preferred stock rights offering                                                |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 3,965     |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 3,965    |  
|Issuance of restricted stock                                                                                      |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 2,279     |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 2,279    |  
|Payment of taxes on vested restricted stock                                                                       |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | (26       | )                                                      |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | (26      | )
|Issuance of warrants to purchase common stock                                                                     |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 344       |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 344      |  
|Stock-based compensation related to stock options                                                                 |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 66        |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 66       |  
|Lapse of early exercise repurchase rights                                                                         |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 460       |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   |           |   |  |   | 460      |  
|Reclassification of vested portion of shareholder notes                                                           |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   | (145   | ) |  |   |       |   |  |   |           |   |  |   | (145     | )
|Forgiveness of shareholder note                                                                                   |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   | 123       |                                                        |  |   |      |  |   | 1,015  |   |  |   |       |   |  |   |           |   |  |   | 1,138    |  
|Unearned compensation related to grants of restricted stock                                                       |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   | (2,279 | ) |  |   |           |   |  |   | (2,279   | )
|Amortization of unearned compensation                                                                             |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   | 926    |   |  |   |           |   |  |   | 926      |  
|Foreign currency translation adjustments                                                                          |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   | (2,668     | ) |  |   | (2,668   | )
|Net loss                                                                                                          |  |                                        |                                          |                                |                 |                     |         |                                 |   |       |                      |   |          |                                                        |  |   |      |  |   |       |   |  |   |       |   |  |   | (51,997    | ) |  |   | (51,997  | )
|                                                                                                                  |  |                                        |                                           |                                |                 |                     |          |                                 |   |        |                      |   |           |                                                        |  |   |       |  |   |        |   |  |   |        |   |  |   |            |   |  |   |          |  
|Balance at December 31, 2004                                                                                      |  | $                                      |                                          |                                |                 | $                   | 59,575   |                                 | $ | 62,802 |                      | $ | 2,174,496 |                                                        |  | $ | 5,947 |  | $ |       |   |  | $ | (1,353 | ) |  | $ | (2,291,279 | ) |  | $ | (112,189 | )
|                                                                                                                  |  |                                        |                                           |                                |                 |                     |          |                                 |   |        |                      |   |           |                                                        |  |   |       |  |   |        |   |  |   |        |   |  |   |            |   |  |   |          |  



The accompanying notes
are an integral part of these consolidated financial statements.



75



---

##### Table of Contents

CRITICAL PATH, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS



|                                                                            |  |                         |          |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                            |  | Year Ended December 31, |         
|                                                                            |  | 2002                    |          |   | 2003 |   |         | 2004 | 
|                                                                            |  | (In thousands)          |         
|Cash flow from operating activities:                                        |  |                         |          |   |      |   |         |      |  |   |         |  
|Net loss                                                                    |  | $                       | (117,911 | ) |      | $ | (62,133 | )    |  | $ | (51,997 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                         |          |   |      |   |         |      |  |   |         |  
|Provision (credit) for allowance for doubtful accounts                      |  |                         | 673      |   |      |   | 199     |      |  |   | (195    | )
|Depreciation                                                                |  |                         | 27,225   |   |      |   | 16,199  |      |  |   | 9,763   |  
|Amortization of intangible assets                                           |  |                         | 43,295   |   |      |   |        |      |  |   |        |  
|Stock-based costs and expenses                                              |  |                         | 9,997    |   |      |   | 85      |      |  |   | 1,915   |  
|Amortization of start up costs                                              |  |                         | 274      |   |      |   | 55      |      |  |   | 489     |  
|Amortization of debt issuance costs                                         |  |                         |         |   |      |   |        |      |  |   | 112     |  
|Equity in net loss of joint venture                                         |  |                         | 1,408    |   |      |   |        |      |  |   |        |  
|Change in fair value of embedded derivative liability                       |  |                         | 7,440    |   |      |   | 12,200  |      |  |   | (4,343  | )
|Provision for note receivable allowance                                     |  |                         |         |   |      |   |        |      |  |   | 1,950   |  
|Loss (gain) on investments                                                  |  |                         | 1,530    |   |      |   | (549    | )    |  |   |        |  
|Loss on extinguishment of debt                                              |  |                         |         |   |      |   |        |      |  |   | 12,783  |  
|Fair value of stock issued in settlement of litigation                      |  |                         |         |   |      |   | 5,056   |      |  |   |        |  
|Gain on release of funds held in escrow                                     |  |                         |         |   |      |   | (3,750  | )    |  |   |        |  
|Provision (credit) for restructured operations                              |  |                         | 461      |   |      |   | 579     |      |  |   | (1,589  | )
|Changes in assets and liabilities:                                          |  |                         |          |   |      |   |         |      |  |   |         |  
|Accounts receivable                                                         |  |                         | 3,408    |   |      |   | 8,266   |      |  |   | (4,639  | )
|Other assets                                                                |  |                         | (132     | ) |      |   | (651    | )    |  |   | 512     |  
|Accounts payable                                                            |  |                         | (696     | ) |      |   | (1,079  | )    |  |   | (792    | )
|Accrued compensation and benefits                                           |  |                         | (1,018   | ) |      |   | (1,015  | )    |  |   | 2,177   |  
|Income and other tax liabilities                                            |  |                         | (515     | ) |      |   | (138    | )    |  |   | 1,053   |  
|Other accrued liabilities                                                   |  |                         | (995     | ) |      |   | (6,782  | )    |  |   | 946     |  
|Deferred revenue                                                            |  |                         | 491      |   |      |   | (1,427  | )    |  |   | (472    | )
|                                                                            |  |                         |          |   |      |   |         |      |  |   |         |  
|Net cash used in operating activities                                       |  |                         | (25,065  | ) |      |   | (34,885 | )    |  |   | (32,327 | )
|                                                                            |  |                         |          |   |      |   |         |      |  |   |         |  
|Cash flow from investing activities:                                        |  |                         |          |   |      |   |         |      |  |   |         |  
|Notes receivable from officers                                              |  |                         | 345      |   |      |   | 132     |      |  |   | 240     |  
|Property and equipment purchases                                            |  |                         | (6,770   | ) |      |   | (12,225 | )    |  |   | (4,155  | )
|Sales (purchases) of marketable securities, net                             |  |                         | 172      |   |      |   | 9,573   |      |  |   |        |  
|Payments for acquisitions, net of cash acquired                             |  |                         | 4,511    |   |      |   |        |      |  |   |        |  
|Proceeds from sale of investments                                           |  |                         |         |   |      |   | 2,373   |      |  |   |        |  
|Proceeds from the release of funds held in escrow                           |  |                         |         |   |      |   | 3,750   |      |  |   |        |  
|Restricted cash                                                             |  |                         | (55      | ) |      |   | 2,729   |      |  |   | (2,702  | )
|                                                                            |  |                         |          |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) investing activities                         |  |                         | (1,797   | ) |      |   | 6,332   |      |  |   | (6,617  | )
|                                                                            |  |                         |          |   |      |   |         |      |  |   |         |  
|Cash flow from financing activities:                                        |  |                         |          |   |      |   |         |      |  |   |         |  
|Proceeds from issuance of Common Stock                                      |  |                         | 1,779    |   |      |   | 1,121   |      |  |   | 1,022   |  
|Proceeds from issuance of convertible notes, net                            |  |                         |         |   |      |   | 10,000  |      |  |   | 41,045  |  
|Proceeds from rights offering                                               |  |                         |         |   |      |   |        |      |  |   | 3,965   |  
|Proceeds from line of credit                                                |  |                         |         |   |      |   | 4,900   |      |  |   |        |  
|Principal payments against line of credit facility                          |  |                         |         |   |      |   | (2,602  | )    |  |   | (2,298  | )
|Proceeds from payments of shareholder notes receivable                      |  |                         | 1,230    |   |      |   |        |      |  |   |        |  
|Principal payments on note and lease obligations                            |  |                         | (3,790   | ) |      |   | (814    | )    |  |   | (1,129  | )
|                                                                            |  |                         |          |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) financing activities                         |  |                         | (781     | ) |      |   | 12,605  |      |  |   | 42,605  |  
|                                                                            |  |                         |          |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                        |  |                         | (27,643  | ) |      |   | (15,948 | )    |  |   | 3,661   |  
|Effect of exchange rates on cash and cash equivalents                       |  |                         | 1,678    |   |      |   | 1,434   |      |  |   | 594     |  
|Cash and cash equivalents at beginning of year                              |  |                         | 59,463   |   |      |   | 33,498  |      |  |   | 18,984  |  
|                                                                            |  |                         |          |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of year                                    |  | $                       | 33,498   |   |      | $ | 18,984  |      |  | $ | 23,239  |  
|                                                                            |  |                         |          |   |      |   |         |      |  |   |         |  
|Supplemental cash flow disclosure:                                          |  |                         |          |   |      |   |         |      |  |   |         |  
|Cash paid for interest                                                      |  | $                       | 2,316    |   |      | $ | 2,850   |      |  | $ | 1,823   |  
|Cash paid for income taxes, net of refunds                                  |  | $                       | 2,578    |   |      | $ | 21      |      |  | $ | 746     |  
|Non-cash investing and financing activities:                                |  |                         |          |   |      |   |         |      |  |   |         |  
|Retirement of notes payable through issuance of Preferred Stock             |  | $                       |         |   |      | $ |        |      |  | $ | 45,484  |  



The accompanying notes
are an integral part of these consolidated financial statements.



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CRITICAL PATH, INC.



NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS



Note 1The Company and Summary
of Significant Accounting Policies



The Company



Critical Path, Inc. was incorporated in California on February 19, 1997.
Critical Path, along with its subsidiaries (collectively referred to herein as the Company), delivers software and services that enable the rapid deployment of highly scalable valued-added solutions for messaging and identity management.
The Companys messaging and identity management solutions help organizations expand the range of digital communications services they provide while helping to reduce overall costs. The Companys 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. The Companys 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.



Liquidity



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 cash balances, raise concerns about
the Companys ability to fund operations. Consequently, in the fourth quarter of 2003 and first quarter of 2004 we secured additional funds through several rounds of financing that involved the sale of senior secured notes. In addition, in the
third quarter of 2004 we completed a rights offering which raised approximately $4.0 million, and in the fourth quarter of 2004 we drew $11.0 million from an $18.0 million round of debt financing. In March 2005, the Company drew down the remaining
$7.0 million from the $18.0 million round of debt financing. 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
revenues or 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 the Companys ability to incur
additional indebtedness is subject to certain limitations as discussed in the section below captioned Ability to incur additional indebtedness. The Company does not believe that equity financing on terms reasonably acceptable is
currently available.



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



|                                             |  |                                |          |   |      |   |         |      |  |   |         |  
|-------------------------------------------- |  | ------------------------------ | -------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                             |  | Fiscal year ended December 31, |         
|                                             |  | 2002                           |          |   | 2003 |   |         | 2004 | 
|                                             |  | (in thousands)                 |         
|Net loss attributable to common shareholders |  | $                              | (131,815 | ) |      | $ | (74,579 | )    |  | $ | (66,562 | )
|Net cash used by operating activities        |  |                                | (25,065  | ) |      |   | (34,885 | )    |  |   | (32,327 | )



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 completed over the past several years. The Companys principal sources of
liquidity include its cash and cash equivalents. As of December 31, 2004, the Company had cash and cash equivalents available for operations totaling $23.2 million, of which $6.7 million was located in accounts outside the United States and which is
not readily 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
Companys cash located in



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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. Accordingly, the Companys readily available cash resources in the
United States as of December 31, 2004 were $16.5 million, which included $11.0 million drawn from an $18.0 million round of debt financing completed in December 2004. As of December 31, 2004, the Company had cash collateralized letters of credit
totaling approximately $2.7 million. This cash is recorded as restricted cash on the Companys balance sheet and is not readily available for operations; however, the Company believes that it will be able to reduce its letters of credit upon
relocating its headquarters facility.



Based on the
Companys financing activities in the fourth quarter of 2004 and the draw in March 2005 of the remaining $7.0 million of the $18.0 million debt financing, the Company believes that it has sufficient cash to meet its cash operating requirements
for the next 12 months, including the $1.3 million lease termination payment discussed in Note 18Subsequent Events along with the $5.6 million repayment of the outstanding 53/4% Convertible
Subordinated Notes (the 53/4% Notes) due on April 1, 2005 as well as the investments in capital equipment to
support the transition of the Companys hosted messaging environment from an out-sourced model to one that would be performed in-house and to support the Companys on-going research and development efforts. For the long-term, the Company
believes that its operating activities will be able to provide the liquidity and capital resources sufficient to support its business.



At December 31, 2004 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 its letters of credit, totaling approximately $2.7 million. For additional information with respect to the credit facility, see Note 9Credit Facility.



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, under the terms of the Series D Cumulative Redeemable Convertible Preferred Stock (the Series D preferred stock), the Company must seek the consent
of the holders of a majority of its Series D preferred stock in order to incur any additional indebtedness. The Company is not required to obtain any third-party consents in order to draw down the remaining $7.0 million of the 13.9% Notes.



Basis of Presentation



The consolidated financial statements include the accounts of the Company,
and its wholly-owned and majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The equity method is used to account for investments in unconsolidated entities if the Company has
the ability to exercise significant influence over financial and operating matters, but does not have the ability to control such entities. The cost method is used to account for equity investments in unconsolidated entities where the Company does
not have the ability to exercise significant influence over financial and operating matters.



Reverse stock split



The share and per share amounts presented in these consolidated financial statements have been retroactively restated to give effect to a one-for-four reverse stock split, affected on August 1, 2003, of the Companys authorized and
outstanding common stock and for all shares of Common Stock subject to stock options and warrants. In addition, the conversion price of the Series D preferred stock presented in these



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



consolidated financial statements has been retroactively restated as a result of the reverse stock split. As of August 1, 2003, the total number of shares of
Common Stock outstanding was 81,595,042 shares and as of immediately following the one-for-four reverse split, Critical Path had 20,398,076 shares of Common Stock outstanding.



Reclassifications



Certain amounts previously reported have been reclassified to conform to the current period presentation and such reclassifications did not have an effect
on the prior periods net loss attributable to common shares.



Use of
Estimates



The preparation of financial statements in
conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and reported amounts of revenues and expenses during the reporting period. These estimates are based on information available as of the date of the financial statements and actual results could differ from those estimates.



Acquisitions



The Company has accounted for all business combinations using the purchase
method of accounting. Results of operations of the acquired businesses are included in the Companys financial results from the date of the acquisition. Assets and liabilities of the companies acquired are recorded at their fair value at the
acquisition date. The excess of the purchase price over the fair value of separately identified tangible and intangible assets acquired and liabilities assumed are included in goodwill in the accompanying consolidated balance sheets. The fair value
of separately identified intangible assets was determined by management based upon accepted valuation methodologies and in consultation with valuation advisers using various valuation methodologies.



Cash Equivalents and Restricted Cash



The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. Cash equivalents consist primarily of deposits in money market funds. Restricted cash is composed of amounts held on deposit that are required as collateral related to certain lease and other
obligations of the Company.



Concentration of Credit Risk



Financial instruments that potentially subject the Company to a
concentration of credit risk consist of cash and cash equivalents, restricted cash and accounts receivable. Cash and cash equivalents and restricted cash are deposited with financial institutions that management believes are creditworthy. While the
Companys accounts receivable are derived from product and service transactions with geographically dispersed companies that operate in a number of horizontal markets, certain customers may be negatively impacted as a result of an economic
downturn or other industry or market related conditions.



Valuation
Allowance for Doubtful Accounts



The Company performs
ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customers current creditworthiness, as determined by the Companys review of their current credit information. The Company
continually monitors collections and payments from customers and maintains a provision for estimated credit losses based on a percentage of its accounts receivable, the historical



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



experience and any specific customer collection issues that the Company has identified. While such credit losses have historically been within the
Companys expectations and appropriate reserves have been established, the Company cannot guarantee that it will continue to experience the same credit loss rates that the Company has experienced in the past. Material differences may result in
the amount and timing of revenue and or expenses for any period if management made different judgments or utilized different estimates.



Fair Value of Financial Instruments



The Companys financial instruments, including cash and cash equivalents, restricted cash, accounts and notes receivable and accounts payable, are
carried at cost, which approximates fair value due to the short maturity of these instruments. The fair value of the Companys notes payable are disclosed in Note 10Notes Payable.



Derivative Instruments



The Company accounts for derivative instruments in accordance with the provisions of SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, and its related interpretations and complies with SFAS No. 138, Accounting for Certain Derivative Instruments and Hedging Activitiesan amendment of FASB Statement No. 133. SFAS No. 133
and SFAS No. 138 establish accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities.



The Companys Series D preferred stock and the Amended Series D
preferred stock contain an embedded derivative instrument, related to the change-in-control feature of the Series D preferred stock, which is recorded as a liability on the Companys balance sheet in accordance with current authoritative
guidance. At December 31, 2003, the embedded derivative instrument was recorded in the carrying value of the Series D preferred stock, in accordance with the authoritative guidance at such time, but has been reclassed to long-term liabilities 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 December 31, 2003 the estimated fair value of the embedded derivative liability was $24.9 million and at December 31, 2004, the
estimated fair value of the embedded derivative liability in the Amended Series D preferred stock was $3.0 million. See also Note 13Mandatorily Redeemable Preferred Stock.



The Company also carries a derivative instrument associated with warrants which were issued as part of an $11.0 million
financing transaction completed in December 2004. The proceeds from the financing transaction were allocated to the notes and warrants based upon their relative estimated fair values. The estimated fair value allocated to the warrants of $2.1
million has been classified as a derivative instrument and recorded as a long-term liability on the Companys balance sheet. In accordance with 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). Because these notes were issued at the end of the Companys
fiscal year, the warrant derivative liability is being carried on the Companys books at its initial fair value of $2.1 million at December 31, 2004. See also Note 10Notes Payable.



Property and Equipment



Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line
method over the shorter of the estimated useful lives of the assets or the remaining lease term. The Company generally depreciates computer equipment and software, and furniture and fixtures over useful lives of three years.



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Gains and losses on disposals are included in results of operations at amounts equal to the
difference between the net book value of the disposed assets and the proceeds received upon disposal. Expenditures for replacements and improvements are capitalized, while expenditures for maintenance and repairs are charged to operations as
incurred.



Software Costs for Internal Use



The Company capitalizes costs related to software for internal use. These
costs primarily include purchased software and qualifying external consulting fees and are amortized over their estimated useful lives, generally three years. The amortization expense is included in general and administrative expenses. During 2002,
2003 and 2004, approximately $278,000, $174,000 and $237,000, respectively, of internal use software costs were capitalized, and amortization of $1.3 million, $1.1 million and $350,000, respectively, was charged to expense.



Software Costs for Products



Development costs related to software products are expensed as incurred, as
research and development costs, until technological feasibility of the product has been established. The Company has defined the establishment of technological feasibility as the completion of a working model. There is typically a relatively short
time period between technological feasibility and product release, and the amount of costs incurred during such period is insignificant; as a result, capitalization of software development costs has been infrequent and insignificant. Amortization of
approximately $267,000 was recorded in each of 2002 and 2003 associated with software development costs capitalized in 2000. There were no capitalized software development costs to amortize in 2004 and no amounts were capitalized during 2002, 2003
and 2004.



Goodwill



As of January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other
Intangible Assets. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill,
reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing goodwill and other intangibles. The standard also requires
that goodwill be allocated to the Companys reporting units for purposes of impairment testing. The Company identified one reporting unit for the purposes of this analysis: digital communications software and services.



This impairment review involves a two-step process as follows:



|       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Step 1 |  | The Company compares the fair value of its reporting unit to the carrying value, including goodwill, of the unit. If the carrying value, including goodwill, exceeds the units fair
value, the Company moves on to step 2. If the reporting units fair value exceeds the carrying value, no further work is performed and no impairment charge is necessary.                                                                                                                                                                                                                                                                                                                                                                                                                           
|       | 
|Step 2 |  | The Company performs an allocation of the fair value of the reporting unit to its identifiable tangible and non-goodwill intangible assets and liabilities. This derives an implied fair value
for the reporting units goodwill. The Company then compares the implied fair value of the reporting units goodwill with the carrying amount of the reporting units goodwill. If the carrying amount of the reporting units
goodwill is greater than the implied fair value of its goodwill, an impairment charge would be recognized for the excess. Purchased technology and other identifiable intangible assets are carried at cost less accumulated amortization. The Company
amortizes other identifiable intangibles on a straight-line basis over their estimated useful lives.



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



See Note 7Goodwill and Other Intangible Assets, for a discussion of the results of the
Companys 2004 impairment review.



Finite-lived Intangibles and
Long-lived Assets



Finite-lived intangible assets are
presented at cost, net of accumulated amortization. Amortization is calculated using the straight-line method over estimated useful lives of the assets, which has historically been between 3 and 5 years. The Company will record an impairment charge
on finite-lived intangibles or long-lived assets when it determines that the carrying value of intangibles and long-lived assets may not be recoverable. Factors considered important which could trigger an impairment, include, but are not limited to:



| |  |  | significant under performance relative to expected historical or projected future operating results;
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | significant changes in the manner of the Companys use of the acquired assets or the strategy for the Companys overall business;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | significant negative industry or economic trends;
| | - |  | -------------------------------------------------



| |  |  | significant decline in the Companys stock price for a sustained period; and
| | - |  | ----------------------------------------------------------------------------



| |  |  | the Companys market capitalization relative to net book value.
| | - |  | ---------------------------------------------------------------



Based upon the existence of one or more of the above indicators of impairment, the Company measures any impairment based on a projected discounted cash
flow method using a discount rate determined by the Companys management to be commensurate with the risk inherent in the Companys current business model. See also Note 6Property and Equipment and Note 7Goodwill and Other
Intangible Assets.



Revenue Recognition



The Company recognizes revenue related to the sale of the Companys
licensed software products, hosted messaging and communication services, professional services and post-contract customer maintenance and support services. Revenue is recognized once the related products and services have been delivered and
collection of all fees is considered probable.



| |  |  | License Revenues
| | - |  | ----------------



| |  | Software license. The Company derives software license revenues from perpetual and term licenses for the Companys messaging and identity management solutions and for
third-party software which the Company resells. License revenues are recognized when persuasive evidence of an arrangement exists, delivery of the licensed software to the customer has occurred and the collection of a fixed or determinable license
fee is considered probable.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Companys revenue recognition policies require that revenues recognized from software arrangements be allocated to each element of the arrangement based on
the fair values of the elements, such as software products, post contract customer support, installation, training or other services. License software sales that involve multiple elements, including software license and undelivered maintenance and
support and professional services, are recognized such that the Company allocates revenue to the delivered elements of the arrangement using the residual value method based on evidence of the fair value of the undelivered elements. The vendor
specific objective evidence of fair values for the ongoing maintenance obligations are based upon the prices paid for the separate renewal of these services by the customer or upon substantive renewal rates stated in the contractual arrangements.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



| | Vendor specific objective evidence of the fair value of other services, primarily professional services, is based upon substantive rates stated in the
contractual arrangements or upon separate sales of these services at substantive rates.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | If an arrangement includes specific customization or modification services that are deemed essential to the functionality of the product, the Company recognizes the entire
arrangement fee using the percentage of completion method. Under this method, individual contract revenues are recorded based on the percentage relationship of the contract costs incurred as compared to managements estimate of the total cost
to complete the contract. If fair value cannot be determined for more than one individual element of a multiple element arrangement, revenue is recognized ratably over the term of the agreement.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | License fees are also received from resellers under arrangements that do not provide product return or exchange rights. Revenues from reseller agreements may include a
nonrefundable, advance royalty which is payable upon the signing of the contract and license fees based on the contracted value of the Companys products purchased by the reseller. Guaranteed license fees from resellers, where no right of
return exists, are recognized when persuasive evidence of an arrangement exists, delivery of the licensed software has occurred and the collection of a fixed or determinable license fee is considered probable. Non-guaranteed per-copy license fees
from resellers are initially deferred and are recognized when they are reported as sold to end-users by the reseller.
| |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Service Revenues
| | - |  | ----------------



Hosted messaging services. The Company derives hosted messaging revenues from fees for hosting services it offers related to its messaging and
collaboration solutions. These are primarily based upon monthly contractual per unit rates for the services involved, which are recognized on a monthly basis over the term of the contract beginning with the month in which service delivery starts.
Amounts billed or received in advance of service delivery, including but not limited to branding and set-up fees, are initially deferred and subsequently recognized on a ratable basis over the expected term of the relationship beginning with the
month in which service delivery starts.



| |  | Professional services. The Company derives professional service revenues from fees primarily related to training, installation and configuration services. The associated
revenues are recognized in the period in which the services are performed.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Maintenance and support. The Company derives maintenance and support service revenues from fees for post-contract customer support agreements associated with product
licenses. Such services typically include rights to future update and upgrade product releases and dial-up and on-site support services. Fees are deferred and recognized ratably over the term of the support contract, generally one year.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Advertising Expense



Advertising and promotion costs are expensed as incurred. Costs associated
with the development of print or other media campaigns are deferred until the period that includes the first commercial use of the media campaign. Costs associated with industry trade shows and customer conferences are deferred until the period that
includes the applicable trade show or conference. Advertising costs totaled $353,000, $49,000 and $36,000 during 2002, 2003 and 2004, respectively.



Research and Development



Research and development costs include expenses incurred by the Company to develop and enhance its digital communications software and services. Research
and development costs, including acquired in-process research and development costs, are recognized as expense, when incurred.



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Stock-Based Compensation



The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and its related interpretations and complies with the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation. Under APB No. 25,
compensation expense for fixed options is based on the difference, if any, on the date of the grant, between the fair value of the Companys stock and the exercise price of the option. The Company amortizes stock-based compensation using the
accelerated method over the remaining vesting periods of the related options, which is generally four years.



The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
(EITF) Issue No. 96-18. The shares underlying warrants or options, which are unvested, are remeasured at each reporting date until a measurement date occurs, at which time the fair value of the warrant is fixed. The related charge is
amortized over the estimated term of the relationship. In the event such remeasurement results in increases or decreases from the initial fair value, which could be substantial, these increases or decreases will be recognized immediately, if the
fair value of the shares underlying the milestone has been previously recognized, or over the remaining term, if not. Currently, all related amortization has been recognized as advertising expense over the term of the estimated benefit period. See
also Note 7Goodwill and Other Intangible Assets.



The
following stock-based compensation amounts, as reported in the Companys Consolidated Statement of Operations for 2002, 2003 and 2004, are further detailed on a product or functional basis as follows:



|                                                           |  |                         |       |      |   |       |  |   |      
|---------------------------------------------------------- |  | ----------------------- | ----- | ---- | - | ----- |  | - | -----
|                                                           |  | Year Ended December 31,
|                                                           |  | 2002                    |       | 2003 |   | 2004 
|                                                           |  | (In thousands)         
|Stock-based expense reported in cost of net revenues:      |  |                         |       |      |   |       |  |   |      
|Hosted messaging                                           |  | $                       | 590   |      | $ | 8     |  | $ | 28   
|Professional services                                      |  |                         | 222   |      |   | 3     |  |   | 47   
|Maintenance and support                                    |  |                         | 413   |      |   | 6     |  |   | 1    
|                                                           |  |                         |       |      |   |       |  |   |      
|Total stock-based expense reported in cost of net revenues |  |                         | 1,225 |      |   | 17    |  |   | 76   
|                                                           |  |                         |       |      |   |       |  |   |      
|Stock-based expense reported in operating expenses:        |  |                         |       |      |   |       |  |   |      
|Sales and marketing                                        |  |                         | 3,877 |      |   | 18    |  |   | 48   
|Research and development                                   |  |                         | 1,214 |      |   | 15    |  |   | 37   
|General and administrative                                 |  |                         | 3,681 |      |   | 35    |  |   | 1,754
|Settlement of litigation                                   |  |                         |      |      |   | 5,056 |  |   |     
|                                                           |  |                         |       |      |   |       |  |   |      
|Total stock-based expense reported in operating expenses   |  |                         | 8,772 |      |   | 5,124 |  |   | 1,839
|Total stock-based expenses                                 |  | $                       | 9,997 |      | $ | 5,141 |  | $ | 1,915
|                                                           |  |                         |       |      |   |       |  |   |      



Of the stock-based
charges incurred by the Company in 2004 totaling $1,915,000, $926,000 represents the initial vesting of restricted stock and units granted in 2004, and $989,000 represents stock-based costs associated with severance agreements for certain terminated
employees and consulting arrangements. These charges were included in operating expenses based on the functions of the related employees and consultants. See Note 14Shareholders equity (deficit) for a further discussion.



In 2003, the Company recorded a stock-based charge of $5,056,000
associated with the issuance of shares of Common Stock and Series D Preferred Stock to settle litigation. See Note 12Commitments and Contingencies for additional information.



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



In 2002, the Company recognized amortization expense of $9,997,000 associated with the amortization
of unearned compensation arising from the grant of employee stock options granted in 2001 with below market exercise prices. Based upon the functions of the employees and consultants participating in the related option grants, $1.2 million of this
charge was allocated to cost of net revenues and the remaining expenses were allocated to operating expenses. See Note 14Shareholders equity (deficit) for a further discussion.



Pursuant to the requirements of 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 (ESPP), the pro forma amounts of the Companys net loss and net loss per share would have been as follows:



|                                                                                                          |  |                                          |          |   |      |   |          |      |  |   |         |  
|--------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | -------- | - | ---- | - | -------- | ---- |  | - | ------- | -
|                                                                                                          |  | Year Ended December 31,                  |         
|                                                                                                          |  | 2002                                     |          |   | 2003 |   |          | 2004 | 
|                                                                                                          |  | (In thousands, except per share amounts) |         
|Net loss attributable to common sharesas reported                                                        |  | $                                        | (131,815 | ) |      | $ | (74,579  | )    |  | $ | (66,562 | )
|Add:                                                                                                      |  |                                          |          |   |      |   |          |      |  |   |         |  
|Stock-based employee compensation expense included in reported net loss attributable to common shares,    |  |                                          | 9,997    |   |      |   | 59       |      |  |   | 1,915   |  
|Deduct:                                                                                                   |  |                                          |          |   |      |   |          |      |  |   |         |  
|Total stock-based employee compensation expense determined under a fair value based method for all grants |  |                                          | (68,658  | ) |      |   | (26,696  | )    |  |   | (8,571  | )
|                                                                                                          |  |                                          |          |   |      |   |          |      |  |   |         |  
|Net loss attributable to common sharespro forma                                                          |  | $                                        | (190,476 | ) |      | $ | (101,216 | )    |  | $ | (73,218 | )
|                                                                                                          |  |                                          |          |   |      |   |          |      |  |   |         |  
|Basic and diluted net loss per share attributable to common sharesas reported                            |  | $                                        | (6.78    | ) |      | $ | (3.73    | )    |  | $ | (3.15   | )
|                                                                                                          |  |                                          |          |   |      |   |          |      |  |   |         |  
|Basic and diluted net loss per share attributable to common sharespro forma                              |  | $                                        | (9.80    | ) |      | $ | (5.06    | )    |  | $ | (3.47   | )
|                                                                                                          |  |                                          |          |   |      |   |          |      |  |   |         |  



The weighted average
fair value of options granted were $4.41, $2.99 and $1.20 during 2002, 2003 and 2004, respectively. 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:



|                          |  |                         |   |  |            |   |  |             |  
|------------------------- |  | ----------------------- | - |  | ---------- | - |  | ----------- | -
|                          |  | Year Ended December 31, |  
|                          |  | 2002                    |   |  | 2003       |   |  | 2004        |  
|Risk-free interest rate   |  | 2.6                     | % |  | 1.7-3.0    | % |  | 2.4-3.5     | %
|Expected lives (in years) |  | 4.0                     |   |  | 4.0        |   |  | 4.0         |  
|Dividend yield            |  | 0.0                     | % |  | 0.0        | % |  | 0.0         | %
|Expected volatility       |  | 111.0                   | % |  | 97.8-141.1 | % |  | 119.6-138.5 | %



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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 FAS 123, using the following assumptions:



|                          |  |                         |   |  |            |   |  |             |  
|------------------------- |  | ----------------------- | - |  | ---------- | - |  | ----------- | -
|                          |  | Year Ended December 31, |  
|                          |  | 2002                    |   |  | 2003       |   |  | 2004        |  
|Risk-free interest rate   |  | 2.6                     | % |  | 1.6-2.6    | % |  | 2.3-2.6     | %
|Expected lives (in years) |  | 1.0                     |   |  | 1.0        |   |  | 1.2         |  
|Dividend yield            |  | 0.0                     | % |  | 0.0        | % |  | 0.0         | %
|% Expected volatility     |  | 111.0                   | % |  | 97.8-139.8 | % |  | 132.9-139.8 | %



The aggregate fair
value of ESPP purchase rights granted in 2002, 2003 and 2004 was approximately $446,000, $294,000 and $128,000, respectively, which equates to a per purchase right of $1.52, $1.61 and $1.77, respectively, during 2002, 2003 and 2004.



Income Taxes



Income taxes are computed using an asset and liability approach, which requires the recognition of taxes payable or
refundable for the current year and deferred tax assets and liabilities for the future tax consequences of events that have been recognized in the Companys consolidated financial statements or tax returns. The measurement of current and
deferred tax assets and liabilities are based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated. Deferred tax assets are reduced, if necessary, by the amount of any tax benefits that, based
on available evidence, are more likely than not to be realized.



Net Loss
Per Share Attributed to Common Shares



Basic net loss per
share attributed to common shares is computed by dividing the net loss attributable to common shares for the period by the weighted average number of common shares outstanding during the period. Shares subject to repurchase by the Company and shares
held in escrow in connection with certain acquisition agreements are excluded from the basic calculation. Diluted net loss per share attributed to common shares is computed by dividing the net loss attributable to common shares for the period by the
weighted average number of common and potential common shares outstanding during the period, if the effect of each class of potential common shares is dilutive. Potential common shares include restricted Common Stock, shares held in escrow, Common
Stock subject to repurchase rights, and incremental Common and Preferred shares issuable upon the exercise of stock options and warrants and upon conversion of Series D preferred stock, the Senior Secured Convertible Notes and the Convertible
Subordinated Notes. See also Note 16Net Loss Per Share Attributed to Common Shares.



Comprehensive Income (Loss)



The Company accounts for and reports comprehensive income or loss and its components in its financial statements. Comprehensive income (loss), as defined, includes the Companys net income or loss and all other changes in equity (net
assets) during the period from non-owner sources.



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Changes in accumulated other comprehensive income (loss) during 2002, 2003 and 2004 were as follows
(in thousands):



|                                         |  |                                                       |        |   |                                 |   |        |       |  |   |        |  
|---------------------------------------- |  | ----------------------------------------------------- | ------ | - | ------------------------------- | - | ------ | ----- |  | - | ------ | -
|                                         |  | Unrealized gain(loss) onavailable-for-saleinvestments |        |   | Cumulativetranslationadjustment |   |        | Total | 
|Balance at December 31, 2001             |  | $                                                     | (790   | ) |                                 | $ | (1,998 | )     |  | $ | (2,788 | )
|Unrealized investment losses             |  |                                                       | (671   | ) |                                 |   |       |       |  |   | (671   | )
|Foreign currency translation adjustments |  |                                                       |       |   |                                 |   | 2,416  |       |  |   | 2,416  |  
|                                         |  |                                                       |        |   |                                 |   |        |       |  |   |        |  
|Balance at December 31, 2002             |  | $                                                     | (1,461 | ) |                                 | $ | 418    |       |  | $ | (1,043 | )
|                                         |  |                                                       |        |   |                                 |   |        |       |  |   |        |  
|Unrealized investment gains              |  |                                                       | 1,461  |   |                                 |   |       |       |  |   | 1,461  |  
|Foreign currency translation adjustments |  |                                                       |       |   |                                 |   | 1,696  |       |  |   | 1,696  |  
|                                         |  |                                                       |        |   |                                 |   |        |       |  |   |        |  
|Balance at December 31, 2003             |  | $                                                     |       |   |                                 | $ | 2,114  |       |  | $ | 2,114  |  
|                                         |  |                                                       |        |   |                                 |   |        |       |  |   |        |  
|Foreign currency translation adjustments |  |                                                       |       |   |                                 |   | (2,668 | )     |  |   | (2,668 | )
|                                         |  |                                                       |        |   |                                 |   |        |       |  |   |        |  
|Balance at December 31, 2004             |  | $                                                     |       |   |                                 | $ | (554   | )     |  | $ | (554   | )
|                                         |  |                                                       |        |   |                                 |   |        |       |  |   |        |  



There were no tax
effects allocated to any components of other comprehensive income during 2002, 2003 or 2004.



Foreign Currency



The
Company considers the local currencies of each of its foreign operations to be the functional currency in those operations. Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenues
and expenses are translated at average rates of exchange prevailing during the period. Translation adjustments are charged or credited to other comprehensive income, a component of shareholders equity (deficit). Gains and losses on foreign
currency transactions are included in non-operating income and expense. The Company recognized net losses from foreign currency transactions in the amount of $817,000 and $440,000 in 2002 and 2003, respectively, and a net gain of $3.1 million in
2004.



Segment and Geographic Information



The Company currently manages its business in a manner that requires it to
report financial results for one segment: Digital communications software and services. The management of the Company primarily uses one measure of profitability to measure the performance of this segmentAdjusted EBITDA. Adjusted EBITDA is a
non-GAAP measure which represents the Companys earnings before interest income, interest expense, provision for income taxes, depreciation, amortization and adjusted to exclude other items such as other income (expense), net, loss on
extinguishment of debt, gain on investments, non-cash severance, reserve for officer notes receivable, restructuring expenses, stock-based expenses and accretion on mandatorily redeemable preferred stock. See also Note 17Product and Geographic
Information.



Recent Accounting Pronouncements



In March 2004, the Financial Accounting Standards Board (FASB) approved the
consensus reached on the Emerging Issues Task Force Issue (EITF) No. 03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-01 provides guidance on determining when an investment is
considered impaired, whether that impairment is other than temporary and the measurement of an impairment



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



loss. EITF 03-01 also provides new disclosure requirements for other-than-temporary impairments on debt and equity investments. In September 2004, the FASB
delayed until further notice the effective date of the measurement and recognition guidance contained in EITF 03-01, however the disclosure requirements of EITF 03-01 are currently effective. The Company has adopted the disclosure requirements of
EITF 03-01.



In April 2004, the EITF issued EITF 03-06,
Participating Securities and the Two-Class Method under SFAS No. 128, Earnings per Share. EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock
that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock. The issue also provides further guidance in applying the two-class method of calculating earnings
per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a
security. EITF 03-06 is effective for fiscal periods beginning after March 15, 2004. The adoption of EITF 03-06 did not have a material impact on the Companys results of operations and financial position.



In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment.
The statement replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. This statement focuses primarily on accounting for transactions in which an
entity obtains employee services in share-based payment transactions. The adoption of the statement will result in the expensing of the fair value of stock options granted to employees in the financial statements. Currently, the Company only
discloses the impact of expensing the fair value of stock options in the notes to the financial statements (see Stock-based compensationsection presented earlier in this Note). The statement is effective beginning with the Companys
third quarter of 2005.



The statement applies to new equity
awards and to equity awards modified, repurchased, or canceled after the effective date. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of the effective date
shall be recognized as the requisite service is rendered on or after the effective date. The compensation cost for that portion of awards shall be based on the grant-date fair value of those awards as calculated from the pro forma disclosures under
Statement No. 123. Changes to the grant-date fair value of equity awards granted before the effective date of this statement are precluded. The compensation cost for those earlier awards shall be attributed to periods beginning on or after the
effective date of this statement using the attribution method that was used under Statement No. 123, except that the method of recognizing forfeitures only as they occur shall not be continued. Any unearned or deferred compensation related to those
earlier awards shall be eliminated against the appropriate equity accounts. Additionally, common stock purchased pursuant to stock options granted under the Companys employee stock purchase plan will be expensed based upon the fair market
value of the stock option.



The statement also allows for a
modified version of retrospective application to periods before the effective date. Modified retrospective application may be applied either (a) to all prior years for which Statement No. 123 was effective or (b) only to prior interim periods in the
year of initial adoption. An entity that chooses to apply the modified retrospective method to all prior years for which Statement No. 123 was effective shall adjust financial statements for prior periods to give effect to the fair-value-based
method of accounting for awards granted, modified, or settled in cash in fiscal years beginning after December 15, 1994, on a basis consistent with the pro forma disclosures required for those periods by Statement No. 123. Accordingly, compensation
cost and the related tax effects will be recognized in those financial statements as though they had been accounted for under Statement No. 123. Changes to amounts as originally measured on a pro forma basis are precluded.



The adoption of SFAS No. 123R will have a material impact on the
Companys results of operations, increasing cost of revenues, sales and marketing expenses, research and development expenses and general and



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



administrative expenses. The future results will be impacted by the number and value of additional stock option grants as well as the value of existing
unvested stock options.



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.



In October 2004, the American Jobs Creation Act of 2004 (the AJCA) was passed. The AJCA provides a deduction for income from
qualified domestic production activities which will be phased in from 2005 through 2010. In return, the AJCA also provides for a two-year phase-out of the existing extra-territorial income exclusion for foreign sales that was viewed to be
inconsistent with international trade protocols by the European Union. In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-1, Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified
Production Activities by the American Jobs Creation Act of 2004. FSP 109-1 treats the deduction as a special deduction as described in FAS No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities
existing at the enactment date. Rather, the impact of this deduction will be reported in the same period in which the deduction is claimed in the Compnays tax return. The Company is currently evaluating the impact the AJCA will have on the
Companys results of operations and financial position.



The AJCA also creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. The deduction is
subject to a number of limitations. The Company is currently evaluating the AJCA and is not yet in a position to decide whether, or to what extent, to repatriate foreign earnings that have not yet been remitted to the United States.



On March 29, 2005, the SEC issued Staff Accounting Bulletin (SAB) 107 which
express the views of the SEC regarding the interaction between SFAS No. 123R and certain SEC rules and regulations and provided the SECs views regarding the valuation of share-based payment arrangements for public companies. In particular, SAB 107
provides guidance related to share-based payment transactions with nonemployees, the transition from nonpublic to public entity status, valuation methods (including assumptions such as expected volatility and expected term), the accounting for
certain redeemable financial instruments issue under share-based payment arrangements, the classification of compensation expense, non-GAAP financial measures, first-time adoption of SFAS No. 123R in and interim period, capitalization of
compensation cost related to share-based payment arrangements. The accounting for income tax effects of share-based payment arrangements upon adoption of SFAS No. 123R, the modification of employee share options prior to adoption of SFAS No. 123R
and disclosures in Managements Discussion and Analysis of Financial Condition and Results of Operations subsequent to adoption of SFAS No. 123R. We are currently evaluating the impact SAB 107 will have on our results of operations and financial
position.



Note 2Acquisition



On June 6, 2002, the Company acquired the remaining 60% ownership interest
that it did not already own in its Japanese joint venture, Critical Path Pacific, Inc., from Mitsui and Co. Ltd., NTT Communications



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Corporation and NEC Corporation, for $3.0 million in cash and the assumption of $2.6 million in business restructuring and capital lease obligations. The
excess of the purchase price of $5.6 million over the fair value of the acquired net assets, primarily working capital and fixed assets, of $4.6 million was recorded as goodwill. In accordance with SFAS No. 142, this goodwill asset of approximately
$1.0 million will not be amortized; however, the Company will test this asset for impairment on an annual basis, or more frequently if events or circumstances indicate that the asset might be impaired. The Company began including the financial
results of Critical Path Pacific in its own consolidated results subsequent to the acquisition date.



Note 3Strategic Restructuring



The following tables summarize strategic restructuring costs incurred by the Company during the three years ended December 31, 2004:



|                               |  |                    |      |   |                                                     |   |      |                                                 |  |   |       |   |  |   |      |  
|------------------------------ |  | ------------------ | ---- | - | --------------------------------------------------- | - | ---- | ----------------------------------------------- |  | - | ----- | - |  | - | ---- | -
|                               |  | Workforcereduction |      |   | Facility andoperationsconsolidationand othercharges |   |      | Non-coreproduct andservice salesanddivestitures |  |   | Total |  
|                               |  | (in millions)      |     
|Liability at December 31, 2001 |  | $                  | 0.1  |   |                                                     | $ | 1.9  |                                                 |  | $ | 0.2   |   |  | $ | 2.2  |  
|Total gross charges            |  |                    | 2.1  |   |                                                     |   | 1.1  |                                                 |  |   |      |   |  |   | 3.2  |  
|Adjustments                    |  |                    |     |   |                                                     |   |     |                                                 |  |   |      |   |  |   |     |  
|                               |  |                    |      |   |                                                     |   |      |                                                 |  |   |       |   |  |   |      |  
|Total net charge               |  |                    | 2.1  |   |                                                     |   | 1.1  |                                                 |  |   |      |   |  |   | 3.2  |  
|Cash receipts (payments)       |  |                    | (1.0 | ) |                                                     |   | (1.4 | )                                               |  |   | 0.1   |   |  |   | (2.3 | )
|Noncash charges                |  |                    |     |   |                                                     |   | (0.5 | )                                               |  |   |      |   |  |   | (0.5 | )
|                               |  |                    |      |   |                                                     |   |      |                                                 |  |   |       |   |  |   |      |  
|Liability at December 31, 2002 |  |                    | 1.2  |   |                                                     |   | 1.1  |                                                 |  |   | 0.3   |   |  |   | 2.6  |  
|Total gross charges            |  |                    | 6.0  |   |                                                     |   | 1.8  |                                                 |  |   | 0.3   |   |  |   | 8.1  |  
|Adjustments                    |  |                    | (0.6 | ) |                                                     |   | (0.3 | )                                               |  |   | (0.3  | ) |  |   | (1.2 | )
|                               |  |                    |      |   |                                                     |   |      |                                                 |  |   |       |   |  |   |      |  
|Total net charge               |  |                    | 5.4  |   |                                                     |   | 1.5  |                                                 |  |   |      |   |  |   | 6.9  |  
|Cash receipts (payments)       |  |                    | (6.2 | ) |                                                     |   | (1.8 | )                                               |  |   | (0.3  | ) |  |   | (8.3 | )
|Noncash charges                |  |                    | (0.2 | ) |                                                     |   | (0.4 | )                                               |  |   |      |   |  |   | (0.6 | )
|                               |  |                    |      |   |                                                     |   |      |                                                 |  |   |       |   |  |   |      |  
|Liability at December 31, 2003 |  |                    | 0.2  |   |                                                     |   | 0.6  |                                                 |  |   | 0.0   |   |  |   | 0.8  |  
|Total gross charges (credits)  |  |                    | 4.4  |   |                                                     |   | 0.9  |                                                 |  |   | 0.6   |   |  |   | 5.9  |  
|Adjustments                    |  |                    |     |   |                                                     |   |     |                                                 |  |   | (2.3  | ) |  |   | (2.3 | )
|                               |  |                    |      |   |                                                     |   |      |                                                 |  |   |       |   |  |   |      |  
|Total net charge               |  |                    | 4.4  |   |                                                     |   | 0.9  |                                                 |  |   | (1.7  | ) |  |   | 3.6  |  
|Cash receipts (payments)       |  |                    | (4.5 | ) |                                                     |   | (0.6 | )                                               |  |   | (0.1  | ) |  |   | (5.2 | )
|Noncash charges                |  |                    |     |   |                                                     |   | (0.2 | )                                               |  |   | 1.8   |   |  |   | 1.6  |  
|                               |  |                    |      |   |                                                     |   |      |                                                 |  |   |       |   |  |   |      |  
|Liability at December 31, 2004 |  | $                  | 0.1  |   |                                                     | $ | 0.7  |                                                 |  | $ |      |   |  | $ | 0.8  |  
|                               |  |                    |      |   |                                                     |   |      |                                                 |  |   |       |   |  |   |      |  



In April 2001, the
Company announced a strategic restructuring plan that involved reorganizing and refocusing Critical Paths product and service offerings, a workforce reduction, and a facilities and operations consolidation. Additionally, the Company
implemented an expense management plan to further reduce operating costs while maintaining strong customer service. The Company completed its restructuring plan in 2001, including the divestiture of products and services deemed to be non-core
products and services to the continued operations of the Company, a 44% reduction in headcount, a 65% reduction in the number of facilities and the implementation of other cost cutting measures, resulting in a significant reduction in overall
operating expenses. The non-core products and services comprised approximately 21% of total revenues in the year ended December 31, 2001.



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



During 2001, the Company sold or discontinued its non-core products and services and as a result of
these transactions recognized a net gain of $1.0 million for the year ended December 31, 2001. The Company reduced its headcount from 1,011 employees at March 31, 2001 to 562 employees at December 31, 2001. Charges related to the headcount reduction
consisted primarily of the payment of severance and fringe benefits, and aggregated approximately $10.3 million during 2001. In connection with these restructuring actions, the Company reduced the number of facilities it occupied from 77 at March
31, 2001 to 27 at December 31, 2001. Lease termination and facility consolidation related charges consisted primarily of lease termination costs, future lease payments and related fees, and aggregated approximately $9.0 million during 2001.



The initiatives contemplated under these restructurings were
completed during 2003, and during the first quarter of 2003, the Company reversed approximately $1.2 million in restructuring expenses, which were originally accrued in 2001 and 2002 associated with the restructuring initiatives discussed above, as
the Company determined these amounts will not be paid in the future. During the fourth quarter of 2004, the company reversed approximately 2.3 million in restructuring expenses which were originally accrued in 2001. The reversal of these expenses is
reflected in the Adjustments column of the Strategic Restructuring table presented above.



In May 2002, the Board of Directors approved a restructuring plan to reduce the Companys expense levels consistent with the business climate at that
time. In connection with the plan, a restructuring charge of $1.5 million was recognized in the second quarter of 2002. This charge was comprised of approximately $1.2 million in severance and related costs associated with the elimination of
approximately 39 positions and $0.3 million in facilities lease termination costs. The balance of the accrual at December 31, 2004 was approximately $0.1 million and is expected to be utilized during the first half of 2005.



In January 2003, the Company announced a restructuring initiative designed to
further reduce its expense levels in an effort to achieve operating profitability. The plan included the consolidation of certain office locations and a global workforce reduction of approximately 175 positions, or approximately 30% of the
workforce. The headcount reduction was partially offset by outsourcing approximately 75 positions to lower cost service providers. The Company incurred aggregate charges of approximately $8.0 million resulting from the cost reduction plan, inclusive
of $7.0 million in cash and $1.0 million in non-cash expenses. Included in this plan were approximately $1.7 million in charges incurred in the fourth quarter of 2002, comprised of approximately $0.7 million in severance and related costs and $1.0
million in facilities lease termination costs. During the first quarter of 2004, this initiative was completed and there was no remaining balance accrued at December 31, 2004.



In November 2003, the Company announced that it was restructuring certain of its facility lease obligations in an effort to
reduce its long-term cash obligations. In addition, the Company identified an additional 16 positions, primarily held by management-level employees, which were to be eliminated. Costs totaling $1.9 million were recognized during the fourth quarter
of 2003 associated with these initiatives, including $1.4 million in lease restructuring and termination costs and $0.5 million in severance and related headcount reduction costs. Costs totaling $1.1 million were recognized during the first quarter
of 2004 associated with these initiatives, including $0.1 million in lease restructuring and termination costs and $1.0 million in severance and related headcount reduction costs. Additionally, costs totaling $1.3 million were recognized during the
second quarter of 2004, including $0.8 million in severance and related headcount reduction costs and $0.5 million in facility consolidation and other related costs.



In August 2004, the Company expanded its 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. This effort began in August 2004 and is expected to continue into the first quarter of 2005. During the three months ended September 30,
2004, the Company recorded restructuring



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



charges related to these activities totaling $2.6 million, consisting primarily of $2.1 million for employee severance costs and $0.5 million for costs
related to the closure or consolidation of certain facilities and operations. Additional restructuring charges totaling $0.9 million were recorded during the three months ended December 31, 2004, primarily associated with the restructuring of the
Companys hosted messaging operations.



As of December 31,
2004, the Company was carrying remaining accruals totaling $0.7 million associated with its 2004 restructuring activities. These accruals should be utilized by the end of 2005.



Note 4Accounts Receivable



|                                |  |                |        |   |      |   |        |  
|------------------------------- |  | -------------- | ------ | - | ---- | - | ------ | -
|                                |  | December 31,   |       
|                                |  | 2003           |        |   | 2004 |  
|                                |  | (In thousands) |       
|Accounts receivable             |  | $              | 18,534 |   |      | $ | 20,502 |  
|Allowance for doubtful accounts |  |                | (1,654 | ) |      |   | (835   | )
|                                |  |                |        |   |      |   |        |  
|Accounts receivable, net        |  | $              | 16,880 |   |      | $ | 19,667 |  
|                                |  |                |        |   |      |   |        |  



At December 31, 2003
and 2004, The Company did not have any customers that accounted for more than 10% of its accounts receivable.



The Company maintains reserves for potential credit losses on customer accounts when deemed necessary. The Company analyzes specific accounts receivable,
historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts.



Allowance for doubtful accounts



|                        |  |                              |       |                                      |   |      |                          |  |   |                        |   |  |   |      
|----------------------- |  | ---------------------------- | ----- | ------------------------------------ | - | ---- | ------------------------ |  | - | ---------------------- | - |  | - | -----
|Year Ended December 31, |  | Balance atBeginning ofPeriod |       | AdditionsCharged toCosts andExpenses |   |      | Deductions andWrite-offs |  |   | Balance atEnd ofPeriod
|2004                    |  | $                            | 1,654 |                                      | $ | (195 | )                        |  | $ | (624                   | ) |  | $ | 835  
|2003                    |  | $                            | 1,586 |                                      | $ | 199  |                          |  | $ | (131                   | ) |  | $ | 1,654
|2002                    |  | $                            | 1,182 |                                      | $ | 673  |                          |  | $ | (269                   | ) |  | $ | 1,586



Note 5Investments



In June 2000, the Company established a joint venture,
Critical Path Pacific, Inc., with Mitsui and Co., Ltd., NTT Communications Corporation and NEC Corporation to deliver advanced Internet messaging solutions to businesses in Asia. The Company invested $7.5 million, acquiring a 40% ownership interest
in the joint venture. This investment was accounted for using the equity method. During 2001 and 2002, the Company recorded equity in net loss of joint venture of approximately $1.9 million and $1.4 million, respectively. On June 6, 2002, the
Company acquired the remaining 60% ownership interest in the joint venture and began including the financial results of Critical Path Pacific in its own consolidated results subsequent to the acquisition date. See also Note 2Acquisitions.



During 2002, the Company determined that the impairment of
certain of its investments were deemed to be other-than-temporary and recorded write downs of $1.5 million. During 2003, the sale of the Companys remaining investments resulted in a net gain of $549,000, which was comprised of $2.4 million in
aggregate cash proceeds, the recognition of $1.5 million in unrealized losses and the elimination of $357,000 in assets held as equity investments. As of December 31, 2003 and 2004, the Company was not carrying any investments on its balance sheet.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 6Property and Equipment



|                                                |  |                |          |   |      |   |          |  
|----------------------------------------------- |  | -------------- | -------- | - | ---- | - | -------- | -
|                                                |  | December 31,   |         
|                                                |  | 2003           |          |   | 2004 |  
|                                                |  | (In thousands) |         
|Computer equipment and software                 |  | $              | 119,336  |   |      | $ | 120,063  |  
|Furniture and fixtures                          |  |                | 9,313    |   |      |   | 6,627    |  
|Leasehold improvements                          |  |                | 2,030    |   |      |   | 2,145    |  
|                                                |  |                |          |   |      |   |          |  
|                                                |  |                | 130,679  |   |      |   | 128,835  |  
|Less: Accumulated depreciation and amortization |  |                | (115,858 | ) |      |   | (117,456 | )
|                                                |  |                |          |   |      |   |          |  
|                                                |  | $              | 14,821   |   |      | $ | 11,379   |  
|                                                |  |                |          |   |      |   |          |  



At December 31, 2003
and 2004 property and equipment included $5.6 million and $0.2 million of assets under capital leases, respectively, and related accumulated amortization totaled $4.5 million and $0.2 million at December 31, 2003 and 2004, respectively. All assets
under capital leases relate to computer equipment and software.



During 2004, the Company retired fixed assets which were taken out of service due primarily to decisions made associated with its restructuring activities. Fixed assets having a total original cost of $9.7 million and accumulated
depreciation of $9.7 million were retired. The fixed assets which were retired were primarily computer equipment and software, and furniture and fixtures located in the Companys United States ($4.7 million), Japanese ($3.0 million) and
European ($2.0 million) operations.



Depreciation expense
totaled $27.2 million, $16.2 million and $9.8 million during 2002, 2003 and 2004, respectively.



Note 7Goodwill and Other Intangible Assets



At December 31, 2004, the Company was carrying goodwill of $6.6 million, which is no longer being amortized, in accordance with SFAS No. 142. During the second quarter of 2002, the Company recorded goodwill of
approximately $1.0 million associated with its acquisition of the remaining 60% ownership interest in Critical Path Pacific, Inc. (see also Note 2Acquisitions). All acquired intangible assets were fully amortized as of December 31, 2002.



During the fourth quarter of 2004, the Company performed its
annual impairment review, at which time it determined that the goodwill was not impaired. The results of Step 1 of the goodwill impairment analysis showed that goodwill was not impaired as the market value of the Companys one reporting unit
exceeded its carrying value, including goodwill. Accordingly, Step 2 was not performed. The market value of the reporting unit was estimated by multiplying the number of shares of Company stock outstanding on the analysis date by the most recent
stock market closing price. The Company will continue to test for impairment on an annual basis and on a more frequent basis if events occur or circumstances change that would more likely than not reduce the fair value of any of the Companys
reporting units below their carrying value. See also Note 1The Company and Summary of Significant Accounting Policies.



There was no intangible asset amortization expense in 2003 and 2004. Intangible asset amortization expense was $43.3 million in 2002, and in accordance
with SFAS No. 142, did not include any goodwill amortization. Based on the types of other identifiable intangibles acquired, during 2002 amortization expense of $18.5 million was allocated to cost of net revenues and amortization expense of $24.8
million was allocated to operating expenses. The identifiable intangible assets which existed during 2002 primarily related to existing technology



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



for some of the Companys licensed products, which were acquired in 2000, and certain amounts related to assembled workforce, which were acquired in
1999 and 2000. These intangible assets were fully amortized as of the end of 2002.



2003 Warrants



Equity Office Management LLC



In November 2003, the Company entered into an agreement with one of its
landlords, Equity Office Management LLC, pursuant to which the lease covering the Companys Santa Monica facility was restructured. As part of the agreement, Equity Office Management LLC agreed to early terminate the Companys lease
obligation in exchange for $381,000 in cash and warrants to purchase 25,000 shares of Common Stock. The warrants were fully vested upon issuance and are exercisable over a five year period beginning on December 1, 2003, at a price of $2.49 per
share.



Using the Black-Scholes option pricing model and
assuming a term of five years and expected volatility of 138%, the fair value of the warrants on the effective date of the agreement approximated $48,000, which was recorded in restructuring and other expenses in the fourth quarter of 2003.



1999 Warrants



ICQ



In January 1999, the Company entered into an agreement with ICQ, Inc., a subsidiary of AOL Time Warner, pursuant to which
the Company provides email hosting services that are integrated with ICQs instant messaging service provided to ICQs customers. As part of the agreement, ICQ agreed to provide sub-branded advertising for the Company in exchange for
warrants to purchase 2,442,766 shares of Series B Preferred Stock, issuable upon attainment of each of five milestones.



As of April 9, 2000, all five milestones had been attained and all related warrants were exercised during 2000 in two net exercises of 766,674 and
1,441,067 shares. Using the Black-Scholes option-pricing model and assuming a term of seven years and expected volatility of 90%, the final revised aggregate fair value of all vested warrants was $93.8 million, which was being amortized to
advertising expense using the straight-line method over four years. Aggregate charges to stock-based expenses of $14.7 million were recorded to operating expenses during 2002 related to these warrants and the value of these warrants was fully
amortized at December 31, 2002.



Qwest Communications Corporation



In October 1999, the Company entered into an agreement
with Qwest Communications Corporation, a telecommunications company, pursuant to which the Company agreed to provide email hosting services to Qwests customers. As part of the agreement, Qwest agreed to provide sub-branded advertising for
Critical Path in exchange for warrants to purchase up to a maximum of 3,534,540 shares of Common Stock upon attainment of each of six milestones.



The shares underlying the milestones for which achievement was considered probable were remeasured at each subsequent reporting date, beginning at
December 31, 1999, until each sub-branded Qwest mailbox registration threshold was achieved and the related warrant shares vest, at which time the fair value attributable to each tranche of the warrant was fixed. In the event such remeasurement
resulted in an increase or decrease from the initial fair value, these increases or decreases were recognized immediately, if the fair value of the shares underlying the milestone had been previously recognized, or over the remaining term, if not.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



In October 1999, the first of the six milestones had been attained. Using the Black-Scholes
option-pricing model and assuming a term of 5 years and expected volatility of 90%, the final revised aggregate fair value of the vested warrants associated with the first milestone approximated $22.2 million, which was amortized to advertising
expense using the straight-line method over three years. The Company expects that future changes in the trading price of the Companys Common Stock at the end of each quarter, and at the time certain milestones are considered probable and
achieved, may cause additional substantial changes in the ultimate amount of the related stock-based charges.



As of December 31, 2001, only the first of the six milestones had been attained. None of the remaining milestones are considered probable and as a result,
the fair value of the warrants relating to the shares underlying the second through sixth milestones has not been recognized. During 2002, $4.6 million was charged to stock-based operating expense related to the vested warrants and the value of
these warrants was fully amortized at December 31, 2002.



Worldsport Network
Ltd.



In December 1999, the Company entered into an
agreement with Worldsport Network Ltd., the sole and exclusive provider of Internet solutions for the General Association of International Sports Federations (GAISF) and a majority of the international federations it recognizes. Under
the terms of the agreement, Worldsport offers the Companys web-based email and calendaring services to the GAISF network and its members. As part of the agreement, Worldsport agreed to provide sub-branded advertising for the Company in
exchange for warrants to purchase up to a 1.25% equity interest in the Company on a fully diluted basis upon attainment of each of five milestones based on the number of email boxes for which Worldsport registers and provides sub-branding. The
warrants are exercisable for five years after becoming vested. Any warrants not vested within five years of the date of the agreement will be canceled. Worldsport ceased operations and filed for bankruptcy during 2000 and the Company continues to
believe the warrants will ultimately expire unvested and unexercised.



Lessor Warrants



In December 1999, the Company
entered into an agreement with one of its lessors, in connection with an office lease, pursuant- to which the lessor was issued warrants to purchase up to a maximum of 25,000 shares of the Companys Common Stock. The warrants may be exercised
beginning January 1, 2000 through December 20, 2006 at a price of $90.00 per share. The warrants vest at the beginning of each month on a straight-line basis in the amount of 521 shares per month. At December 31, 2004, the warrants remained
unexercised.



Using the Black-Scholes option pricing model and
assuming a term of six years and expected volatility of 90%, the fair value of the warrants on the effective date of the agreement approximated $2.0 million, which was being amortized to general and administrative expenses using the straight-line
method over ten years beginning January 2000. During both 2000 and 2001, approximately $200,000 was charged to stock-based expense related to the vested warrants. In March 2002, the lease was terminated and the remaining value of $1.6 million was
recognized to stock-based expense.



Telco



In January 2000, docSpace entered into an agreement with a major
telecommunications company (Telco) pursuant to which docSpace would provide secure messaging services to the Telcos customers. As part of the agreement, Telco agreed to provide marketing, publicity, and promotional services to
docSpace. As a result of the completion of the Companys acquisition of docSpace, the Company assumed warrants that allowed Telco to purchase up to a maximum of 349,123 shares of the Companys Common Stock upon attainment of each of three
milestones.



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Subsequent to the acquisition, the Company entered into discussions with Telco to modify their
relationship. Accordingly, the vesting provisions of the proposed agreement were modified to reflect the requirements of the new relationship. As of December 31, 2004, none of the vesting milestones of the original agreement had been attained and
none of the milestones are considered probable. Accordingly no deferred compensation associated with the warrants has been recognized. The Company expects that future changes in the trading price of the Companys Common Stock at the end of each
quarter, and at the time certain milestones are achieved, may cause substantial changes in the ultimate amount of the related stock-based charges.



Note 8Related Party Transactions



General Atlantic Partners



In November 2003, the Company issued $10 million in 10% Senior Secured Convertible Notes to General Atlantic Partners. Upon shareholder approval in July
2004, these notes plus accrued and unpaid interest were converted into approximately 7.3 million shares of Series E Redeemable Convertible Preferred Stock (Series E preferred stock). See Note 10Notes Payable.



In December 2004, the Company received aggregate proceeds of $11.0 million
from a group of investors, including affiliates of General Atlantic Partners and the Cheung Kong Group, in exchange for notes issued in the amount of $11.0 million principal and warrants to purchase 235,712 shares of Series F Redeemable Convertible
Preferred Stock (Series F preferred stock). Under the Purchase Agreement, the Company has an option to issue an additional $7.0 million in Notes and warrants to purchase 149,998 shares of Series F preferred stock. Each Note will bear interest at
thirteen and nine-tenths (13.9) percent per annum. In March 2005, the Company issued the remaining $7.0 million of these notes. See Note 10Notes Payable.



The Company also leases a small amount of office space from the General Atlantic Partners in Washington D.C., which is utilized by Critical Path
employees who are based in that region of the country. The term of the lease is on a month-to-month basis at $2,500 per month which the Company believes to be the fair market value of such space.



Cheung Kong Group



In November 2003, the Company executed an agreement, subject to shareholder approval, to exchange approximately $32.8
million in face value of its 53/4% Notes, which were held by a group of investors led by Cheung Kong Group and
its Whampoa Limited affiliates, for approximately 21.9 million shares of Series E preferred stock. At a special meeting in July 2004, the Company received shareholder approval for this transaction. See Note 10Notes Payable.



In December 2004, the Company received aggregate proceeds of $11.0 million
from a group of investors, including affiliates of General Atlantic Partners and the Cheung Kong Group, in exchange for notes issued in the amount of $11.0 million principal and warrants to purchase 235,712 shares of Series F preferred stock. Under
the Purchase Agreement, the Company had an option to issue an additional $7.0 million in Notes and warrants to purchase 149,998 shares of Series F preferred stock. In March 2005, the Company issued the remaining $7.0 million of these notes. Each
Note will bear interest at thirteen and nine-tenths (13.9) percent per annum. See Note 10Notes Payable.



Vectis Group, LLC



In
March 2001, the Company entered into certain agreements with Vectis Group, LLC (Vectis Group) to engage Vectis Group to act as an advisor to the Company with respect to various strategic alternatives the Company was exploring and to
assist with other management related services. As part of the agreement, Vectis Group agreed to provide consulting services to the Company in exchange for a monthly retainer fee, potential



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transactionbased fees associated with certain strategic asset sales and investments in Critical Path and immediately exercisable warrants to purchase
500,000 shares of the Companys Common Stock with an exercise price of $2.00 per share, issuable upon execution of the agreement. Using the Black-Scholes option-pricing model and assuming a term of three years, the term of the agreement, and
expected volatility of 215%, the initial and final fair value of the warrant on the effective date of the agreement approximated $732,000, which was recognized upon the execution of the agreement in March 2001, because the relationship was
terminable at any time. During the term of the agreement, the Company paid Vectis Group an aggregate of approximately $1.1 million in retainer fees and expenses, paid monthly over the life of the agreements, and approximately $3.1 million in
transactional fees, which included approximately $2.8 million in connection with the Series D preferred stock financing transaction in November 2001, in which Vectis Group participated as one of several investors in this transaction led by General
Atlantic Partners and its affiliates. See also Note 13Financing Transactions and Preferred Stock. William McGlashan, Jr., a principal in Vectis Group, and a member of the Board of Directors of the Company, was appointed interim President and
Chief Operating Officer of the Company in April 2001 and was later appointed Vice Chairman and Chief Executive Officer. Effective September 30, 2001, the Company terminated its agreements with Vectis Group for consulting and other transactional
services. In connection with the termination of the agreements, certain other employees of Vectis Group became employees of Critical Path. The Company paid to Vectis a total of approximately $12,500 for expense reimbursement in February 2002.
Although the agreements were terminated, certain obligations under the agreement survived, including the transaction fee paid in connection with the Companys financing transaction in 2001 and related indemnification obligations.



Release of The docSpace Company Escrow Funds



In June 2003, the Company entered into an agreement with the former
shareholders of The docSpace Company, Inc. to release back to the Company approximately $3.8 million of approximately $4.7 million in remaining funds held in escrow related to the Companys acquisition of The docSpace Company in 2000. The funds
were remitted to the Company in June 2003, and the Company recognized a gain of $3.8 million in Other Income during the second quarter of 2003.



The escrow account was initially established in February 2000 with $5.0 million to be used to reimburse the former shareholders of The docSpace Company
for certain qualifying expenses related to the establishment, maintenance and dissolution of the various holding companies established by the sellers in connection with the structuring of The docSpace Company acquisition. The escrow fund is being
terminated in March 2005 and any remaining outstanding qualifying expenses will be processed for reimbursement. The funds held in escrow are expected to be sufficient to cover these qualifying expenses and, following the final accounting, any
remaining monies will be remitted to Critical Path, Inc.



Notes Receivable
From Shareholders



During 1998, the Company issued a full
recourse note to a shareholder and former Chief Executive Officer, Douglas Hickey, equal to $1.06 million. Mr. Hickeys full recourse note accrues interest at the rate of 4.51% per annum and is secured by shares of the Companys Common
Stock owned by Mr. Hickey. In February 2001, Mr. Hickey terminated his employment with the Company. In connection with the termination, the repayment of the $1.06 million note receivable and accrued interest was extended to May 9, 2002. Mr. Hickey
repaid this note in full with interest in March 2002.



Notes Receivable From
Officers



In connection with his employment agreement, in
October 2001 the Company advanced a loan to and held a note receivable from Pierre Van Beneden, President, totaling $350,000. Mr. Van Benedens loan was interest free



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for the first year and was forgiven in monthly installments over the first year of Van Benedens employment, resulting in a compensation charge to
operating expense ratably over the first twelve months of his employment. As of October 8, 2002, the one-year anniversary of his employment with the Company, the note had been fully forgiven. Mr. Van Benedens employment terminated shortly
thereafter.



During 2001 and in connection with his employment
agreement, the Company advanced a loan to and held a note receivable from David Hayden, Executive Chairman and a Director of the Company, in the amount of $1.5 million. The full recourse note accrues interest at the rate of 6.75% per annum and could
be repaid by the achievement of performance-based milestones described in Mr. Haydens employment agreement and performance loan agreement. The loan was also subject to forgiveness upon certain change of control events. In February 2002, the
Board approved an amendment of Mr. Haydens employment agreement that eliminated the original performance-based milestones in favor of a single performance-based milestone tied to a change of control event. In addition, the Board increased the
amount available under the loan agreement by an additional $450,000, which was funded in March 2002. The loan amount was secured by a first priority security interest in all of Mr. Haydens shares and options in the Company, with all other
terms of the loan and other agreements unchanged. In July 2002, in connection with the settlement of the terms and conditions of Mr. Haydens termination of employment with the Company, some of the terms of the loan were altered as described in
this section below under Termination Agreements. During 2004, as a result of a decline in the value of the underlying collateral and concerns about the ultimate collectability of the note, the Company established a balance sheet
allowance in the amount of $1,950,000, which was recorded as a component of general and administrative operating expenses.



In December 2001, the Board approved a fully secured loan to William McGlashan, Jr., the Companys Chief Executive Officer, of up to $4.0 million in
connection with the purchase of a principal residence in the San Francisco Bay Area. In May 2002, the Compensation Committee of the Board and Mr. McGlashan agreed to amend the agreement in order to reduce the amount of the loan commitment to $1.5
million. No portion of the loan commitment was funded.



In
connection with the reduction of the loan commitment, in May 2002 Mr. McGlashan was granted an option to purchase 1,000,000 shares of the Companys Common Stock, at an exercise price of $1.74 per share, which was the fair market value on the
date of grant. The option was immediately exercisable subject to the Companys lapsing right of repurchase at a price equal to the exercise price per share over a three year period. Mr. McGlashan exercised his right to early exercise purchase
the shares through a promissory note and stock pledge agreement in May 2002. As such, the Company held a promissory note in the amount of $1,740,000 secured by shares of Common Stock. The promissory note accrues interest at the adjustable quarterly
reference rate of Fidelity Investments or similar banking entity as the shares vest with respect to that portion of the purchase price representing the purchase price of the vested shares.



In accordance with EITF Issue No. 00-23, the early exercise of these options
is not considered a substantive exercise, for accounting purposes, until the repurchase right lapses. Accordingly, the total exercise price of these options was initially recognized as an asset, in Other assets, and as a liability, in Capital lease
and other obligations. These balances have been reclassified to shareholders deficit, in Notes receivable from shareholders, Common Stock and Paid in Capital, as the right of repurchase lapses. One third lapsed in May 2003, and one
thirty-sixth lapses monthly thereafter.



In April 2004, in
connection with the settlement of the terms and conditions of Mr. McGlashans termination of employment with the Company, the Company forgave the note receivable. At the date of Mr. McGlashans termination in April 2004, options associated
with $1,015,000 of the note receivable balance had vested and this portion of the note had been reclassified to Notes receivable from shareholders in shareholders



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deficit. The remaining $725,000 was associated with the unvested portion of his options and was classified in Other assets. See the separate discussion below
under Termination Agreements.



Termination Agreements



In May 2002, David Hayden resigned his employment with
the Company and from the Board of Directors. In connection with a separation agreement finalized in July 2002, Mr. Hayden received a lump sum separation payment of $350,000 plus applicable taxes, continuation of health and welfare benefits until May
31, 2003, an extension to repay the $1.95 million loan with the Company until no later than June 30, 2005, an extension of the period within which he may exercise his vested stock options until no later than June 30, 2005, acceleration of a portion
of his unvested options if a change of control of the Company occurs prior to September 30, 2003 and reimbursement for $50,000 of legal fees incurred. In connection with the provision of these benefits, Mr. Hayden agreed to (i) forfeit the right
under the severance provisions of his employment agreement to an additional one year extension of the $1.95 million loan until August 2006; (ii) pay all proceeds (net of taxes) from the sale of any shares held by him in the Company to reduce the
principal balance of the $1.95 million loan; and (iii) forfeit his right to receive a $2.5 million loan from the Company to exercise certain of his stock options. All sales of common stock of the Company by Mr. Hayden will be made under a publicly
filed trading plan. In addition, Mr. Hayden and the Company executed a mutual release of claims. As a result of Mr. Haydens separation, the Company recorded aggregate one-time charges of $2.6 million, included in operating expenses, inclusive
of $572,000 related to the separation payment and legal fee reimbursements made to Mr. Hayden and $2.0 million in stock-based expenses related to the extension of the exercise period on Mr. Haydens vested stock options.



In October 2002, Pierre Van Beneden terminated his employment as president of
the Company, but continued through January 2003 as a consultant. In connection with a separation agreement and release, Mr. Van Beneden agreed to provide consulting services to the Company on a commissioned basis and shall receive the benefits to
which he was entitled under his employment agreement. Such employment agreement benefits, which were paid in January 2003 upon the completion of the consulting term, included a lump sum payment of $337,500, representing nine months base salary,
accelerated vesting on a portion of his option grants, triggering a charge of $17,000 to stock-based expenses, and commissions of $50,000. These payments reflect all cash obligations of the Company to Mr. Van Beneden and accordingly no additional
payments will be made in connection with the consulting services portion of his termination agreement. As an additional benefit under the separation agreement, Mr. Van Beneden was granted an extension until January 17, 2004 to exercise his option
grants. Mr. Van Beneden and the Company executed a mutual release of all claims.



In February 2003, Laureen DeBuono terminated her employment as executive vice president and chief financial officer of the Company, but continued through June 2003 as a consultant. In connection with a separation
agreement and release, Ms. DeBuono received a lump sum payment of $208,000, representing four months base salary, and a $25,000 payment intended to cover reimburseable expenses incurred during her tenure with the Company. Ms. DeBuono was paid
$125,000 associated with the consulting work performed through June 2003. As an additional benefit under the separation agreement, Ms. DeBuono was granted an extension until December 31, 2004, to exercise her option grants, resulting in a charge of
$92,000 to stock-based expenses.



In August 2003, Robert Allen
Shipp terminated his employment as president of the Company, but continued through December 2003 as a consultant. In connection with a separation agreement and release, Mr. Shipp was paid a lump sum payment of $262,500, representing nine months base
salary. The consulting services to be performed by Mr. Shipp were to be performed on a commissioned basis and no amounts had been paid or remained to be earned as of December 31, 2003.



In April 2004, the Company entered into a separation agreement with William McGlashan, Jr., the Companys Chief
Executive Officer. Under the terms of the agreement, Mr. McGlashan received a lump sum



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payment of $400,000 and the Company forgave a note receivable in the amount of $1.7 million. Mr. McGlashan surrendered 250,000 shares of the Companys
common stock, but received an extension of the exercise period for options to purchase 430,424 shares of Critical Path common stock to April 2007. As a result, the Company recorded compensation expense of $1.5 million during the second quarter of
2004.



Consulting Agreements



In April 2002, the Company retained the services of CTD, LLC
(CTD), an operational planning consulting company. The founder and president of CTD was Patrick Tracy Currie, who subsequently became the Companys Executive Vice President, Operations and General Manager of Hosted Operations
following the termination of the consulting arrangement with CTD as described below. Mr. Currie and his spouse shared full ownership of CTD. Under the terms of the Statement of Work entered into between the Company and CTD, CTD received payments for
its services based on daily rates as well as reimbursement of costs associated with the work performed. In connection with this consulting arrangement, the Company paid to CTD an aggregate of approximately $320,000 in 2003.



In August 2002, the Company retained the services of The Cohen Group, an
international strategic consulting company. The chairman and chief executive officer of The Cohen Group is William S. Cohen, a former member of the Board of Directors of the Company. Under the agreement, The Cohen Group received a $150,000 retainer
fee to be credited against a sliding scale of earned sales and referral commissions on transactions resulting in license revenue for the Company. The agreement is for a one year renewable term, with reimbursement for specified expenses up to a cap
of 5% of the retainer and a provision for extension in the event the retainer fee is not earned during the term. This agreement was not renewed in 2003.



In August 2002, the Company hired R.B. Webber & Company, strategic management consultants, to prepare an executive level research and forecast
presentation on the enterprise messaging market. The agreement provided for a flat fee of $85,000 over a two month period for the services of several consultants of R.B. Webber and Company, with reimbursement for expenses capped at 5% of the fee.
Jeffrey Webber, a former member of the Board of Directors of the Company, is a partner of R.B. Webber and Company. Mr. Webber shall also provide consulting services under the agreement.



Note 9Credit Facility



In September 2002, the Company entered into a $15.0 million one-year line of credit with Silicon Valley Bank (the Bank), to be utilized for working
capital and general corporate operations. The credit facility was amended in March 2003 and again in July 2003, as a result of non-compliance with the financial covenants of the credit facility. The Company regained compliance with the covenants in
the credit facility upon execution of the line of credit agreement in July 2003 and extended the maturity of the credit facility to January 2004. In December 2003, the Company was not in compliance with a certain financial covenant which was
subsequently waived by the Bank.



In January 2004, the Company
executed an amendment with the Bank, which reduced the size of the credit line to a maximum of $5.0 million and extended the maturity date to October 2004. In March 2004 the credit facility was amended to increase the size of the borrowing
availability under the credit facility to a maximum of $6.0 million and extend the maturity date to June 2005. In April 2004 the credit facility was amended as a result of non-compliance with certain financial covenants.



During the three months ended June 30, 2004, the Company was not in
compliance with a certain financial covenant relating to the minimum Americas revenue for the months ended April 30, May 31 or June 30, 2004. As



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a result, in August 2004 the credit facility was amended and the Company entered into a pledge and security agreement with the Bank pursuant to which the
Company was required to cash collateralize letters of credit previously held under the credit facility, totaling approximately $2.7 million, during the third quarter of 2004. This cash is considered restricted as reported on the balance sheet as of
December 31, 2004 and, as such, is unavailable for operating activities. Furthermore, while the Company still maintains this credit facility with the Bank, the August 2004 amendment terminates the Banks commitment to make loans under the
credit facility, does not permit any further borrowing by the Company and removes all covenants. The maturity date of the credit facility is June 30, 2005.



In connection with the March 2004 amendment, the Company agreed to issue warrants to purchase up to 100,000 shares of its common stock to the Bank. These
warrants were fully exercisable upon grant, had an exercise price of $2.07 per share and have an expiration date in March 2011. The warrants were valued using the Black-Scholes option pricing model, assuming volatility of 146%, a risk-free interest
rate of 3% and a seven-year term. In connection with the issuance of this warrant, the Company recorded a charge of $0.2 million to interest expense during the first quarter of 2004.



Note 10Notes Payable



53/4% Convertible Subordinated
Notes



During 2000, the Company issued $300.0
million of five-year, 53/4% Convertible Subordinated Notes (53/4% Notes) due April 2005, to qualified institutional buyers in reliance on Rule 144A under the Securities Act of 1933. Holders may convert the 53/4% Notes into shares of Common Stock at any time before their maturity or the business day before their redemption
or repurchase by the Company. The conversion rate is 9.8546 shares per $1,000 principal amount of 53/4% Notes
subject to adjustment in certain circumstances. This rate is equivalent to a conversion price of approximately $101.48 per share. On or after the third business day after April 1, 2003, through March 31, 2004, the Company has the option to redeem
all or a portion of the 53/4% Notes that have not been previously converted at the redemption price equal to
102.30% of the principal amount. During the period from April 1, 2004 through March 31, 2005, the Company has the option to redeem all or a portion of the 53/4% Notes that have been previously converted at the redemption price equal to 101.15% of the principal amount. Thereafter the redemption price is equal to 100% of the principal amount. The 53/4% Notes are non-callable for three years. In the event of a Change in Control, as defined in 53/4% Notes Offering Circular, the 53/4% Notes holders have the option of requiring the Company to repurchase any 53/4% Notes held at a price of 100% of the principal amount of the 53/4% Notes plus accrued interest to the date of repurchase.



The Company incurred approximately $10.8 million in debt issuance costs, consisting primarily of underwriting discount and legal and other professional
fees. These costs have been capitalized and will be recognized as a component of interest expense on a straight-line basis, which approximates the effective interest method, over the five-year term of the 53/4% Notes. During 2002, 2003 and 2004, the Company recorded interest expense related to the amortization of the debt
issuance costs of $275,000, $275,000 and $436,000, respectively.



Interest is payable on April 1 and October 1 of each year. As of December 31, 2002, 2003 and 2004, there was approximately $556,000, $556,000 and $80,000 in interest payable, respectively. During 2002, 2003 and 2004, the Company recorded
interest expense related to the 53/4% Notes of $2.2 million, $2.2 million and $1.3, respectively. The 53/4% Notes are subordinated in right of payment to all senior debt of the Company and effectively subordinated to all
existing and future debt and other liabilities of the Companys subsidiaries.



The holders of the Subordinated Notes may convert the notes into shares of the Companys common stock at any time before their maturity or the
business day before their redemption or repurchase by us. The conversion



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rate is 9.8546 shares per $1,000 principal amount of notes subject to adjustment in specified circumstances. This rate is equivalent to a conversion price of
approximately $405.92 per share. In the event of a change of control, the holders of the Subordinated Notes have the option of requiring the Company to repurchase any notes held at a price of 100% of the principal amount of the notes plus accrued
interest to the date of repurchase.



During 2001, the Company
retired $261.4 million of face value of the 53/4% Notes, which resulted in an extraordinary gain on retirement
of $179.3 million, inclusive of $6.8 million in write-downs of related debt issuance costs. The Company used cash of $53.1 million and equity in order to retire the 53/4% Notes, inclusive of approximately $4.4 million in accrued interest.



In November 2003, the Company executed an agreement to exchange approximately $32.8 million in face value of the Subordinated Notes, held by a group of
investors led by the Cheung Kong Group and its Whampoa Limited affiliates including Campina Enterprises Limited, Cenwell Limited, Great Affluent Limited, Dragonfield Limited and Lion Cosmos Limited (referred to collectively as the Cheung Kong
Investors), for approximately 21.9 million shares of Series E preferred stock. At a special meeting in July 2004, the Company received shareholder approval for this transaction. As a result of the conversion, during the third quarter of 2004 a
non-cash charge of $12.8 million equal to the fair value of the Series E preferred stock less the carrying value of the related Subordinated Notes, net of unamortized issuance costs, was recorded as of the date of the exchange as loss on
extinguishment of debt in the statement of operations.



At
December 31, 2004, the total balance of the Subordinated Notes outstanding was $5.6 million. The Subordinated Notes are carried at cost and had an approximate fair value of $4.3 million at December 31, 2004.



10% Senior Secured Convertible Notes



In November 2003, the Company issued $10 million in 10% Senior Secured
Convertible Notes to General Atlantic Partners 74, L.P., GAP Coinvestment Partners II, L.P., GapStar, LLC and GAPCO GmbH & Co. K.G. (referred to collectively as the General Atlantic Investors). In January 2004, the Company issued $15.0 million
in principal amount of the Senior Notes to Permal U.S. Opportunities Limited, Zaxis Equity Neutral, L.P., Zaxis Institutional Partners, L.P., Zaxis Offshore Limited, Zaxis Partners, L.P. and Passport Master Fund, L.P (collectively, the January 2004
Investors). In March 2004, the Company issued $18.5 million in principal amount of the Senior Notes to investment entities affiliated with Crosslink Capital, Criterion Capital Management, Heights Capital Management and Apex Capital (collectively,
the March 2004 Investors).



The 10% Senior Secured Convertible
Notes become due and payable on the consummation of a qualified asset sale, a change of control or any financing or series of financings that in the aggregate raises at least $40 million. Additionally, the notes become due and payable when declared
due and payable by a holder upon the occurrence of an event of default, which include, subject to some exceptions: (1) the Companys failure to pay any amounts due under notes when they are due and payable, (2) the Companys default on any
indebtedness with a principal amount of at least $500,000, (3) the Companys voluntary or involuntary bankruptcy, (4) any judgment for the payment of money of more than $500,000, (5) the attachment by its lenders of any of its assets, or (6)
the occurrence of any event having a material adverse effect on the Companys business, operations, assets, properties or condition.



The 10% Senior Secured Convertible Notes also contain a financial covenant that requires the Company to maintain a minimum monthly average operating cash
flow, over any given fiscal quarter, for its operations in the Americas of negative $3.0 million. Additionally, the Company may not incur, create or assume indebtedness or liens under the notes, with specified exceptions. Also, with some exceptions,
under the notes it may not: (1) merge with another entity, (2) make any restricted payments, including dividends, distributions and the



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redemption any of its options or capital stock, (3) enter into any transactions with any affiliates, (4) make investments, (5) change the nature of the
Companys business, (6) permit the Companys domestic subsidiaries to hold real or personal property in excess of specified amounts or (7) create any new subsidiaries. If the Company breaches any representation or warranty or fail to abide
by any of its covenants, including the foregoing covenants, then the 10% Senior Secured Convertible Notes may become immediately due and payable.



At a special meeting in July 2004, the Company received approval from its shareholders to convert all of these Senior Notes plus accrued and unpaid
interest, into Series E preferred stock at $1.50 per share. The following table provides the number of shares of Series E preferred stock issued upon conversion:



|                           |  |                |        |                                                   |   |       |  |   |        |  |       
|-------------------------- |  | -------------- | ------ | ------------------------------------------------- | - | ----- |  | - | ------ |  | ------
|                           |  | Senior notes   |        | Converted into shares of Series E preferred stock
|                           |  | Principal      |        | Accrued interest                                  |   | Total | 
|                           |  | (in thousands)
|General Atlantic Investors |  | $              | 10,000 |                                                   | $ | 628   |  | $ | 10,628 |  | 7,333 
|January 2004 Investors     |  |                | 15,000 |                                                   |   | 729   |  |   | 15,729 |  | 10,483
|March 2004 Investors       |  |                | 18,500 |                                                   |   | 627   |  |   | 19,127 |  | 12,748
|                           |  |                |        |                                                   |   |       |  |   |        |  |       
|                           |  | $              | 43,500 |                                                   | $ | 1,984 |  | $ | 45,484 |  | 30,564
|                           |  |                |        |                                                   |   |       |  |   |        |  |       



As a result of this
conversion, there was no outstanding principal or interest related to these Senior Notes as of December 31, 2004.



13.9% Senior Notes



In December 2004, the Company issued $11.0 million in principal amount of 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. 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. Under the Purchase Agreement, the Company had an option to issue an
additional $7.0 million in Notes, and warrants to purchase an additional 149,998 shares of Series F preferred stock, which expires as of March 31, 2005.



The 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 Notes are due and payable on the earlier to occur of the maturity of the 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. In March 2005, the Company issued the remaining $7.0 million of these notes.



The $11.0 million in proceeds from the financing transaction were allocated to the Notes and warrants based upon their relative estimated fair values. The estimated fair value of the warrants of $2.1 million 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). Because these notes were issued
at the end of the Companys fiscal year, the warrant derivative liability is being carried on the Companys books at its initial fair value of $2.1 million at December 31, 2004.



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These Senior Notes were carried on the balance sheet as long-term Notes payable as
follows at December 31, 2004:



|                                                                           |  |                  |        |  
|-------------------------------------------------------------------------- |  | ---------------- | ------ | -
|                                                                           |  | December 31,2004 |       
|Proceeds from issuance of 13.9% Senior Notes                               |  | $                | 11,000 |  
|Less: Fair value of Series F preferred stock warrant derivative instrument |  |                  | (2,125 | )
|                                                                           |  |                  |        |  
|Carrying value of 13.9% Senior Notes                                       |  | $                | 8,875  |  
|                                                                           |  |                  |        |  



For the two days the
notes were issued in 2004, the Company recorded accrued interest of $8,000. These notes are carried at cost and had an approximate fair value of $9.0 million at December 31, 2004. The Company valued the option for the 90 day commitment period. The
value of such option was immaterial.



Note 11Income Taxes



The Company did not provide any deferred federal or state
income tax benefit for any of the periods presented because it has experienced operating losses since inception. The Company has provided a full valuation allowance on its net deferred tax assets, consisting primarily of net operating loss
carryforwards, because of uncertainty regarding its realizability.



At December 31, 2004, the Company had approximately $379 million of federal and $148 million of state net operating loss carryforwards available to offset future taxable income. Federal and state net operating loss carryforwards expire in
varying amounts through 2024 for federal and 2014 for state purposes. Under the Tax Reform Act of 1986, the amounts of and benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. Events which cause
limitations in the amount of net operating losses that the Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over a three year period. These carryforwards will begin to
expire at various times starting in 2013 and 2006 for federal and state tax purposes, respectively.



Since inception, the Company has incurred several ownership changes which have limited the Companys ability to utilize loss carryforwards as defined
in IRC Section 382. Based on an ownership change which took place in January 2000, the losses are subject to a limitation of $324 million per year. Further ownership changes subsequent to January 2001 could have occurred and could place further
limitations on the utilization of losses and credits. The Company believes the limitation should not have a material effect on the future utilization of the losses.



At December 31, 2004, the Company had federal and state tax credit carryforwards for income tax purposes of approximately $6
million and $10 million, respectively. If not utilized, the federal credits will expire through 2024. State tax credit carryforwards of $6 million, if unused, will expire through 2011. The remaining state tax credit carryforwards of $4 million have
an indefinite life.



Loss before provision for income taxes
consists of the following (in thousands):



|         |  |      |          |   |      |   |         |      |  |   |         |  
|-------- |  | ---- | -------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|         |  | 2002 |          |   | 2003 |   |         | 2004 | 
|Domestic |  | $    | (114,578 | ) |      | $ | (51,613 | )    |  | $ | (45,853 | )
|Foreign  |  |      | (2,354   | ) |      |   | (9,664  | )    |  |   | (5,032  | )
|         |  |      |          |   |      |   |         |      |  |   |         |  
|Total    |  | $    | (116,932 | ) |      | $ | (61,277 | )    |  | $ | (50,885 | )
|         |  |      |          |   |      |   |         |      |  |   |         |  



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The components of the provision for income taxes are as follows (in thousands):



|         |  |              |       |   |      |   |      |  |   |      
|-------- |  | ------------ | ----- | - | ---- | - | ---- |  | - | -----
|         |  | December 31,
|         |  | 2002         |       |   | 2003 |   | 2004
|Current: |  |              |       |   |      |   |      |  |   |      
|Federal  |  | $            | (800  | ) |      | $ | 50   |  | $ | 39   
|Foreign  |  |              | 1,779 |   |      |   | 806  |  |   | 1,073
|         |  |              |       |   |      |   |      |  |   |      
|         |  | $            | 979   |   |      | $ | 856  |  | $ | 1,112
|         |  |              |       |   |      |   |      |  |   |      



Deferred tax assets
consist of the following (in thousands):



|                                 |  |              |          |   |      |   |          |  
|-------------------------------- |  | ------------ | -------- | - | ---- | - | -------- | -
|                                 |  | December 31, |         
|                                 |  | 2003         |          |   | 2004 |  
|Deferred tax assets              |  |              |          |   |      |   |          |  
|Net operating loss carryforwards |  | $            | 128,912  |   |      | $ | 137,473  |  
|Tax credits                      |  |              | 15,841   |   |      |   | 15,901   |  
|Fixed assets                     |  |              | 4,568    |   |      |   | 3,103    |  
|Intangible assets                |  |              | 4,283    |   |      |   | 3,957    |  
|Accrued liabilities              |  |              | 1,486    |   |      |   | 4,354    |  
|                                 |  |              |          |   |      |   |          |  
|Gross deferred tax assets        |  | $            | 155,090  |   |      | $ | 164,788  |  
|                                 |  |              |          |   |      |   |          |  
|Valuation allowance              |  | $            | (155,090 | ) |      | $ | (164,788 | )
|                                 |  |              |          |   |      |   |          |  
|Net deferred tax assets          |  | $            |         |   |      | $ |         |  
|                                 |  |              |          |   |      |   |          |  



The net increases in
the valuation allowance for 2002, 2003 and 2004 were $28.7 million, $22.6 million and $9.7 million, respectively.



Reconciliation of the statutory federal income tax rate to the Companys effective tax rate:



|                                        |  |              |    |  |      |    |  |      |   
|--------------------------------------- |  | ------------ | -- |  | ---- | -- |  | ---- | --
|                                        |  | December 31, |   
|                                        |  | 2002         |    |  | 2003 |    |  | 2004 |   
|Tax at federal statutory rate           |  | (34          | )% |  | (34  | )% |  | (34  | )%
|State, net of federal benefit           |  | (3           | )% |  | (5   | )% |  | (6   | )%
|Stock-based expenses                    |  | 0            | %  |  | 0    | %  |  | 1    | % 
|Research and development credits        |  | (1           | )% |  | (1   | )% |  | 0    | % 
|Change in valuation allowance           |  | 26           | %  |  | 33   | %  |  | 30   | % 
|Foreign taxes                           |  | 5            | %  |  | 7    | %  |  | 7    | % 
|Loss on extinguishment of debt          |  | 0            | %  |  | 0    | %  |  | 8    | % 
|Change in value of embedded derivatives |  | 0            | %  |  | 0    | %  |  | (3   | )%
|Warrant amortization                    |  | 5            | %  |  | 0    | %  |  | 0    | % 
|Other                                   |  | 3            | %  |  | 1    | %  |  | (1   | )%
|                                        |  |              |    |  |      |    |  |      |   
|Provision for income taxes              |  | 1            | %  |  | 1    | %  |  | 2    | % 
|                                        |  |              |    |  |      |    |  |      |   



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Note 12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
during 2002, 2003 and 2004, totaled $4.8 million, $5.3 million and $5.2 million, respectively. Future minimum lease payments under noncancelable operating and capital leases are as follows:



|                                           |  |                |       |   |                 |   |       
|------------------------------------------ |  | -------------- | ----- | - | --------------- | - | ------
|                                           |  | CapitalLeases  |       |   | OperatingLeases
|                                           |  | (In thousands)
|Year Ending December 31                    |  |                |       |   |                 |   |       
|2005                                       |  | $              | 1,084 |   |                 | $ | 5,270 
|2006                                       |  |                |      |   |                 |   | 5,140 
|2007                                       |  |                |      |   |                 |   | 1,973 
|2008                                       |  |                |      |   |                 |   | 1,311 
|2009                                       |  |                |      |   |                 |   | 1,104 
|2010 and beyond                            |  |                |       |   |                 |   | 4,882 
|                                           |  |                |       |   |                 |   |       
|Total minimum lease payments               |  | $              | 1,084 |   |                 | $ | 19,680
|                                           |  |                |       |   |                 |   |       
|Less: Amount representing interest         |  |                | (17   | ) |                 |   |       
|                                           |  |                |       |   |                 |   |       
|Present value of capital lease obligations |  | $              | 1,067 |   |                 |   |       
|                                           |  |                |       |   |                 |   |       



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 $766,000 through August 2005.



Other Contractual Obligations



The Company entered into other contractual obligations which total $4.4 million at December 31, 2004. 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 4 years, including $3.1 million in 2005.



Potential relocation of San Francisco offices



In September 2004, the Company received a notice from the landlord of its headquarters facility in San Francisco, California notifying the Company that
the landlord had found a new tenant for its 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 expects to vacate its facilities at 350 The Embarcadero and move into new office space provided at
2 Harrison Street, Suite #200 by no later than June 29, 2005. In connection with the landlords substitution right and the Companys relocation, the Company will be required to make a lease termination payment totaling approximately $1.3
million on June 1, 2005; however, the annual rent, on a cash basis, for the Companys headquarters facility will decline from approximately $2.5 million per year to an amount that, although still under negotiation, the Company expects to be
less than $0.6 million per year. Additionally, the



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Company will incur costs related to the physical move and build out of the new facility, however the Company cannot currently estimate these costs as it has
not yet engaged a moving company nor completed a detailed leasehold improvement plan.



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.



Action in the Superior Court of San Diego. In December 2003, the Company was named in a lawsuit filed by former
shareholders of Remedy Corporation against current and former officers and directors of Peregrine Systems, Inc., Peregrines former accountants, some of Peregrines customers, including us, and various other unnamed defendants. The
operative complaint alleges that the Company, as Peregrines customer, engaged in a fraudulent transaction with Peregrine that was not accounted for by Peregrine in conformity with generally accepted accounting principles (GAAP) and that this
substantially inflated the value of Peregrine securities issued as consideration in Remedys merger with Peregrine approximately one year later in August 2001. The operative complaint alleges causes of action against the Company for fraud and
deceit, violations of California Corporations Code provisions regarding aiding and abetting securities fraud, common law conspiracy to commit fraud, and common law aiding and abetting the commission of fraud. The complaint seeks an unspecified
amount of compensatory and punitive damages, along with rescission of the Peregrine securities purchased in the Remedy merger, interest and attorneys fees. Effective as of January 2005, the Company entered into a settlement agreement providing that
the claims against us would be dismissed immediately without prejudice. Thereafter, upon our satisfaction of certain conditions, the plaintiffs are obligated to dismiss the claims with prejudice. Such conditions consist principally of informal
discovery such as, for example, providing access to employees and consultants who may have knowledge relevant to the plaintiffs continuing case against the remaining defendants and providing documents which may be relevant to such case. The
settlement involved no cash or other financial consideration. The Company had not recorded a liability against this claim as of December 31, 2004.



Securities Action in Northern District of California. On April 30, 2002, MBCP PeerLogic LLC and other named plaintiffs filed suit in the U.S.
District Court for the Southern District of New York against the Company and certain of the Companys former officers. The plaintiff shareholders had opted out of a shareholder litigation settlement that was approved by the U.S. District Court
for the Northern District of California. On November 25, 2003, the Company entered into settlement of these claims, approved by the United States District Court for the Northern District of California, pursuant to which the Company agreed to issue
553,914 shares of Common Stock and 188,587 shares of Series D preferred stock in exchange for a release of plaintiffs claims, and recorded a charge of $5.1 million related to the value of these issuances as stock-based expensegeneral and
administrative in 2003. The Company also agreed to exchange 69,149 shares of Series D preferred stock for shares of Series E preferred stock, subject to the Company obtaining shareholder approval. The Company received shareholder approval in July
2004 to issue shares of Series E preferred stock, and the Company



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



exchanged 86,232 shares of Series D preferred stock (including accrued dividends) held by the various plaintiff shareholders comprising MBCP Peerlogic for
829,873 shares of Series E preferred stock. The exchange of Series D for Series E preferred stock did not result in any charge to the Company.



The plaintiffs claims against the Company were voluntarily dismissed with prejudice, and without costs or attorneys fees to any party. The
Companys counterclaims against plaintiffs were also dismissed with prejudice, and without costs or attorneys fees to any party.



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 December 31,
2004.



Lease Dispute. In July 2000, PeerLogic, Inc.
signed a lease for office space in San Francisco, California. In December 2000, Critical Path acquired PeerLogic as a wholly owned subsidiary. After review, the Company determined that local zoning laws likely prohibited a business such as the
Company or PeerLogic from occupying the leased premises, and promptly sought a zoning determination from the San Francisco Zoning Administrator to resolve the matter. The Zoning Administrator determined that the Companys proposed use of the
leased premises was not permitted, but the landlord appealed this determination and prevailed before the San Francisco Board of Appeals. In July 2002, the Company filed a Petition for Writ of Mandamus with the San Francisco Superior Court, seeking
reversal of the San Francisco Board of Appeals decision. In June 2003, the Court granted the Companys petition and subsequently entered a judgment and writ remanding the matter to the San Francisco Board of Appeals and directing the
Board of Appeals to make a new determination consistent with its judgment. The landlord subsequently appealed the Superior Courts ruling.



In April 2002, the landlord filed suit in San Francisco Superior Court against the Company alleging, among other things, breach of the lease and tort
claims related to the lease transaction. In its complaint, the landlord sought unspecified damages for back rent, attorneys fees, treble damages under certain statutes, and unspecified punitive damages. In August 2003, the Company filed the
Companys answer to the second amended complaint and a cross-complaint against the landlord, under which the Company sought compensatory damages and unspecified punitive damages for the landlords failure to disclose the zoning
restrictions on the leased premises before the lease was signed. In June 2004, the Company settled this litigation as well as the zoning dispute described above in exchange for $100,000 in cash and a warrant to purchase 100,000 shares of the
Companys Common Stock at a purchase price equal to current fair market value as of the date of settlement. Using the Black-Scholes option pricing model and assuming a term of 2.8 years and an expected volatility of 140%, the fair value of the
warrant on the date of the settlement of $147,000 was recognized as a restructuring expense.



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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



a 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 December 31, 2004.



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.



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 13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 $3,075,000 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,



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



conversion into shares of Common Stock calculated based on the Accreted Valuethat 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 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 $5.25
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, the Company agreed to seek shareholder approval to
amend the warrants to reduce the exercise price per share from $4.20 to $1.50.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



In July 2004, at the Companys special meeting, shareholders approved a proposal to amend and
restate the certificate of determination of preferences of Series D preferred stock (the Amended Series D) to, among other things, amend the Series D preferred stock liquidation preference upon a liquidation and change of control, eliminate the
participation feature, reduce the conversion price from $4.20 to $1.50, reduce the amount of dividends to which the holders of Series D preferred stock are entitled and extend the automatic redemption date to July 2008. The following table sets
forth the carrying value of the Series D preferred stock at December 31, 2003, prior to the amended and restated certificate of determination, and the Amended Series D preferred stock at December 31, 2004:



|                                                                                     |  |                  |         |   |                  |   |       
|------------------------------------------------------------------------------------ |  | ---------------- | ------- | - | ---------------- | - | ------
|                                                                                     |  | December 31,2003 |         |   | December 31,2004
|                                                                                     |  | (in thousands)  
|Series D preferred stockprior to approved and restated certificate of determination |  | $                | 58,755  |   |                  | $ |      
|Series D preferred stockAmended Series D                                            |  |                  |        |   |                  |   | 56,355
|Less issuance costs                                                                  |  |                  | (3,075  | ) |                  |   |      
|                                                                                     |  |                  |         |   |                  |   |       
|Series D preferred stock, net of issuance costs                                      |  |                  | 55,680  |   |                  |   | 56,355
|Less amounts allocated to:                                                           |  |                  |         |   |                  |   |       
|Common stock warrants                                                                |  |                  | (5,250  | ) |                  |   |      
|Beneficial conversion feature                                                        |  |                  | (41,475 | ) |                  |   |      
|Add liquidation preference                                                           |  |                  | 19,640  |   |                  |   |      
|Reclassification of embedded derivative instrument                                   |  |                  | (24,890 | ) |                  |   |      
|Add amortization and accretion                                                       |  |                  | 26,706  |   |                  |   | 3,220 
|                                                                                     |  |                  |         |   |                  |   |       
|Carrying value of Series D preferred stock                                           |  |                  | 30,411  |   |                  |   |      
|Carrying value of Amended Series D preferred stock                                   |  | $                |        |   |                  | $ | 59,575
|                                                                                     |  |                  |         |   |                  |   |       
|Liquidation value of Series D preferred stock                                        |  |                  | 67,494  |   |                  |   |      
|Liquidation value of Amended Series D preferred stock                                |  | $                |        |   |                  | $ | 70,568
|                                                                                     |  |                  |         |   |                  |   |       



The Series D preferred
stock and the Amended Series D preferred stock contain an embedded derivative instrument, related to the change-in-control feature of the Series D preferred stock, which is recorded as a liability on the Companys balance sheet in accordance
with current authoritative guidance. At December 31, 2003, the embedded derivative instrument was recorded in the carrying value of the Series D preferred stock, in accordance with the authoritative guidance at such time but has been reclassed 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 December 31, 2003 the estimated fair value of the embedded derivative liability was $24.9 million and at December 31, 2004, the
estimated fair value of the embedded derivative liability in the Amended Series D preferred stock was $3.0 million. Net charges to other expense during 2002 and 2003 of $7.4 million and $12.2 million, respectively, were recognized as a result of the
increase in value of the liquidation preference. During 2004, a net credit to other expense in the amount of $4.3 million was recognized as a result of a decrease in the value of the embedded derivative liability.



MBCP Peerlogic



In November 2003, the Company issued 188,587 shares of Series D preferred stock to MBCP Peerlogic (MBCP Shares)
related to the settlement of certain litigation, resulting in a charge of $3.8 million (see also Note 12Commitments and Contingencies). Additionally, 69,149 of these shares were automatically convertible



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



into Series E preferred stock to the extent such preferred stock was issued in the future. In July 2004 the Company received shareholder approval to issue
shares of Series E preferred stock, and the Company exchanged 86,232 shares of Series D preferred stock (including accrued dividends) held by the various named plaintiff shareholders comprising MBCP Peerlogic for 829,873 shares of Series E preferred
stock. The exchange of Series D for Series E preferred stock did not result in any charge to the Company.



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 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 Subordinated
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.



The carrying value of the Series E preferred stock at December 31, 2004 is as follows (in thousands):



|                                                |  |   |         |  
|----------------------------------------------- |  | - | ------- | -
|Series E preferred stock                        |  | $ | 79,621  |  
|Less: Issuance costs                            |  |   | (4,736  | )
|                                                |  |   |         |  
|Series E preferred stock, net of issuance costs |  |   | 74,885  |  
|Less amounts allocated to:                      |  |   |         |  
|Beneficial conversion feature                   |  |   | (16,337 | )
|Add amortization and accretion                  |  |   | 4,254   |  
|                                                |  |   |         |  
|Carrying value of Series E preferred stock      |  | $ | 62,802  |  
|                                                |  |   |         |  
|Liquidation value of Series E preferred stock   |  | $ | 86,100  |  
|                                                |  |   |         |  



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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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.



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 December 31, 2004, no shares of Series F preferred stock were outstanding.
Warrants to purchase 235,712 shares of Series F preferred stock were issued in December 2004 as part of the issuance of the $11 million of 13.9% Senior Convertible Notes. See Note 10Notes Payable, for a further discussion of this transaction.



Accretion on mandatorily redeemable preferred stock



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



|                                           |  |                         |        |      |   |        |  |   |       
|------------------------------------------ |  | ----------------------- | ------ | ---- | - | ------ |  | - | ------
|                                           |  | Year ended December 31,
|(Thousands of $s)                         |  | 2002                    |        | 2003 |   | 2004  
|Accrued dividends                          |  | $                       | 4,868  |      | $ | 4,935  |  | $ | 7,315 
|Accretion of beneficial conversion feature |  |                         | 9,036  |      |   | 7,511  |  |   | 5,349 
|Accretion of the redemption value          |  |                         |       |      |   |       |  |   | 1,901 
|                                           |  |                         |        |      |   |        |  |   |       
|                                           |  | $                       | 13,904 |      | $ | 12,446 |  | $ | 14,565
|                                           |  |                         |        |      |   |        |  |   |       



Preferred Stock Rights Offering



In August 2004, the Company consummated a rights offering
pursuant to which 2.6 million shares of Series E preferred stock were issued at a purchase price of $1.50 per share. The offering generated gross proceeds to the Company of approximately $4.0 million, exclusive of costs incurred associated with the
offering.



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 14Shareholders Equity (Deficit)



Changes in shares of Common Stock outstanding were:



|                                                   |  |                         |  |        |  |        |  
|-------------------------------------------------- |  | ----------------------- |  | ------ |  | ------ | -
|                                                   |  | Year Ended December 31, | 
|                                                   |  | 2002                    |  | 2003   |  | 2004   |  
|                                                   |  | (In thousands)          | 
|Common Stock Shares outstanding, beginning of year |  | 19,145                  |  | 20,032 |  | 21,078 |  
|Issuance of common stock                           |  | 296                     |  | 666    |  | 1,969  |  
|Exercise of stock options                          |  | 591                     |  | 380    |  | 313    |  
|Purchase of common stock                           |  |                        |  |       |  | (273   | )
|                                                   |  |                         |  |        |  |        |  
|Shares outstanding, end of year                    |  | 20,032                  |  | 21,078 |  | 23,087 |  
|                                                   |  |                         |  |        |  |        |  



Of the 273,000 shares
of common stock repurchased by the Company during 2004, 250,000 shares were surrendered by Mr. McGlashan as part of his April 2004 separation agreement with the Company. See Note 8 Related Party Transactions, for a further discussion.



Incorporation and Authorized Capital



The Companys Articles of Incorporation, as amended, authorize the
Company to issue 200 million shares of Common Stock at $0.001 par value, and 5 million shares of Preferred Stock, at $0.001 par value. The holders of Preferred Stock have various voting and dividend rights as well as preferences in the event of
liquidation.



Employee Stock Purchase Plan



During 1999, the Board of Directors adopted and the shareholders approved
the 1999 Employee Stock Purchase Plan (ESPP). The Company authorized 150,000 shares for issuance at inception. The number of shares of Common Stock reserved under the ESPP increases annually on January 1 of each year beginning in 2000 by
an amount equal to 1% of the Companys issued and outstanding Common Stock. However, such increases are limited to 250,000 additional shares each year. Employees generally will be eligible to participate in the ESPP if the Company customarily
employs them for more than 20 hours per week and more than five months in a calendar year and they are not 5% or greater shareholders. Under the ESPP, eligible employees may select a rate of payroll deduction up to 15% of their compensation subject
to certain maximum purchase limitations per period and other statutory limitations. The ESPP was implemented in a series of overlapping twenty-four month offering periods beginning on the effective date of the Companys initial public offering
with subsequent offering periods beginning on the first trading day on or after May 1 and November 1 of each year. Purchases will occur on each April 30 and October 31 (the Purchase Dates) during each participation period. Under the
ESPP, eligible employees have the opportunity to purchase shares of Common Stock at a purchase price equal to 85% of the fair market value per share of Common Stock on either the start date of the offering period or the Purchase Date of the related
purchase period, whichever is less. Stock purchases under the ESPP in 2002, 2003 and 2004 were 295,748, 113,106 and 48,059 shares, respectively, at a price of $3.12 and $1.56 per share in 2002, $3.40 and $3.21 per share in 2003, and $1.99 and $0.59
per share in 2004. As of December 31, 2004, 669,338 shares were available under the ESPP for future issuance.



Stock Options



During
1998 and 1999, the Companys Board of Directors adopted the 1998 Stock Option Plan and the 1999 Nonstatutory Stock Option Plan, respectively (together, the Option Plans and each a Plan). The 1998 Plan



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



provides for the granting of options to purchase up to 10,197,185 shares of common stock to employees, officers, directors and consultants, with an increase
annually on January 1 of each year by an amount equal to 2% of the total number of shares of the Companys Common Stock authorized for issuance at the end of the most recently concluded fiscal year, and the 1999 Plan provides for the granting
of up to 7,062,500 shares of common stock to non-executive officer employees or the initial employment grant for executive officers. In November 2001, the Board approved an increase of 2,812,500 to the number of option shares reserved for grant to
non-executive officer employees under the 1999 Plan. The 1998 Plan is a shareholder approved plan and allows for options to be granted as either incentive stock options (ISOs) or nonqualified stock options (NSOs). Options
granted under the 1999 Plan may only be nonqualified stock options (NSOs). ISOs may be granted only to Company employees, including officers and employee directors. NSOs may be granted to Company employees, non-employee directors and
consultants. At December 31, 2004, the total number of shares of common stock available for option grants was 4,022,353 and 265,598 under the 1998 Plan and the 1999 Plan, respectively.



The Company has, in connection with the acquisition of various companies, assumed the stock option plans of each acquired
company. At December 31, 2003 and 2004, a total of 80,542 shares and 48,519 shares, respectively, of the Companys Common Stock were reserved for issuance upon exercise of outstanding options issued under the assumed plans, and the related
options are included in the table below.



Options under the
1998 Plan may be granted at prices no less than 85% of the estimated fair market value of the shares on the date of grant as determined by the Board of Directors, provided, however, that (i) the exercise price of an ISO may not be less than 100% of
the fair market value of the shares on the date of grant, and (ii) the exercise price of an ISO granted to a 10% shareholder may not be less than 110% of the fair market value of the shares on the date of grant. Option grants under the
Companys Option Plans generally vest 25% per year and are generally exercisable for a maximum period of ten years from the date of grant.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Changes in stock options outstanding, granted, exercisable, canceled and available, during 2002, 2003
and 2004 under the option plans are identified below. The number of options or awards available for grant at December 31, 2004 under the 1998 and 1999 Plans also reflects the issuance of 2,181,000 shares of restricted stock awarded in 2004 under the
1998 Plan. The Company only grants new options from the 1998 Plan and 1999 Plan, accordingly the Options or Awards Available under the 1998 and 1999 Plans information provided below includes only stock option information related to these plans and
no information related to any of the other acquired or assumed stock option plans (shares in thousands).



|                                    |  |                                                         |                 |  |                           |                                |  |   |      
|----------------------------------- |  | ------------------------------------------------------- | --------------- |  | ------------------------- | ------------------------------ |  | - | -----
|                                    |  | Options or AwardsAvailable Under the 1998And 1999 Plans |                 |  | Outstanding Option Grants
|                                    |  |                                                         | Number ofShares |  |                           | Weighted AverageExercise Price
|Beginning balance December 31, 2001 |  | 5,118                                                   |                 |  | 10,071                    |                                |  | $ | 35.56
|Additional shares reserved          |  | 2,500                                                   |                 |  |                           |                                |  |   |      
|Granted and assumed                 |  | (5,220                                                  | )               |  | 5,220                     |                                |  | $ | 5.28 
|Exercised                           |  |                                                         |                 |  | (591                      | )                              |  | $ | 4.88 
|Canceled                            |  | 1,881                                                   |                 |  | (1,907                    | )                              |  | $ | 39.92
|                                    |  |                                                         |                 |  |                           |                                |  |   |      
|Balance at December 31, 2002        |  | 4,279                                                   |                 |  | 12,793                    |                                |  | $ | 23.96
|Additional shares reserved          |  | 2,500                                                   |                 |  |                           |                                |  |   |      
|Granted and assumed                 |  | (3,441                                                  | )               |  | 3,441                     |                                |  | $ | 2.99 
|Exercised                           |  |                                                         |                 |  | (380                      | )                              |  | $ | 2.36 
|Canceled                            |  | 2,795                                                   |                 |  | (2,833                    | )                              |  | $ | 32.72
|                                    |  |                                                         |                 |  |                           |                                |  |   |      
|Balance at December 31, 2003        |  | 6,133                                                   |                 |  | 13,021                    |                                |  | $ | 17.07
|Additional shares reserved          |  | 2,500                                                   |                 |  |                           |                                |  |   |      
|Granted and assumed                 |  | (7,971                                                  | )               |  | 7,971                     |                                |  | $ | 1.45 
|Exercised                           |  |                                                         |                 |  | (313                      | )                              |  | $ | 2.56 
|Restricted stock issued             |  | (2,181                                                  | )               |  |                           |                                |  |   |      
|Canceled                            |  | 5,807                                                   |                 |  | (5,792                    | )                              |  | $ | 11.04
|                                    |  |                                                         |                 |  |                           |                                |  |   |      
|Ending balance at December 31, 2004 |  | 4,288                                                   |                 |  | 14,887                    |                                |  | $ | 11.25
|                                    |  |                                                         |                 |  |                           |                                |  |   |      
|Outstanding Options Exercisable:    |  |                                                         |                 |  |                           |                                |  |   |      
|December 31, 2002                   |  |                                                         |                 |  | 5,862                     |                                |  | $ | 35.24
|December 31, 2003                   |  |                                                         |                 |  | 6,896                     |                                |  | $ | 27.01
|December 31, 2004                   |  |                                                         |                 |  | 7,543                     |                                |  | $ | 20.57



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following table summarizes information about stock options outstanding at December 31, 2004
(options in thousands):



|                         |  |                     |  |                                          |  |                               |        |                   |       |                               |   |       
|------------------------ |  | ------------------- |  | ---------------------------------------- |  | ----------------------------- | ------ | ----------------- | ----- | ----------------------------- | - | ------
|                         |  | Options Outstanding |  | Options Exercisable                     
|Range of Exercise Prices |  | NumberOutstanding   |  | WeightedAverageRemainingContractual Life |  | WeightedAverageExercise Price |        | NumberExercisable |       | WeightedAverageExercise Price
|$    0.09 - $    0.65    |  | 2,132               |  | 9.72                                     |  | $                             | 0.62   |                   | 126   |                               | $ | 0.58  
|$    0.66 - $    1.44    |  | 1,774               |  | 7.77                                     |  |                               | 1.22   |                   | 1,097 |                               |   | 1.44  
|$    1.52 - $    1.60    |  | 1,857               |  | 8.54                                     |  |                               | 1.57   |                   | 729   |                               |   | 1.58  
|$    1.65 - $    2.11    |  | 2,446               |  | 9.14                                     |  |                               | 1.96   |                   | 518   |                               |   | 1.99  
|$    2.12 - $    3.12    |  | 2,293               |  | 8.57                                     |  |                               | 2.75   |                   | 1,187 |                               |   | 2.87  
|$    3.15 - $    4.44    |  | 1,788               |  | 6.88                                     |  |                               | 3.78   |                   | 1,424 |                               |   | 3.84  
|$    4.48 - $  10.24     |  | 1,949               |  | 6.92                                     |  |                               | 6.43   |                   | 1,822 |                               |   | 6.48  
|$  10.28 - $  50.00      |  | 81                  |  | 5.42                                     |  |                               | 13.87  |                   | 73    |                               |   | 14.15 
|$  51.52 - $100.00       |  | 23                  |  | 4.88                                     |  |                               | 88.10  |                   | 23    |                               |   | 88.10 
|$113.68 - $200.00        |  | 204                 |  | 5.28                                     |  |                               | 170.09 |                   | 204   |                               |   | 170.09
|$202.00 - $342.80        |  | 340                 |  | 5.34                                     |  |                               | 273.25 |                   | 340   |                               |   | 273.25
|                         |  |                     |  |                                          |  |                               |        |                   |       |                               |   |       
|                         |  | 14,887              |  | 8.17                                     |  | $                             | 11.25  |                   | 7,543 |                               | $ | 20.57 
|                         |  |                     |  |                                          |  |                               |        |                   |       |                               |   |       



Preferred Stock Rights Agreement



On March 19, 2001 pursuant to a Preferred Stock Rights
Agreement (the Rights Agreement) between the Company and Computershare Trust Company, Inc., as Rights Agent (the Rights Agent), the Companys Board of Directors (i) declared a dividend of one right (a Right)
to purchase one one-thousandth share of the Companys Series C Participating Preferred Stock (Series C Preferred) for each outstanding share of Common Stock, par value $0.001 per share (Common Shares), of the Company,
and (ii) authorized the issuance to each holder of Exchangeable Shares (as defined below) of one Right for each exchangeable Share held. An Exchangeable Share is a share of Class A Non-Voting Preferred Shares of Critical Path Messaging
Co., an unlimited liability company existing under the laws of the Province of Nova Scotia and a wholly-owned subsidiary of the Company. Each Exchangeable Share is exchangeable for one Common Share. The Rights were issued on May 15, 2001 (the
Record Date), to shareholders of record as of the close of business on that date. Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series C Preferred at an exercise price of $25.00
(the Purchase Price), subject to adjustment.



The
Rights will become exercisable following the tenth day after a person or group announces the acquisition of 15% or more of the Companys common stock or announces commencement of a tender or exchange offer, the consummation of which would
result in ownership by the person or group of 15% or more of the common stock of the Company. The Company will be entitled to redeem the Rights at $0.01 per Right at any time on or before the fifth day following acquisition by a person or group of
15% or more of the Companys common stock. The Rights will expire on the earlier of May 15, 2011 or exchange or redemption of the Rights.



Restricted stock and other stock-based compensation



In March and August 2004, the Company issued 707,368 and 680,823 shares of restricted stock, respectively, to Mark Ferrer, the Companys Chief
Executive Officer, in connection with Mr. Ferrers employment agreement. In November 2004, the Company issued 515,000 shares of restricted stock and 277,708 restricted stock units to Executive Officers and certain key employees of the Company.



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The restricted stock gives employees certain ownership rights, including the right to vote on
shareholder matters; whereas, restricted stock units do not convey any voting rights, but present the holder with the right to receive shares of Critical Path common stock as the underlying units vest. The restricted stock and restricted stock units
vest 25% every 6 months over a term of 2 years, with any unvested shares/units forfeited if a recipient terminates their employment with the Company.



The fair value of the restricted stock and stock units on the date of grant totaled approximately $2.3 million in 2004 and was recorded in
shareholders equity as unearned compensation. The unearned compensation is amortized to stock-based expense over the vesting period of the underlying shares and units. During 2004, amortization expense of $926,000 was recognized in stock-based
expense associated with the initial vesting of the restricted shares and units granted in 2004.



In connection with certain stock option grants and Common Stock issuances to employees, directors and advisors during 1998 and 1999, the Company
recognized unearned compensation totaling $19.9 million and $22.3 million, respectively, which is being amortized over the vesting periods of the related options. In March 2001, the Company granted employee stock options with exercise prices below
market value on the date of grant in connection with a program designed to provide incentives for current employees of the Company to continue their employment. The Company issued stock options representing an aggregate of 12.9 million shares,
vesting monthly over a 2-year period, and recognized unearned compensation related to the program totaling $21.4 million, which were subsequently reduced as a result of employee terminations throughout 2001 and 2002. Amortization expense recognized
during 2002, 2003 and 2004 totaled approximately $10.0 million, $59,000 and zero, respectively. Based on the functions of the employees and consultants participating in the related option grants, during 2002 and 2003, expenses of $1.2 million and
$17,000, respectively, were allocated to cost of net revenues and the remaining expenses were allocated to operating expenses. The Company periodically assesses unearned compensation and adjusts the remaining unamortized balance for employee
terminations and resignations.



In February 2002, the Court
gave preliminary approval to the settlement of the principal class action litigation. In June 2002, the Court entered its final approval of the settlement. In connection with the settlement, the Company agreed to issue warrants to purchase up to
850,000 shares of the Companys common stock at $10.00 per share, and recorded a charge of $697,000 to operating expense related to the fair value of these warrants. As a result of the Companys one-for-four reverse stock split in 2003,
these warrants are now exercisable into 212,500 shares of the Companys common stock at an exercise price of $40.00 per share. The warrants expire in June 2005.



During 2002, 2003 and 2004, the Company incurred stock-based charges of approximately $17,000, $181,000 and $989,000,
respectively, in connection with certain severance agreements for terminated employees and consulting arrangements. These charges were included in operating expenses based on the functions of the related employees and consultants.



Note 15Defined Contribution Plan



The Company maintains a defined contribution plan, the Critical Path 401(k)
Plan, under which its employees are eligible to participate. Participants may make voluntary contributions based on a percentage of their compensation, within certain limitations. Under the plan, discretionary contributions may be made by the
Company. Participants are fully vested in the Companys contributions after a specified number of years of service, as defined under the plan. No contributions have been made by the Company since its inception.



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



In certain of the European countries where Critical Path has subsidiaries, the Company makes
contributions to pension funds for their employees. During 2002, 2003 and 2004, the Company made contributions totaling $443,000, $490,000 and $559,000, respectively.



Note 16Loss Per Share Attributed to Common Shares



Net loss per share is calculated as follows:



|                                                                   |  |                                          |          |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------ |  | ---------------------------------------- | -------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                   |  | Year Ended December 31,                  |         
|                                                                   |  | 2002                                     |          |   | 2003 |   |         | 2004 | 
|                                                                   |  | (In thousands, except per share amounts) |         
|Net loss attributed to common shares                               |  |                                          |          |   |      |   |         |      |  |   |         |  
|Net loss                                                           |  | $                                        | (117,911 | ) |      | $ | (62,133 | )    |  | $ | (51,997 | )
|Accretion on mandatorily redeemable preferred stock                |  |                                          | (13,904  | ) |      |   | (12,446 | )    |  |   | (14,565 | )
|                                                                   |  |                                          |          |   |      |   |         |      |  |   |         |  
|Net loss attributable to common shares                             |  | $                                        | (131,815 | ) |      | $ | (74,579 | )    |  | $ | (66,562 | )
|                                                                   |  |                                          |          |   |      |   |         |      |  |   |         |  
|Weighted average shares outstanding                                |  |                                          |          |   |      |   |         |      |  |   |         |  
|Weighted average shares outstanding                                |  |                                          | 19,664   |   |      |   | 20,239  |      |  |   | 21,363  |  
|Weighted average shares subject to repurchase agreements           |  |                                          | (133     | ) |      |   | (133    | )    |  |   | (240    | )
|Weighted average shares held in escrow related to acquisitions     |  |                                          | (86      | ) |      |   | (86     | )    |  |   |        |  
|                                                                   |  |                                          |          |   |      |   |         |      |  |   |         |  
|Shares used in computation of basic and diluted net loss per share |  |                                          | 19,445   |   |      |   | 20,020  |      |  |   | 21,123  |  
|                                                                   |  |                                          |          |   |      |   |         |      |  |   |         |  
|Basic and diluted net loss per share attributed to common shares   |  |                                          |          |   |      |   |         |      |  |   |         |  
|Net loss attributable per common share                             |  | $                                        | (6.78    | ) |      | $ | (3.73   | )    |  | $ | (3.15   | )
|                                                                   |  |                                          |          |   |      |   |         |      |  |   |         |  



At December 31, 2002,
2003 and 2004, there were 28,898,783, 59,121,524 and 125,371,459, 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. The weighted average exercise prices of the potential common shares excluded from the determination of diluted net loss per share at December 31, 2002, 2003 and 2004 were $19.88, $9.86 and $4.01, respectively.



Note 17Product and Geographic Information



Revenue information on a product basis is as follows:



|                              |  |                         |        |      |   |        |  |   |        |  
|----------------------------- |  | ----------------------- | ------ | ---- | - | ------ |  | - | ------ | -
|                              |  | Year Ended December 31, |       
|                              |  | 2002                    |        | 2003 |   | 2004   | 
|                              |  | (In thousands)          |       
|Net revenues                  |  |                         |        |      |   |        |  |   |        |  
|Software license              |  |                         |        |      |   |        |  |   |        |  
|Messaging server              |  | $                       | 16,663 |      | $ | 6932   |  | $ | 7,837  | ]
|Identity management solutions |  |                         | 15,944 |      |   | 10,102 |  |   | 5,291  |  
|Other                         |  |                         | 2,569  |      |   | 5070   |  |   | 6,198  | ]
|Service                       |  |                         |        |      |   |        |  |   |        |  
|Hosted messaging              |  |                         | 24,893 |      |   | 19,444 |  |   | 17,842 |  
|Maintenance and support       |  |                         | 15,471 |      |   | 18,434 |  |   | 21,075 |  
|Professional services         |  |                         | 11,593 |      |   | 12,315 |  |   | 12,829 |  
|                              |  |                         |        |      |   |        |  |   |        |  
|                              |  | $                       | 87,133 |      | $ | 72,297 |  | $ | 71,072 |  
|                              |  |                         |        |      |   |        |  |   |        |  



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Information regarding revenues and long-lived assets attributable to the Companys primary
geographic regions are as follows:



|              |  |                         |        |      |   |        |  |   |       
|------------- |  | ----------------------- | ------ | ---- | - | ------ |  | - | ------
|              |  | Year Ended December 31,
|              |  | 2002                    |        | 2003 |   | 2004  
|              |  | (In thousands)         
|Net revenues  |  |                         |        |      |   |        |  |   |       
|United States |  | $                       | 40,461 |      | $ | 27,102 |  | $ | 21,117
|Europe        |  |                         | 40,083 |      |   | 39,629 |  |   | 46,795
|Latin America |  |                         | 2,736  |      |   | 2,157  |  |   | 1,529 
|Asia Pacific  |  |                         | 3,853  |      |   | 3,409  |  |   | 1,631 
|              |  |                         |        |      |   |        |  |   |       
|              |  | $                       | 87,133 |      | $ | 72,297 |  | $ | 71,072
|              |  |                         |        |      |   |        |  |   |       



|                  |  |              |        |      |   |        |  |   |       
|----------------- |  | ------------ | ------ | ---- | - | ------ |  | - | ------
|                  |  | December 31,
|                  |  | 2002         |        | 2003 |   | 2004  
|Long-lived assets |  |              |        |      |   |        |  |   |       
|United States     |  | $            | 17,366 |      | $ | 11,127 |  | $ | 8,281 
|Other             |  |              | 776    |      |   | 3,693  |  |   | 3,098 
|                  |  |              |        |      |   |        |  |   |       
|                  |  | $            | 18,142 |      | $ | 14,821 |  | $ | 11,379
|                  |  |              |        |      |   |        |  |   |       



The long-lived assets
in the table above represent the Companys total property and equipment presented on a geographic basis at each period end. For each of the periods presented, the Company did not have any other long-lived assets to present on a geographic
basis. Goodwill is excluded from this analysis.



During 2002,
2003 and 2004, the Company did not have any customers that accounted for more than 10% of its revenues.



Note 18Subsequent Events



Conversion of Series D Preferred Stock to Shares of Common Stock



On January 10, 2005, the Company converted 581,818 shares of Series D preferred stock, plus accrued dividend, held by entities associated with the Vectis Group into 6,701,943 shares of common stock.



Financing Activities



On March 9, 2005, the Companys Board of Directors approved a
resolution to proceed with the issuance of the remaining $7,000,000 in 13.9% promissory 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 this financing transaction, the Company will also issue warrants to purchase 149,998 shares of
Series F preferred stock at a per share purchase price of $14.00 per share, which is equivalent to $1.40 per share on a common equivalent basis. The Notes will 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 Notes would be due and payable on the earlier to occur of the maturity of the 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.



In March 2005, the Company issued the remaining $7.0 million of these notes.



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CRITICAL PATH, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Facility Relocation



In September 2004, the Company received a notice from the landlord of its headquarters facility in San Francisco, California
notifying the Company that the landlord had found a new tenant for its 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 expects to vacate its facilities at 350 The Embarcadero and move
into new office space provided at 2 Harrison Street, Suite #200 by no later than June 29, 2005. In connection with the landlords substitution right and the Companys relocation, the Company will be required to make a lease termination
payment totaling approximately $1.3 million on June 1, 2005; however, the annual rent, on a cash basis, for the Companys headquarters facility will decline from approximately $2.5 million per year to an amount that, although still under
negotiation, the Company expects to be less than $0.6 million per year. Additionally, the Company will incur costs related to the physical move and build out of the new facility, however the Company cannot currently estimate these costs as it has
not yet engaged a moving company nor completed a detailed leasehold improvement plan.



Registration of Series E Preferred Stock



The Company has recently received a demand from holders of Series E preferred stock to register shares of the Companys common stock issuable upon conversion of their shares of Series E preferred stock. The
Company is currently in the process of preparing a Form S-3 registration statement for filing shortly after the filing of this Annual Report on Form 10-K, which when completed will register up to 30 million shares of the Companys common stock.
Any conversion of the Companys preferred stock into shares of common stock would increase the number of additional shares of common stock that may be sold into the market.



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SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) 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.



Date: March 31, 2005Critical Path, Inc./s/    MARK J. FERRERMark J. Ferrer Chief Executive Officer and Chairman of the Board (Principal Executive
Officer)




POWER OF
ATTORNEY



KNOW ALL MEN BY THESE PRESENTS, that each person
whose signature appears below constitutes and appoints Mark J. Ferrer and James A. Clark and each of them, his true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission granting unto
said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying
and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes may lawfully do or cause to be done by virtue hereof.



Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.



|                                                |  |                                                                                                                     |  |                 
|----------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------- |  | ----------------
|Signature                                       |  | Title                                                                                                               |  | Date            
|                                                |  |                                                                                                                    
|/s/    MARK J. FERRERMark J. Ferrer             |  | Chief Executive Officer and Chairman of the Board (Principal Executive Officer)                                     |  | March 31, 2005  
|                                                |  |                                                                                                                    
|/s/    JAMES A. CLARKJames A. Clark             |  | Executive Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |  | March 31, 2005  
|                                                |  |                                                                                                                    
|/s/    TOM TINSELYTom Tinsely                   |  | Director                                                                                                            |  | March 29, 2005  
|                                                |  |                                                                                                                    
|Edmond Ip Tak
Chuen                             |  | Director                                                                                                            |  | March     , 2005
|                                                |  |                                                                                                                    
|/s/    PETER L.S.
CURRIEPeter L.S.
Currie       |  | Director                                                                                                            |  | March 29, 2005  
|                                                |  |                                                                                                                    
|/s/    ROSS M. DOVERoss M. Dove                 |  | Director                                                                                                            |  | March 31, 2005  
|                                                |  |                                                                                                                    
|/s/    FROST R.R.
PRIOLEAUFrost R.R.
Prioleau   |  | Director                                                                                                            |  | March 29, 2005  
|                                                |  |                                                                                                                    
|/s/    MICHAEL J.
SHANNAHANMichael J.
Shannahan |  | Director                                                                                                            |  | March 29, 2005  



122