<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------------
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
[ ] 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 333-42177
MICROMUSE INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3288385
- ------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
139 TOWNSEND STREET
SAN FRANCISCO, CALIFORNIA 94107
(415) 538-9090
(Address, including ZIP code, and telephone number)
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 [ ]
15,977,035 shares of Common Stock, $0.01 par value, were outstanding as of
July 31, 1998.
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MICROMUSE INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
PART I - Financial Information
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets at June 30, 1998 and
September 30, 1997 3
Condensed Consolidated Statements of Operations for the three and
nine months ended June 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows for the nine
months ended June 30, 1998 and 1997 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
PART II - Other Information
Item 1. Legal Proceedings 24
Item 2. Changes in Securities and use of Proceeds 24
Item 3. Defaults upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 25
Signature 26
</TABLE>
2
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Part I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
MICROMUSE INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
ASSETS
<TABLE>
<CAPTION>
June 30, September 30,
1998 1997
-------- -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 23,503 $ 13,741
Short-term investments 20,254 --
Accounts receivable 5,386 4,461
Prepaid expenses and other current assets 1,400 935
Related party loan -- 1,153
-------- --------
Total current assets 50,543 20,290
Property and equipment, net 2,724 2,450
-------- --------
$ 53,267 $ 22,740
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 1,670 $ 2,654
Accrued expenses 3,918 3,133
Deferred revenues 4,649 1,322
-------- --------
Total current liabilities 10,237 7,109
Redeemable convertible preferred stock; $0.01 par value; 5,988 shares
authorized; 4,488 shares issued and outstanding at September 30, 1997 -- 22,865
Stockholders' equity (deficit):
Common stock; $0.01 par value; 60,000 shares authorized; 6,706 and 14,892
shares outstanding as of September 30, 1997
and June 30, 1998, respectively 148 67
Additional paid-in capital 55,455 2,390
Treasury stock, at cost: 120 shares at September 30, 1997 -- (300)
Deferred compensation (173) (215)
Cumulative translation adjustment (100) 52
Accumulated deficit (12,300) (9,228)
-------- --------
Total stockholders' equity (deficit) 43,030 (7,234)
-------- --------
$ 53,267 $ 22,740
======== ========
</TABLE>
See accompanying notes to the condensed consolidated financial statements
3
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MICROMUSE INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three months ended Nine months ended
June 30, June 30,
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
License $ 6,023 $ 2,094 $ 14,672 $ 3,991
Maintenance and services 1,570 590 3,945 1,630
-------- -------- -------- --------
Total revenues 7,593 2,684 18,617 5,621
-------- -------- -------- --------
Cost of revenues:
License 318 155 945 324
Maintenance and services 797 303 2,361 649
-------- -------- -------- --------
Total cost of revenues 1,115 458 3,306 973
-------- -------- -------- --------
Gross profit 6,478 2,226 15,311 4,648
-------- -------- -------- --------
Operating expenses:
Sales and marketing 4,186 1,714 10,819 4,669
Research and development 1,398 596 3,804 1,282
General and administrative 1,251 714 3,154 2,734
-------- -------- -------- --------
Total operating expenses 6,835 3,024 17,777 8,685
-------- -------- -------- --------
Loss from operations (357) (798) (2,466) (4,037)
Other income (expense) 568 (464) 778 (888)
-------- -------- -------- --------
Income (loss) before income taxes 211 (1,262) (1,688) (4,925)
Income taxes 50 -- 50 --
-------- -------- -------- --------
Income (loss) from continuing operations 161 (1,262) (1,738) (4,925)
Loss from discontinued operations -- (2) -- (104)
-------- -------- -------- --------
Net income (loss) 161 (1,264) (1,738) (5,029)
Accretion on redeemable convertible preferred stock -- (264) (1,334) (353)
-------- -------- -------- --------
Net income (loss) applicable to holders of common stock $ 161 $ (1,528) $ (3,072) $ (5,382)
======== ======== ======== ========
Basic and diluted per share data:
Income (loss) from continuing operations applicable to
holders of common stock $ 0.01 $ (0.23) $ (0.29) $ (0.84)
Loss from discontinued operations -- 0.00 -- (0.02)
Net income (loss) applicable to holders of common stock $ 0.01 $ (0.23) $ (0.29) $ (0.86)
Weighted average shares used in computing:
Basic net income (loss) per share 14,880 6,551 10,487 6,250
Diluted net income (loss) per share 16,209 6,551 10,487 6,250
</TABLE>
See accompanying notes to the condensed consolidated financial statements
4
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MICROMUSE INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Nine months ended
June 30,
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (1,738) $ (5,029)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization 903 615
Amortization of deferred employee compensation 42 --
Changes in operating assets and liabilities:
Accounts receivable (925) 1,702
Inventories -- (94)
Prepaid expenses and other current assets (465) (189)
Related party loan 1,153 (738)
Accounts payable (984) (231)
Accrued expenses 785 (40)
Deferred revenue 3,327 941
-------- --------
Net cash provided by (used in) operating activities 2,098 (3,063)
-------- --------
Cash flows used in investing activities:
Capital expenditures (1,177) (907)
Purchase of short-term investments (20,254) --
-------- --------
Net cash used in investing activities (21,431) (907)
-------- --------
Cash flows from financing activities:
Payment of bank overdraft -- (814)
Proceeds from short-term notes -- 2,500
Payment of short-term notes -- (3,611)
Payment of long-term notes -- (68)
Proceeds from issuance of common stock 34,247 --
Proceeds from issuance of redeemable convertible preferred
stock -- 6,730
Purchase of treasury stock (5,000) --
-------- --------
Net cash provided by financing activities 29,247 4,737
-------- --------
Effects of exchange rate changes on cash and cash equivalents (152) 47
-------- --------
Net increase in cash and cash equivalents 9,762 814
Cash and cash equivalents at beginning of period 13,741 594
-------- --------
Cash and cash equivalents at end of period $ 23,503 $ 1,408
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period - interest $ -- $ 125
======== ========
Noncash financing activities:
Accretion on redeemable convertible preferred stock $ 1,334 $ 353
======== ========
Exercise of warrant to purchase redeemable convertible
Series A preferred stock for common stock $ 1,588 $ --
======== ========
Conversion of redeemable convertible Series B and C
preferred stock to common stock $ 22,611 $ --
======== ========
</TABLE>
See accompanying notes to the condensed consolidated financial statements
5
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MICROMUSE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The condensed consolidated financial statements are the unaudited historical
financial statements of Micromuse Inc. and subsidiaries (the "Company") and
reflect all adjustments (consisting only of normal recurring accruals) that, in
the opinion of management, are necessary for a fair presentation of interim
period results. These condensed consolidated financial statements should be read
in conjunction with the financial statements and notes thereto included in the
Company's Registration Statements on Form S-1 as filed with the Securities and
Exchange Commission on February 12 and July 28, 1998. The September 30, 1997
consolidated balance sheet included herein was derived from audited financial
statements, but does not include all disclosures, including notes, required by
generally accepted accounting principles.
The results of operations for the current interim period are not necessarily
indicative of results to be expected for the entire current year or other future
interim periods.
Cash Equivalents
The Company considers all highly liquid instruments with a purchased maturity of
90 days or less to be cash equivalents.
Marketable Securities
The Company has invested in certain equity securities that are categorized as
held-to-maturity. The fair value of these investments, which are accounted for
using the amortized cost-basis of accounting, approximate their carrying value
due to their short maturities.
Net Income (Loss) Per Share
Basic net income (loss) per share is calculated using the weighted-average
number of common shares outstanding during the period. Diluted net income (loss)
per share is calculated using the weighted-average number of common shares
outstanding during the period and, when dilutive, the weighted average number of
potential common shares from the assumed exercise of outstanding options to
purchase common stock using the treasury stock method. Excluded from the
computation of diluted loss per share for the three and nine-month periods ended
June 30, 1997 and the nine-month period ended June 30, 1998 were options to
acquire $1.2 million and $1.6 million shares of common stock, respectively, with
a weighted average exercise price of $2.34 and $4.43 per share, respectively,
because their effect would be anti-dilutive. A reconciliation of the numerators
and denominators used in the basic and diluted net income (loss) per share
amounts follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
June 30, June 30,
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Numerator for basic and diluted net income (loss)
Applicable to holders of common stock $ 161 $(1,528) $(3,072) $(5,382)
======= ======= ======= =======
Denominator for basic net income (loss) per
Share - weighted-average shares outstanding 14,880 6,551 10,487 6,250
Effect of dilutive common stock options 1,329 -- -- --
------- ------- ------- -------
Denominator for diluted net income (loss)
per share 16,209 6,551 10,487 6,250
======= ======= ======= =======
</TABLE>
6
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MICROMUSE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Recent Pronouncement
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognizes
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions are
met, a derivative may be specifically designated and accounted for as (a) a
hedge of the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment, (b) a hedge of the exposure to
variable cash flows of a forecasted transaction, or (c) a hedge of the foreign
currency exposure of a net investment in a foreign operation, an unrecognized
firm commitment, an available-for-sale security, or a foreign-currency
denominated forecasted transaction. For a derivative not designated as a hedging
instrument, changes in the fair value of the derivative are recognized in
earnings in the period of change. This statement will be effective for all
annual and interim periods beginning after June 15, 1999 and management does not
believe the adoption of SFAS No. 133 will have a material effect on the
financial position of the Company.
NOTE 2. REGISTRATION STATEMENTS
In February 1998, the Company raised $34.2 million of net proceeds from the sale
of 3.2 million shares of the Company's common stock pursuant to an initial
public offering (IPO). Under the terms of the offering, all the outstanding
shares of Series B and Series C preferred stock were converted into 2.0 million
shares and 2.4 million shares of common stock, respectively, upon the closing of
the IPO. In addition, a warrant to purchase Series A Preferred Stock was
converted into 1.5 million shares of common stock.
In July 1998, the Company raised $22.9 million of net proceeds from the sale of
1.0 million shares of the Company's common stock pursuant to a secondary public
offering. Under the terms of the offering, 1,000,000 shares were sold by the
Company and 2,000,000 shares were sold by the participating stockholders.
NOTE 3. EMPLOYEE STOCK PURCHASE PLAN
In February 1998, the Company adopted the Company's 1998 Employee Stock Purchase
Plan (the "ESPP") to provide employees of the Company with an opportunity to
purchase Common Stock through payroll deductions. Under the ESPP 300,000 shares
of Common Stock have been reserved for issuance. All full-time regular employees
who were employed by the Company on the effective date of the initial public
offering were eligible to participate in the ESPP after completing a three-month
waiting period.
Eligible employees may contribute up to 15% of their total cash compensation to
the ESPP. Amounts withheld are applied at the end of every six-month
accumulation period to purchase shares of Common Stock, but not more than 1,250
shares per accumulation period. The value of the Common Stock (determined as of
the beginning of the offering period) that may be purchased by any participant
in a calendar year is limited to $25,000. Participants may withdraw their
contributions at any time before stock is purchased.
The purchase price is equal to 85% of the lower of (a) the market price of
Common Stock immediately before the beginning of the applicable offering period
or (b) the market price of Common Stock at the
7
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MICROMUSE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
time of the purchase. In general, each offering period is 24 months long, but a
new offering period begins every six months. Thus up to four overlapping
offering periods may be in effect at the same time. An offering period continues
to apply to a participant for the full 24 months, unless the market price of
Common Stock is lower when a subsequent offering period begins. In that event,
the subsequent offering period automatically becomes the applicable period for
purposes of determining the purchase price. The first accumulation and offering
periods commenced on the effective date of the IPO and will end on July 31, 1998
and January 31, 2000, respectively.
NOTE 4. DEFINED CONTRIBUTION PLAN
In February 1998, the Company adopted a defined contribution plan (the "Plan")
in the United States pursuant to Section 401(a) of the Internal Revenue Code
(the "Code"). All eligible full and part-time employees of the Company who meet
certain age requirements may participate in the Plan. Participants may
contribute up to 20% of their pre-tax compensation, but not in excess of the
maximum allowable under the Code. The Plan allows for discretionary
contributions by the Company. Such matching contributions vest based on the
participant's length of service. In addition, the Company may make
profit-sharing contributions at the discretion of the Board of Directors. The
Company made no contributions during the nine-month period ended June 30, 1998.
NOTE 5. SUBSEQUENT EVENT
In July 1998, the Company received correspondence from counsel to a stockholder
and former officer of the Company asserting claims relating to ownership of
intellectual property related to the Company's Netcool/Omnibus product and
claims regarding his ownership of stock in the Company. Specifically, the letter
alleges that the former officer's transfer of intellectual property rights to
the Company was invalid, that he was improperly denied the necessary time in
which to evaluate whether to participate in the follow-on stock offering and
that his lock-up agreement may not be valid with respect to the 170,316 shares
of the Company's Common Stock beneficially owned by him. The Company has
reviewed the claims set forth in the correspondence and based upon such review
does not believe such allegations have merit and, if pursued by such
stockholder, the Company intends to defend any such claims vigorously and
believes that the resolution of such claims will not have a material adverse
effect on the Company's business, operating results or financial condition.
However, if commenced, such litigation could be time-consuming and costly, and
there can be no assurance that the Company would necessarily prevail given the
inherent uncertainties in litigation. In the event the Company does not prevail
in litigation, the Company could be prevented from selling its Netcool/Omnibus
product or required to enter into royalty or licensing agreements or pay
monetary damages. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to the Company or at all. In the event of a
successful claim against the Company, the Company's business, operating results
or financial condition could be materially adversely affected.
8
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MICROMUSE INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following information should be read in conjunction with the condensed
consolidated historical financial information and the notes thereto included in
Item 1 of this Quarterly Report on Form 10-Q and Management's Discussion and
Analysis of Financial Condition and Results of Operations contained in the
Company's Registration Statements on Form S-1 as filed with the Securities and
Exchange Commission on February 12 and July 28, 1998.
The statements contained in this Form 10-Q that are not purely historical are
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, including statements regarding the Company's expectations,
beliefs, hopes, intentions or strategies regarding the future. All
forward-looking statements in this Form 10-Q are based upon information
available to the Company as of the date hereof, and the Company assumes no
obligation to update any such forward-looking statements. Actual results could
differ materially from the Company's current expectations. Factors that could
cause or contribute to such differences include, but are not limited to:
variation in demand for the Company's software products and services; the level
and timing of sales; the extent of product and price competition; introductions
or enhancements of products or delays in introductions or enhancements of
products; hiring and retention of personnel; changes in the mix of products and
services sold; general domestic and international economic and political
conditions; and other factors and risks discussed in "Risk Factors," elsewhere
in this Report, and in the Company's Securities and Exchange Commission filings.
OVERVIEW
Micromuse develops, markets and supports a family of scalable, highly
configurable, rapidly deployable software solutions that enable Service Level
Management -- the effective monitoring and management of multiple elements
underlying an Information Technology infrastructure, including network devices,
computing systems and applications, and the mapping of these elements to the
business services they impact.
Micromuse plc was incorporated in England in 1989 and in March 1997 became a
subsidiary of Micromuse Inc., a Delaware corporation formed in connection with a
corporate reorganization and relocation of the corporate headquarters to San
Francisco, California. As used herein, the term "Micromuse" or the "Company"
refers to Micromuse Inc., Micromuse plc, and their other subsidiaries, unless
the context otherwise requires or unless otherwise expressly stated. The
Company's principal executive offices are located at 139 Townsend Street, San
Francisco, California 94107, and its telephone number at that address is (415)
538-9090.
9
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MICROMUSE INC.
RESULTS OF OPERATIONS
The following table sets forth certain items in the Company's condensed
consolidated statements of operations as a percentage of total revenues for the
periods indicated:
<TABLE>
<CAPTION>
Three months ended Nine months ended
June 30, June 30,
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Revenues:
License 79.3% 78.0% 78.8% 71.0%
Maintenance and services 20.7 22.0 21.2 29.0
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
Cost of revenues:
License 4.2 5.8 5.1 5.8
Maintenance and services 10.5 11.3 12.7 11.5
----- ----- ----- -----
Total cost of revenues 14.7 17.1 17.8 17.3
----- ----- ----- -----
Gross profit 85.3 82.9 82.2 82.7
Operating expenses:
Sales and marketing 55.1 63.8 58.1 83.0
Research and development 18.4 22.2 20.4 22.8
General and administrative 16.5 26.6 17.0 48.6
----- ----- ----- -----
Total operating expenses 90.0 112.6 95.5 154.4
----- ----- ----- -----
Loss from operations (4.7) (29.7) (13.3) (71.7)
Other income (expense) 7.5 (17.3) 4.2 (15.8)
----- ----- ----- -----
Income (loss) before income taxes 2.8 (47.0) (9.1) (87.5)
Income taxes 0.7 -- (0.2) --
----- ----- ----- -----
Income (loss) from continuing 2.1 (47.0) (9.3) (87.5)
operations
Loss from discontinued operations -- (0.1) -- (1.9)
----- ----- ----- -----
Net income (loss) 2.1 (47.1) (9.3) (89.4)
Accretion on redeemable convertible
preferred stock -- (9.8) (7.2) (6.3)
----- ----- ----- -----
Net income (loss) applicable to holders
of common stock 2.1% (56.9)% (16.5)% (95.7)%
===== ===== ===== =====
</TABLE>
Revenues. The Company's revenues increased from $2.7 million for the quarter
ended June 30, 1997 to $7.6 million for the quarter ended June 30, 1998 and from
$5.6 million for the first nine months of fiscal 1997 to $18.6 million for the
first nine months of fiscal 1998. License revenues increased from $2.1 million
and $4.0 million for the quarter and nine months ended June 30, 1997,
respectively, to $6.0 million and $14.7 million for the quarter and nine months
ended June 30, 1998, respectively. These increases in license revenues were
primarily due to an increase in the number of product licenses sold and an
increase in the average transaction size, reflecting increased acceptance of
Netcool/OMNIbus and expansion of the Company's sales organizations. Maintenance
and services revenues increased from $590,000 and $1.6 million for the quarter
and nine months ended June 30, 1997, respectively, to $1.6 million and $3.9
million for the quarter and nine months ended June 30, 1998, respectively. These
10
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MICROMUSE INC.
increases in maintenance and services revenues were a result of providing
maintenance and services to a larger installed base of customers. The percentage
of the Company's total revenue attributable to license revenue increased from
approximately 71% in the nine-month period ended June 30, 1997 to approximately
79% in the nine-month period ended June 30, 1998, due primarily to an increased
focus by the Company in generating license revenues.
Cost of Revenues. The cost of license revenues consists primarily of technology
license fees paid to third-party software vendors and production costs. Cost of
license revenue as a percentage of license revenues decreased to 5% in the third
quarter and 6% in the first nine months of fiscal 1998 from 7% in the third
quarter and 8% in the first nine months of fiscal 1997 due to economies of
scale. The cost of maintenance and services revenues consists primarily of
personnel-related costs incurred in providing maintenance, consulting and
training to customers. Cost of maintenance and services revenues as a percentage
of maintenance and services revenues was 51% in the third quarter of fiscal 1997
and 1998 and increased to 60% in the first nine months of fiscal 1998 from 40%
in the first nine months of fiscal 1997. This increase was principally due to
increased personnel, facilities, and travel costs associated with expanding the
customer support and technical services organizations.
Sales and Marketing Expenses. Sales and marketing expenses increased from $1.7
million and $4.7 million for the quarter and nine-month period ended June 30,
1997, respectively, to $4.2 million and $10.8 million for the quarter and
nine-month period ended June 30, 1998, respectively. These increases in sales
and marketing expenses were primarily due to the increased personnel costs
associated with the expansion of the Company's sales and technical services
departments and increased facilities costs. Sales and marketing expenses as a
percentage of total revenues declined from 64% and 83% for the third quarter and
first nine months of fiscal 1997, respectively, to 55% and 58% for the
comparable periods of fiscal 1998. These reductions were primarily due to net
revenues increasing at a faster rate than sales and marketing expenses.
Additionally, the first nine months of fiscal 1997 included a compensation
charge related to the issuance of stock options.
Research and Development Expenses. Research and development expenses increased
from $596,000 and $1.3 million for the quarter and nine-month period ended June
30, 1997, respectively, to $1.4 million and $3.8 million for the quarter and
nine-month period ended June 30, 1998, respectively. These increases in spending
were the result of increased personnel, additional facilities costs, and an
increase in the computer systems and software development tools required by the
additional personnel. Research and development costs as a percentage of total
revenues declined from 22% and 23% for the third quarter and first nine months
of fiscal 1997, respectively, to 18% and 20% for the comparable periods of
fiscal 1998. These reductions were primarily due to net revenues increasing at a
faster rate than research and development expenses.
General and Administrative Expenses. General and administrative expenses
increased from $714,000 and $2.7 million for the quarter and nine-month period
ended June 30, 1997, respectively, to $1.3 million and $3.2 million for the
quarter and nine-month period ended June 30, 1998, respectively. These increases
were primarily due to increased professional fees, personnel, facilities costs
and associated expenses to support the Company's increased scale of operations.
General and administrative expenses as a percentage of revenues declined from
27% and 49% for the quarter and nine-month period ended June 30, 1997,
respectively, to 17% for the comparable periods of fiscal 1998 due to the
increase in total revenues.
11
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MICROMUSE INC.
Other Income (Expense). Interest expense for the quarter and nine-month period
ended June 30, 1997 was $464,000 and $888,000, respectively, as compared with
interest income of $568,000 and $778,000 for the quarter and nine-month period
ended June 30, 1998, respectively. This change was primarily due to interest
earned on the proceeds raised from the Company's initial public offering during
the period ended June 30, 1998 which offset imputed interest related to the
issuance of a warrant to purchase 1,500,000 shares of Series A Preferred Stock
at a per share exercise price of $2.00.
LIQUIDITY AND CAPITAL RESOURCES As of June 30, 1998, the Company had $23.5
million in cash and cash equivalents and $20.3 million in marketable securities.
In February 1998, the Company sold shares of its common stock in its initial
public offering (IPO) generating net proceeds of $34.2 million. Net cash
generated by operating activities in the nine months ended June 30, 1998 was
primarily attributable to an increase in accrued expenses and deferred revenue
as well as a decrease in the related party loan. These increases in cash and
cash equivalents were partially offset by the purchase of short-term
investments, treasury stock and capital equipment and cash used to fund the net
loss of $1.7 million. Net cash used in operating activities in the nine months
ended June 30, 1997 was primarily attributable to a net loss of $5.0 million.
This decrease in cash and cash equivalents was offset by the $6.7 million of
proceeds from the issuance of redeemable convertible preferred stock in fiscal
1997. In July 1998, the Company sold shares of its common stock in its follow-on
public offering generating net proceeds of $22.9 million.
The Company believes that the net proceeds received by the Company from the IPO
and the follow-on stock offering, together with its current cash balances and
the cash flows generated by operations, if any, will be sufficient to meet its
anticipated cash needs for working capital and capital expenditures for the next
12 months. Thereafter, if cash generated from operations is insufficient to
satisfy the Company's liquidity requirements, the Company may seek to sell
additional equity or convertible debt securities or obtain credit facilities.
The sale of additional equity or debt securities could result in additional
dilution to the Company's stockholders. A portion of the Company's cash may be
used to acquire or invest in complementary businesses or products or to obtain
the right to use complementary technologies. From time to time, in the ordinary
course of business, the Company evaluates potential acquisitions of such
businesses, products or technologies. The Company has no current plans,
agreements or commitments, and is not currently engaged in any negotiations with
respect to any such transaction.
YEAR 2000 COMPLIANCE AND EURO CONVERSION
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, computer systems and/or software used by many
companies may need to be upgraded to comply with such "Year 2000" requirements.
Further, various European states have planned the introduction of a single
currency (known as the Euro) in January 1999. The introduction of the Euro may
result in complex conversion calculations. The Company is currently in the
process of conducting a review of its internal information systems to identify
systems that could be affected by such Year 2000 and Euro conversion
requirements. Further, to accommodate its recent growth, the Company will be
required to continue to implement and improve a variety of operational,
financial and management information systems, procedures and controls on a
timely basis. In particular, the Company will be required to improve its
accounting and financial reporting systems, which currently require substantial
management effort and will be required to implement a U.S.-based financial and
accounting system. The Company expects to incur internal staff costs as well as
consulting and other expenses related to these requirements, including Year 2000
and Euro conversion requirements. The Company cannot estimate the amount of
costs that will be associated with implementing these improvements and changes.
While the Company currently expects that such improvements and changes will not
pose significant operational problems, delays in the
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MICROMUSE INC.
implementation or modification of the Company's information systems could have a
material adverse effect on the Company's business, results of operations and
financial condition.
RISK FACTORS
In addition to the other information in this Report, the following risk factors
should be considered carefully in evaluating the Company and its business.
LIMITED OPERATING HISTORY AS A SOFTWARE COMPANY; UNCERTAINTY OF FUTURE OPERATING
RESULTS. Although the Company began offering services for the network and
systems integration market in 1989, the Company first shipped its internally
developed software product, Netcool/OMNIbus, for the Service Level Management
("SLM") market in January 1995. Accordingly, the Company has only a limited
operating history as a developer and provider of SLM software upon which an
evaluation of its business and prospects can be based. Since inception, the
Company's software business has incurred significant losses that were partially
offset by profits from the Company's systems integration business, which was
divested in the fourth quarter of fiscal 1997. Although the Company did not
incur losses in the fiscal quarter ended June 30, 1998, there can be no
assurance that the Company will be profitable in any period thereafter. The
limited operating history of the Company makes the prediction of future results
of operations difficult if not impossible, and the Company and its prospects
must be considered in light of the risks, costs and difficulties frequently
encountered by emerging companies, particularly companies in the competitive
software industry. Although the Company has achieved recent revenue growth,
there can be no assurance that the Company can generate substantial additional
revenue growth on a quarterly or annual basis, or that any revenue growth that
is achieved can be sustained. In addition, the Company has increased, and plans
to increase further, its operating expenses in order to develop new distribution
channels, increase its sales and marketing efforts, implement and improve its
operational, financial and management information systems, broaden its technical
services and customer support capabilities, fund higher levels of research and
development and expand its administrative resources in anticipation of future
growth. To the extent that increases in such expenses are not subsequently
followed by increased revenues, the Company's business, operating results and
financial condition would be materially adversely affected. In addition, in view
of recent revenue growth, the rapidly evolving nature of its business and
markets and its limited operating history in its current market, the Company
believes that period-to-period comparisons of financial results are not
necessarily meaningful and should not be relied upon as an indication of future
performance. As of June 30, 1998, the Company had accumulated net losses of
$12.3 million.
VARIABILITY OF QUARTERLY OPERATING RESULTS; SEASONALITY. The Company's quarterly
operating results have fluctuated significantly in the past, and will likely
continue to fluctuate in the future, as a result of a number of factors, many of
which are outside the Company's control. These factors include changes in the
demand for the Company's software products and services; the size and timing of
specific sales; the timing of new hires; the level of product and price
competition that the Company encounters; changes in the mix of, and lack of
demand from, distribution channels through which products are sold; the length
of sales cycles; spending patterns and budgetary resources of its customers on
network management software solutions; the success of the Company's new customer
generation activities; introductions or enhancements of products, or delays in
the introductions or enhancements of products, by the Company or its
competitors; market acceptance of new products; the Company's ability to
anticipate and effectively adapt to developing markets and rapidly changing
technologies; the mix of products and services sold; changes in the Company's
sales incentives; changes in the renewal rate of support agreements; the mix of
international and domestic revenue; product life
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MICROMUSE INC.
cycles; software defects and other product quality problems; the Company's
ability to attract, retain and motivate qualified personnel; changes in the mix
of sales to new and existing customers; the extent of industry consolidation;
expansion of the Company's international operations; and general domestic and
international economic and political conditions. The timing of large individual
sales has been difficult for the Company to predict, and large individual sales
have, in some cases, occurred in quarters subsequent to those anticipated by the
Company. There can be no assurance that the loss or deferral of one or more
significant sales would not have a material adverse effect on the Company's
quarterly operating results. In addition, the Company's business has experienced
and may continue to experience significant seasonality. Historically, a
disproportionate amount of the Company's annual revenues have been generated by
sales of its products during the Company's fourth fiscal quarter. There can be
no assurance that this trend will not continue.
The Company typically realizes a significant portion of license revenue in the
last month of a quarter, frequently in the last weeks or even days of a quarter.
As a result, quarter-to-quarter comparisons of operating results are not
necessarily meaningful or indicative of future performance. Furthermore, the
Company believes it is possible that in some future quarter the Company's
operating results will be below the expectations of public market analysts or
investors. In such event, or in the event that adverse conditions prevail, or
are perceived to prevail, with respect to the Company's business or generally,
the market price of the Company's Common Stock would likely be materially
adversely affected.
MANAGEMENT OF GROWTH; NEED TO IMPROVE FINANCIAL SYSTEMS AND CONTROLS. The
Company has recently experienced a period of rapid revenue and customer growth
and a substantial expansion in the number of its personnel and in the scope and
the geographic area of its operations. The Company has grown from 92 employees
on June 30, 1997 to 164 employees on June 30, 1998 and currently plans to
continue to recruit more staff. This growth has resulted in new and increased
responsibilities for management personnel and has placed and continues to place
a significant strain upon the Company's management, operating and financial
systems and resources. Moreover, members of the Company's management team,
including, without limitation, the Chief Financial Officer, Senior Vice
President, Sales and U.S. Controller have been in their current positions with
the Company for a limited period of time. To accommodate recent growth and to
compete effectively and manage future growth, if any, the Company will be
required to continue to implement and improve a variety of operational,
financial and management information systems, procedures and controls on a
timely basis and to expand, train, motivate and manage its work force. In
particular, the Company will be required to improve its accounting and financial
reporting systems, which currently require substantial management effort, and to
successfully manage an increasing number of relationships with customers,
suppliers and employees. These demands will require the addition of new
management personnel, and the Company currently is in the process of recruiting
individuals to fill important management positions such as Vice President,
Marketing, a human resources director and managers for research and development
projects. Further, the Company will need to continue to develop a U.S.-based
financial and accounting system. The Company's future success will depend to a
significant extent on the recruitment and retention of these key personnel, the
implementation and improvement of operational, financial and management systems
and the ability of its current and future executive officers to operate
effectively, both independently and as a group. There can be no assurance that
the Company will be able to execute on a timely and cost-effective basis all
that is necessary to successfully manage any growth, and any failure to do so
could have a material adverse effect on the Company's business, operating
results or financial condition.
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MICROMUSE INC.
NEED TO EXPAND AND IMPROVE PRODUCTIVITY OF SALES FORCE, TECHNICAL SERVICES AND
CUSTOMER SUPPORT ORGANIZATION. To increase market penetration, the Company
continues to hire sales personnel. Based on the Company's experience, it takes
at least six months, if not longer, for a salesperson to become fully
productive. Although the Company increased the size of its sales organization
during the twelve-month period ended June 30, 1998, the Company experienced
difficulty in recruiting a sufficient number of qualified sales people during
the period. There can be no assurance that the Company will be successful in
recruiting additional sales personnel or increasing the productivity of its
sales personnel, and the failure to do so could have a material adverse effect
on the Company's business, financial condition or results of operations. As a
result of the recent expansion of the installed base of Netcool/OMNIbus and the
release of the Company's Netcool/Reporter and Netcool/Internet Service Monitors,
the demands on the Company's technical services and customer support resources
have grown rapidly. See "-- Product Defects; Product Liability." The Company
believes that a high level of technical services, training and customer support
is essential to maintaining its competitive position. The Company will be
required to significantly expand its technical services and customer support
organizations if it is to achieve significant additional revenue growth. In
addition, the Company has recently redeployed personnel from its discontinued
systems integration business and other newly hired personnel and the Company
expects that increased resources will be spent on training and transitioning
such personnel. Competition for additional qualified technical personnel to
perform the required functions is intense. There can be no assurance that the
Company's technical services and customer support resources will be sufficient
to manage any future growth in the Company's business, and any failure of the
Company to expand its technical services and customer support organizations
commensurate with any expansion of the installed base of Netcool/OMNIbus or
sales of Netcool/Reporter or Netcool/Internet Service Monitors would have a
material adverse effect on the Company's business, operating results and
financial condition.
NEED TO EXPAND DISTRIBUTION CHANNELS; DEPENDENCE ON THIRD-PARTY RELATIONSHIPS. A
key element of the Company's business strategy is to develop relationships with
leading network equipment and telecommunications providers and to expand the
third-party channel of distribution. The Company is currently investing, and
plans to continue to invest, significant resources to develop these
relationships and channels of distribution, which could adversely affect the
Company's ability to generate profits. Third-party distributors accounted for
approximately 11% and 22% of the Company's total revenues in fiscal 1997 and the
nine-month period ended June 30, 1998, respectively. There can be no assurance
that the Company will be able to attract additional distributors that will be
able to market the Company's products effectively. Many of the Company's
agreements with third-party distributors are nonexclusive, and many of the
companies with which the Company has agreements also have similar agreements
with the Company's competitors or potential competitors. The Company's
third-party distributors have significantly greater sales and marketing
resources than the Company, and there can be no assurance that their sales and
marketing efforts will not conflict with the Company's direct sales efforts. In
addition, although sales through third-party distributors result in reduced
sales and marketing expense with respect to such sales, the Company sells its
products to third-party distributors at reduced prices, resulting in lower gross
margins on such third-party sales. The Company believes that its success in
penetrating markets for its SLM applications depends in large part on its
ability to maintain its current distribution relationships, in particular, those
with Cisco Systems ("Cisco") and Bay Networks ("Bay"), to cultivate additional
distribution relationships and to cultivate alternative distribution
relationships if distribution channels change. There can be no assurance that
network equipment and telecommunications providers and distributors will not
discontinue their relationships with the Company, compete directly with the
Company or form additional competing
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MICROMUSE INC.
arrangements with the Company's competitors or that the Company will be able to
expand its distribution relationships beyond what currently exists.
EMERGING SERVICE LEVEL MANAGEMENT MARKET; DEPENDENCE ON TELECOMMUNICATIONS
CARRIERS AND OTHER SERVICE PROVIDERS; DEMAND FOR SLM PRODUCTS. The market for
the Company's products is in an early stage of development. Although the rapid
expansion and increasing complexity of computer networks in recent years and the
resulting emergence of SLAs has increased the demand for SLM software products,
the awareness of and the need for such products is a recent development. Because
the market for these products is only beginning to develop, it is difficult to
assess the size of this market, the appropriate features and prices for products
to address this market, the optimal distribution strategy and the competitive
environment that will develop. Failure of the SLM market to grow at anticipated
rates or failure of the Company to properly assess and address the demands from
such market would have a material adverse effect on the Company's business,
operating results and financial condition. Historically, in excess of 15% of the
Company's software revenues have been derived from sales to investment banks.
However, as a result of the Company's strategy to focus on telecommunications
carriers, ISPs and other providers of managed networks, the Company expects
sales to investment banks to comprise a decreasing portion of total revenues
over the long-term. In excess of 45% of the Company's software revenues to date
have been derived from the sale of its products to telecommunications carriers
that deliver advanced communications services to their customers. In addition,
these providers are the central focus of the Company's sales strategy. There can
be no assurance that telecommunications carriers and other service providers
will be able to market their communications services successfully, that SLM will
gain widespread market acceptance or that telecommunications carriers and other
service providers will use the Company's products in the deployment of their
services. Delays in the introduction of advanced services, such as network
management outsourcing, failure of such services to gain widespread market
acceptance or the decision of telecommunications carriers and other service
providers not to use the Company's products in the deployment of these services
would have a material adverse effect on the Company's business, operating
results and financial condition. There can be no assurance the Company will be
able to penetrate these markets further.
COMPETITION. The Company's products are designed for use in the evolving SLM and
enterprise network management markets. Competition in these markets is intense
and is characterized by rapidly changing technologies, new and evolving industry
standards, frequent new product introductions and rapid changes in customer
requirements. The Company's current and prospective competitors offer a variety
of solutions to address the SLM and enterprise network management markets and
generally fall within the following five categories: (i) customer's internal
design and development organizations that produce SLM and network management
applications for their particular needs, in some cases using multiple instances
of products from hardware and software vendors such as Sun Microsystems, Inc.
("Sun"), Hewlett-Packard Company ("HP") and Cabletron Systems, Inc.
("Cabletron"); (ii) vendors of network and systems management frameworks
including Computer Associates International, Inc. ("CA") and International
Business Machines Corporation ("IBM"); (iii) vendors of network and systems
management applications including HP, Sun and IBM; (iv) providers of specific
market applications including Boole & Babbage, Inc. ("Boole & Babbage") and
several smaller software vendors; and (v) systems integrators which primarily
provide programming services to develop customer specific applications including
TCSI Corporation (formerly Teknekron Communications Systems, Inc.) and Objective
Systems Integrators, Inc. ("OSI"). In the future, as the Company enters new
markets, the Company expects that such markets will have additional,
market-specific competitors. In addition, because there are relatively low
barriers to entry in the software market, the Company
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MICROMUSE INC.
expects additional competition from other established and emerging companies.
Increased competition is likely to result in price reductions and may result in
reduced gross margins and loss of market share, any of which could materially
adversely affect the Company's business, operating results or financial
condition.
Many of the Company's existing and potential customers continuously evaluate
whether to design and develop their own network operations support and
management applications or purchase them from outside vendors. Sometimes these
customers internally design and develop their own software solutions for their
particular needs and therefore may be reluctant to purchase products offered by
independent vendors such as the Company. As a result, the Company must
continuously educate existing and prospective customers as to the advantages of
the Company's products versus internally developed network operations support
and management applications.
Many of the Company's current and potential competitors have longer operating
histories and have significantly greater financial, technical, sales, marketing
and other resources, as well as greater name recognition and a larger customer
base, than the Company. As a result, they may be able to devote greater
resources to the development, promotion, sale and support of their products or
to respond more quickly to new or emerging technologies and changes in customer
requirements than the Company. Existing competitors could also increase their
market share by bundling products having management functionality offered by the
Company's products with their current applications. Moreover, the Company's
current and potential competitors may increase their share of the SLM market by
strategic alliances and/or the acquisition of competing companies. In addition,
network operating system vendors could introduce new or upgrade and extend
existing operating systems or environments that include management functionality
offered by the Company's products, which could render the Company's products
obsolete and unmarketable. There can be no assurance that the Company will be
able to compete successfully against current or future competitors or that
competitive pressures faced by the Company will not materially adversely affect
its business, operating results or financial condition.
PRODUCT DEFECTS; PRODUCT LIABILITY. Software products as internally complex as
Netcool/OMNIbus, Netcool/Reporter and Netcool/Internet Service Monitors
frequently contain errors or defects, especially when first introduced or when
new versions or enhancements are released. Despite extensive product testing by
the Company, the Company has in the past released versions of Netcool/OMNIbus
with defects and has discovered software errors in certain of its products after
their introduction. For example, version 3.0 of Netcool/OMNIbus, released in
1996, had a number of material defects. Netcool/Reporter, currently in its
initial release, has features and performance characteristics that have had
limited market appeal. Although the Company is currently devoting significant
management and technical resources to improve the features and performance of
Netcool/Reporter, the Company does not expect significant revenue contribution
from Netcool/Reporter for the foreseeable future. To the extent such efforts
continue to require the allocation of a significant portion of the Company's
technical personnel resources, or if the performance and features of
Netcool/Reporter are not improved, the Company could continue to experience
delays in or failure of market acceptance of Netcool/Reporter, or damage to the
Company's reputation or relationships with its customers, any of which could
have a material adverse effect on the Company's business, operating results or
financial condition. See "-- Need to Expand and Improve Productivity of Sales
Force, Technical Services and Customer Support Organization." Additionally,
there can be no assurance that, despite testing by the Company and by current
and potential customers, defects and errors will not be found in new versions or
enhancements of the Company's products after commencement of commercial
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MICROMUSE INC.
shipments which could have a material adverse effect upon the Company's
business, operating results or financial condition.
Since the Company's products are used by its customers to monitor and address
network problems and avoid failures of the network to support critical business
functions, any design defects, software errors, misuse of the Company's
products, incorrect data from network elements or other potential problems
within or out of the Company's control that may arise from the use of the
Company's products could result in financial or other damages to the Company's
customers. Such customers could seek damages from the Company for any such
losses, which, if successful, could have a material adverse effect on the
Company's business, operating results or financial condition. Although the
Company maintains product liability insurance, there can be no assurance that
such insurance will adequately cover, if at all, any such claims. Further,
although the Company's license agreements with its customers typically contain
provisions designed to limit the Company's exposure to potential claims as well
as any liabilities arising from such claims, such provisions may not effectively
protect the Company against such claims and the liability and costs associated
therewith. Accordingly, any such claim could have a material adverse effect upon
the Company's business, results of operations or financial condition.
LENGTHY SALES CYCLE. The Company's software is generally used for division- or
enterprise-wide, business-critical purposes and involves significant capital
commitments by customers. Potential customers generally commit significant
resources to an evaluation of available enterprise software and require the
Company to expend substantial time, effort and money educating them about the
value of the Company's solutions. Sales of the Company's software products often
require an extensive sales effort throughout a customer's organization because
decisions to license such software generally involve the evaluation of the
software by a significant number of customer personnel in various functional and
geographic areas, each often having specific and conflicting requirements. A
variety of factors, including actions by competitors and other factors over
which the Company has little or no control, may cause potential customers to
favor a particular supplier or to delay or forego a purchase. As a result of
these and other factors, the sales cycle for the Company's products is long,
typically about three to six months. As a result of the length of the sales
cycle for its software products, the Company's ability to forecast the timing
and amount of specific sales is limited, and the delay or failure to complete
one or more large license transactions could have a material adverse effect on
the Company's business, operating results or financial condition and cause the
Company's operating results to vary significantly from quarter to quarter.
DEPENDENCE ON KEY PERSONNEL. The Company's success is substantially dependent
upon a limited number of key management, sales, product development, technical
services and customer support personnel. The loss of the services of one or more
of such key employees could have a material adverse effect on the Company's
business, financial condition or results of operations. In particular, the
Company would be materially adversely affected if it were to lose the services
of Christopher J. Dawes, Chief Executive Officer of the Company, who has
provided significant leadership and direction to the Company since its
inception. The Company does not have employment contracts with any of its key
personnel. In addition, the Company's success will be dependent upon its
continuing ability to attract, train and retain additional highly qualified
management, sales, product development, technical services and customer support
personnel. The Company has at times and continues to experience difficulty in
recruiting qualified personnel. Because the Company faces intense competition in
its recruiting activities, there can be no assurance that the Company will be
able to attract and/or retain qualified personnel. Failure to attract and retain
the necessary qualified personnel on a timely basis could have a material
adverse effect on the Company's business, operating results or financial
condition.
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MICROMUSE INC.
PRODUCT CONCENTRATION. Other than discontinued operations, all of the Company's
revenues have been derived from licenses for its Netcool family of products and
related maintenance, training and consulting services. The Company currently
expects that Netcool/OMNIbus-related revenues will continue to account for all
or substantially all of the Company's revenues for the remainder of fiscal 1998
and for the foreseeable future thereafter. Therefore, the Company's future
operating results, particularly in the near term, are significantly dependent
upon the continued market acceptance of Netcool/OMNIbus, improvements to
Netcool/OMNIbus and new and enhanced Netcool/OMNIbus applications. There can be
no assurance that Netcool/OMNIbus will continue to achieve market acceptance or
that the Company will be successful in developing, introducing or marketing
improvements to Netcool/OMNIbus or new or enhanced Netcool/OMNIbus applications.
The life cycles of Netcool/OMNIbus, including the Netcool/OMNIbus applications,
are difficult to estimate due in large part to the recent emergence of many of
the Company's markets, the effect of future product enhancements and
competition. A decline in the demand for Netcool/OMNIbus as a result of
competition, technological change or other factors would have a material adverse
effect on the Company's business, operating results and financial condition.
SALES CONCENTRATION. To date, a significant portion of the Company's revenues in
any particular period has been attributable to a limited number of customers.
During the quarter ended June 30, 1998, WorldCom B.V., entities affiliated with
WorldCom and entities affiliated with British Telecommunications, accounted for
approximately 17%, 3% and 8%, respectively, of the Company's total revenues.
During the quarter ended March 31, 1998, the Company did not have any customers
that contributed over 10% of total revenues. In addition, during the quarter
ended December 31, 1997, Deutsche Bank AG, an entity affiliated with Deutsche
Bank Securities, an underwriter in the Company's initial public offering,
accounted for approximately 30% of the Company's total revenues. In addition,
America Online accounted for 13% of total revenues in the quarter ended December
31, 1997. During the nine months ended June 30, 1998, entities affiliated with
WorldCom and Deutsche Bank AG accounted for approximately 10% and 13%,
respectively, of the Company's total revenues. In fiscal 1997, entities
affiliated with WorldCom and entities affiliated with British
Telecommunications, accounted for 18% and 9%, respectively, of the Company's
total revenues. In addition, entities affiliated with British Telecommunications
accounted for 57% and 14% of the Company's total revenues for fiscal 1995 and
fiscal 1996, respectively. The Company expects that it will continue to be
dependent upon a limited number of customers for a significant portion of its
revenues in future periods. As a result of this concentration of sales, the
Company's business, operating results or financial condition could be materially
adversely affected by the failure of anticipated orders from significant
customers to materialize or by deferrals or cancellations of orders by
significant customers. In addition, there can be no assurance that revenue from
customers that have accounted for significant revenues in past periods,
individually or as a group, will continue, or if continued, will reach or exceed
historical levels in any future period. The terms of the Company's agreements
with its customers typically contain a one-time license fee and a prepayment of
one year of maintenance fees. The maintenance agreement is renewable annually at
the option of the customer and there are no minimum payment obligations or
obligations to license additional software. Therefore, there can be no assurance
that any of the Company's current customers will generate significant revenues
in future periods. For example, pre-existing customers may be part of, or become
part of, large organizations which standardize using a competitive product.
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MICROMUSE INC.
RISKS ASSOCIATED WITH INTERNATIONAL LICENSING AND OPERATIONS. License,
maintenance and service revenue outside of the United States accounted for 76%,
55% and 48% of the Company's total revenue in fiscal 1995, 1996 and 1997. The
Company expects that international license, maintenance and consulting revenue
will continue to account for a significant portion of its total revenue in
future periods. Currency exchange fluctuations in countries in which the Company
licenses its products or conducts operations historically have had, and in the
future could continue to have, a material adverse effect on the Company's
business, operating results or financial condition by resulting in pricing
levels that are not competitive or expense levels that adversely impact
profitability. In such event, gains and losses on the conversion to United
States dollars of accounts receivable and accounts payable arising from
international operations may contribute to fluctuations in the Company's
operating results. The Company intends to enter into additional international
markets and to continue to expand its operations outside of the United States by
expanding its direct sale force and pursuing additional strategic relationships.
Such expansion will require significant management attention and expenditure of
significant financial resources and could adversely affect the Company's ability
to generate profits. To the extent that the Company is unable to establish
additional foreign operations in a timely manner, the Company's growth, if any,
in international sales will be limited, and the Company's business, operating
results or financial condition could be materially adversely affected. The
Company maintains a significant portion of its operations, including the bulk of
its software development operations, in the United Kingdom. The Company's
international operations and revenue involve a number of inherent risks,
including longer receivables collection periods and greater difficulty in
accounts receivable collection, difficulty in staffing and managing foreign
operations, an even lengthier sales cycle than with domestic customers, the
impact of possible recessionary environments in economies outside the United
States, unexpected changes in regulatory requirements, including a slowdown in
the rate of privatization of telecommunications service providers, reduced
protection for intellectual property rights in some countries and tariffs and
other trade barriers. There can be no assurance that the Company will be able to
sustain or increase revenue derived from international licensing and service or
that the foregoing factors will not have a material adverse effect on the
Company's future international license, service and other revenue, and,
consequently, on the Company's business, operating results or financial
condition. The Company pays the expenses of its international operations in
local currencies and does not currently engage in hedging transactions with
respect to such obligations. In addition, sales in Europe and certain other
parts of the world typically are adversely affected in the quarter ending
September 30, as many customers reduce their business activities during the
summer months. If the Company's international sales become a greater component
of total revenue, these seasonal factors may have a more pronounced effect on
the Company's operating results.
NEW PRODUCTS AND RAPID TECHNOLOGICAL CHANGE; NEED TO MANAGE PRODUCT TRANSITIONS;
DEPENDENCE ON THIRD-PARTY SOFTWARE PLATFORMS. The market for the Company's
products is characterized by rapidly changing technologies, evolving industry
standards, changing regulatory environments, frequent new product introductions
and rapid changes in customer requirements. The introduction or announcement of
products by the Company or its competitors embodying new technologies and the
emergence of new industry standards and practices can render existing products
obsolete and unmarketable. As a result, the life cycles of the Company's
products are difficult to estimate. The Company's future success will depend on
its ability to enhance its existing products and to develop and introduce, on a
timely and cost-effective basis, new products and product features that keep
pace with technological developments and emerging industry standards and address
the increasingly sophisticated needs of its customers. Historically, the Company
has used its close working relationship with large customers to define its
product development direction. There can be no assurance that the Company will
be successful in developing and marketing new products or
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MICROMUSE INC.
product features that respond to technological change or evolving industry
standards, that the Company will not experience difficulties that could delay or
prevent the successful development, introduction and marketing of these new
products and features, or that its new products or product features will
adequately meet the requirements of the marketplace and achieve market
acceptance. In particular, the widespread adoption of the Telecommunications
Management Network ("TMN") architecture for managing telecommunications networks
would force the Company to adapt its products to such standard, and there can be
no assurance that this could be done on a timely or cost-effective basis, if at
all. In addition, to the extent that any product upgrade or enhancement requires
extensive installation and configuration, current customers may postpone or
forgo the purchase of new versions of the Company's products. If the Company is
unable, for technological or other reasons, to develop and introduce
enhancements of existing products or new products in a timely manner, the
Company's business, operating results and financial condition will be materially
adversely affected. In addition, there can be no assurance that the introduction
or announcement of new product offerings by the Company or one or more of its
competitors will not cause customers to defer licensing of existing Company
products. Any such deferment of purchases could have a material adverse effect
on the Company's business, operating results or financial condition.
The Company's products are designed to operate on a variety of hardware and
software platforms employed by its customers in their networks. The Company must
continually modify and enhance its products to keep pace with changes in
hardware and software platforms and database technology. As a result,
uncertainties related to the timing and nature of new product announcements,
introductions or modifications by systems vendors, particularly Sun, IBM, HP,
Cabletron and Cisco and by vendors of relational database software, particularly
Oracle Corporation ("Oracle") and Sybase, Inc. ("Sybase"), could materially
adversely impact the Company's business, operating results or financial
condition. For example, the Company is currently modifying certain of its
products to operate with the Microsoft Windows NT operating system. The failure
of the Company's products to operate effectively across the various existing and
devolving versions of hardware and software platforms and database environments
employed by customers could have a material adverse effect on the Company's
business, operating results or financial condition.
DEPENDENCE UPON PROPRIETARY TECHNOLOGY; RISK OF THIRD-PARTY CLAIMS OF
INFRINGEMENT. The Company's success and ability to compete is dependent in
significant part upon its proprietary software technology. The Company relies on
a combination of trade secret, copyright and trademark laws, nondisclosure and
other contractual agreements and technical measures to protect its proprietary
rights. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or to
obtain and use information that the Company regards as proprietary. There can be
no assurance that the steps taken by the Company to protect its proprietary
technology will prevent misappropriation of such technology, and such
protections may not preclude competitors from developing products with
functionality or features similar to the Company's products. In addition,
effective copyright and trade secret protection may be unavailable or limited in
certain foreign countries. While the Company believes that its products and
trademarks do not infringe upon the proprietary rights of third parties, there
can be no assurance that the Company will not receive future communications from
third parties asserting that the Company's products infringe, or may infringe,
the proprietary rights of third parties. The Company expects that software
product developers will be increasingly subject to infringement claims as the
number of products and competitors in the Company's industry segment grows and
the functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time-consuming, result in costly
litigation and diversion of technical and management personnel, cause
21
<PAGE> 22
MICROMUSE INC.
product shipment delays or require the Company to develop non-infringing
technology or enter into royalty or licensing agreements. Such royalty or
licensing agreements, if required, may not be available on terms acceptable to
the Company or at all. In the event of a successful claim of product
infringement against the Company and failure or inability of the Company to
develop non-infringing technology or license the infringed or similar
technology, the Company's business, operating results or financial condition
could be materially adversely affected.
RISKS ASSOCIATED WITH THIRD-PARTY LICENSES. The Company relies on certain
software that it licenses from third parties, including software that is
integrated with internally developed software and used in the Company's products
to perform key functions. There can be no assurance that these third-party
software licenses will continue to be available to the Company on commercially
reasonable terms or at all. Although the Company believes that alternative
software is available from other third-party suppliers, the loss of or inability
to maintain any of these software licenses or the inability of the third parties
to enhance in a timely and cost-effective manner their products in response to
changing customer needs, industry standards or technological developments could
result in delays or reductions in product shipments by the Company until
equivalent software could be developed internally or identified, licensed and
integrated, which would have a material adverse effect on the Company's
business, operating results and financial condition.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and software
products are coded to accept only two digit entries in the date code field.
These date code fields will need to accept four digit entries to distinguish
21st century dates from 20th century dates. As a result, in less than two years,
computer systems and/or software used by many companies may need to be upgraded
to comply with such "Year 2000" requirements. Significant uncertainty exists in
the software industry concerning the potential effects associated with such
compliance. In the Company's standard license agreements, the Company warrants
to licensees that its software routines and programs are Year 2000 compliant
(i.e. that they accurately process date-related data within any century and
between two or more centuries). Although the Company believes its software
products are Year 2000 compliant, there can be no assurance that the Company's
software products contain all necessary software routines and programs necessary
for the accurate calculation, display, storage and manipulation of data
involving dates. If any of the Company's licensees experience Year 2000
problems, such licensee could assert claims for damages against the Company. Any
such litigation could result in substantial costs and diversion of the Company's
resources even if ultimately decided in favor of the Company. In addition, many
companies are expending significant resources to correct or patch their current
software systems for Year 2000 compliance. These expenditures may result in
reduced funds available to purchase software products such as those offered by
the Company. The occurrence of any of the foregoing could have a material
adverse effect on the Company's business, operating results or financial
condition.
VOLATILITY OF STOCK PRICE. The market price of the Common Stock has been and is
likely to continue to be highly volatile and may be significantly affected by
factors such as actual or anticipated fluctuations in the Company's operating
results, announcements of technological innovations, new products or new
contracts by the Company or its competitors, developments with respect to
copyrights or proprietary rights, adoption of new accounting standards affecting
the software industry, general market conditions and other factors. In addition,
the stock market has from time to time experienced significant price and volume
fluctuations that have particularly affected the market price for the common
stock of technology companies. These types of broad market fluctuations may
adversely affect the market price of the Company's Common Stock. In the past,
following periods of volatility in the market price of a company's securities,
securities class action litigation has often been initiated against
22
<PAGE> 23
MICROMUSE INC.
such company. Such litigation could result in substantial costs and a diversion
of management's attention and resources which could have a material adverse
effect upon the Company's business, operating results or financial condition.
GENERAL ECONOMIC AND MARKET CONDITIONS. Segments of the software industry have
experienced significant economic downturns characterized by decreased product
demand, price erosion, work slowdowns and layoffs. The Company's operations may
in the future experience substantial fluctuations from period to period as a
consequence of general economic conditions affecting the timing of orders from
major customers and other factors affecting capital spending. Although the
Company has a diverse client base, it has targeted certain vertical markets.
Therefore, any economic downturns in general or in the targeted vertical
segments in particular would have a material adverse effect on the Company's
business, operating results and financial condition.
CONTROL BY EXISTING STOCKHOLDERS. As of August 3, 1998, approximately 43% of the
outstanding Common Stock was held by the directors and executive officers of the
Company, together with certain entities affiliated with them, assuming no
exercise of outstanding stock options. As a result, these stockholders, if
acting together, would be able to control substantially all matters requiring
approval by the stockholders of the Company, including the election of all
directors and approval of significant corporate transactions.
ANTI-TAKEOVER EFFECTS OF CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE LAW.
Certain provisions of the Company's Restated Certificate of Incorporation and
Bylaws and certain provisions of Delaware law could delay or make difficult a
merger, tender offer or proxy contest involving the Company. The authorized but
unissued capital stock of the Company includes 5,000,000 shares of preferred
stock. The Board of Directors is authorized to provide for the issuance of such
preferred stock in one or more series and to fix the designations, preferences,
powers and relative, participating, optional or other rights and restrictions
thereof. Accordingly, the Company may in the future issue a series of preferred
stock, without further stockholder approval, that will have preference over the
Common Stock with respect to the payment of dividends and upon liquidation,
dissolution or winding-up of the Company. Further, Section 203 of the General
Corporation Law of the State of Delaware (as amended from time to time, the
"DGCL"), which is applicable to the Company, prohibits certain business
combinations with certain stockholders for a period of three years after they
acquire 15% or more of the outstanding voting stock of a corporation. In
addition, the Restated Certificate of Incorporation provides that the Board of
Directors is divided into two classes of directors with each class serving a
staggered two-year term. The classification of the Board of Directors has the
effect of generally requiring at least two annual stockholder meetings, instead
of one, to replace a majority of the Board members. Any of the foregoing could
adversely affect holders of the Common Stock or discourage or make difficult any
attempt to obtain control of the Company.
23
<PAGE> 24
MICROMUSE INC.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is not a party to any material legal proceeding.
In July 1998, the Company received correspondence from counsel to a
stockholder and former officer of the Company asserting claims relating
to ownership of intellectual property related to the Company's
Netcool/Omnibus product and claims regarding his ownership of stock in
the Company. Specifically, the letter alleges that the former officer's
transfer of intellectual property rights to the Company was invalid,
that he was improperly denied the necessary time in which to evaluate
whether to participate in the secondary stock offering and that his
lock-up agreement may not be valid with respect to the 170,316 shares of
the Company's Common Stock beneficially owned by him. The Company has
reviewed the claims set forth in the correspondence and based upon such
review does not believe such allegations have merit and, if pursued by
such stockholder, the Company intends to vigorously defend any such
claims and believes that the resolution of such claims will not have a
material adverse effect on the Company's business, operating results or
financial condition. However, if commenced, such litigation could be
time-consuming and costly, and there can be no assurance that the
Company would necessarily prevail given the inherent uncertainties in
litigation. In the event the Company does not prevail in litigation, the
Company could be prevented from selling its Netcool/Omnibus product or
required to enter into royalty or licensing agreements or pay monetary
damages. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to the Company or at all. In the event of
a successful claim against the Company, the Company's business,
operating results or financial condition could be materially adversely
affected.
Item 2. Changes in Securities and use of Proceeds.
The effective date of the registration statement for the Company's
initial public offering, filed on Form S-1 under the Securities Act of
1933 (File No. 333-42177), was February 12, 1998 (the "IPO Registration
Statement"). The class of securities registered was Common Stock. The
offering commenced on February 13, 1998 and all securities were sold in
the offering. The managing underwriters for the offering were Deutsche
Morgan Grenfell, NationsBanc Montgomery Securities LLC and Salomon Smith
Barney.
Pursuant to the IPO Registration Statement, the Company sold 3,230,000
shares of its Common Stock for an aggregate offering price of $38.8
million. Also pursuant to the Registration Statement, certain selling
stockholders sold 450,000 shares of Common Stock of the Company for an
aggregate offering price of $5.4 million.
The Company incurred expenses of approximately $4.6 million of which
approximately $2.7 million represented underwriting discounts and
commission and approximately $1.9 million represented other expenses
related to the offering. The net offering proceeds to the Company and
the selling stockholders after total expenses was $24.2 million and $5.0
million, respectively.
The Company used approximately $20.3 million to purchase short-term
investments. The remaining net proceeds have been invested in cash and
cash equivalents. The use of the proceeds from the offering does not
represent a material change in the use of the proceeds described in the
prospectus.
The effective date of the registration statement for the Company's
follow-on public offering, filed on Form S-1 under the Securities Act of
1933 (File No. 333-58975), was July 28, 1998 (the "Follow-On
Registration Statement"). The class of securities registered was Common
Stock. The offering commenced on July 28, 1998 and all securities were
sold in the offering. The managing underwriters for the offering were
Credit Suisse First Boston Corporation, NationsBanc Montgomery
Securities LLC and Salomon Smith Barney.
Pursuant to the Follow-On Registration Statement, the Company sold
1,000,000 shares of its Common Stock for an aggregate offering price of
$24.9 million. Also pursuant to the Follow-On Registration Statement,
certain selling stockholders sold 2,000,000 shares of Common Stock of
the Company for an aggregate offering price of $49.8 million.
The Company estimates that expenses will be approximately $2.0 million
of which approximately $1.4 million will represent underwriting
discounts and commission and approximately $0.6 million represent other
expenses related to the offering. The net offering proceeds to the
Company and the selling stockholders after total expenses are estimated
at $22.9 million and $47.0 million, respectively.
All net proceeds have been invested in cash, cash equivalents and
short-term investments. The use of proceeds from the offering does not
represent a material change in the use of the proceeds described in the
prospectus.
Item 3. Defaults upon Senior Securities. Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders. Not applicable.
Item 5. Other Information. Not applicable.
24
<PAGE> 25
MICROMUSE INC.
Item 6. Exhibits and Reports on Form 8-K:
(a)Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Description
- --------- -----------------------------------------------------------------
<S> <C>
2.1+ Agreement for the sale of the systems integration business of
Micromuse plc by and among Micromuse plc, Horizon Open Systems
(UK) Limited and Horizon Computer Services Limited, dated as of
September 16, 1997.
3.1++ Restated Certificate of Incorporation of the Registrant, as
amended to date.
3.2++ Amended and Restated Bylaws of the Registrant.
4.1++ Reference is made to Exhibits 3.1, 3.2 and 10.4.
4.2+ Specimen Common Stock certificate.
10.1+ Form of Indemnity Agreement entered into between the Registrant
and its directors and officers.
10.2+ 1997 Stock Option/Stock Issuance Plan and forms of agreements
thereunder.
10.3+ 1997 Employee Stock Purchase Plan.
10.4+ Amended and Restated Investors' Rights Agreement by and among the
Registrant and certain stockholders of the Registrant, dated as
of September 8, 1997.
10.5+ Office lease, dated as of March 25, 1997, by and between the
Registrant and SOMA Partners, L.P.
10.6+ Office lease, dated as of March 3, 1997, by and between Micromuse
plc, Marldown Limited and Christopher J. Dawes.
10.7+ Office lease, dated as of March 3, 1993, by and between Micromuse
plc, Guildquote Limited and Christopher J. Dawes.
10.8+ Agreement for the sale of the systems integration business of
Micromuse plc dated as of September 16, 1997. Reference is made
to Exhibit 2.1.
21.1+ Subsidiaries of the Registrant.
27.1 Financial Data Schedule
</TABLE>
+ Incorporated by reference from the exhibit of the same number in the
Registrant's Registration Statement on Form S-1 (Registration No.
333-42177) as filed with the SEC on February 12, 1998.
++ Incorporated by reference from the exhibit of the same number in the
Registrant's Registration Statement on Form S-1 (Registration No.
333-58975) as filed with the SEC on July 28, 1998.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended June
30, 1998.
25
<PAGE> 26
MICROMUSE INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 13, 1998.
MICROMUSE INC.
(Registrant)
By: /s/ STEPHEN A. ALLOTT
------------------------------------
Stephen A. Allott
Chief Financial Officer
(Duly Authorized Officer and Principal
Financial Officer)
26
<PAGE> 27
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
2.1+ Agreement for the sale of the systems integration business of
Micromuse plc by and among Micromuse plc, Horizon Open Systems
(UK) Limited and Horizon Computer Services Limited, dated as of
September 16, 1997.
3.1++ Restated Certificate of Incorporation of the Registrant, as
amended to date.
3.2++ Amended and Restated Bylaws of the Registrant.
4.1++ Reference is made to Exhibits 3.1, 3.2 and 10.4.
4.2+ Specimen Common Stock certificate.
10.1+ Form of Indemnity Agreement entered into between the Registrant
and its directors and officers.
10.2+ 1997 Stock Option/Stock Issuance Plan and forms of agreements
thereunder.
10.3+ 1997 Employee Stock Purchase Plan.
10.4+ Amended and Restated Investors' Rights Agreement by and among the
Registrant and certain stockholders of the Registrant, dated as
of September 8, 1997.
10.5+ Office lease, dated as of March 25, 1997, by and between the
Registrant and SOMA Partners, L.P.
10.6+ Office lease, dated as of March 3, 1997, by and between Micromuse
plc, Marldown Limited and Christopher J. Dawes.
10.7+ Office lease, dated as of March 3, 1993, by and between Micromuse
plc, Guildquote Limited and Christopher J. Dawes.
10.8+ Agreement for the sale of the systems integration business of
Micromuse plc dated as of September 16, 1997. Reference is made
to Exhibit 2.1.
21.1+ Subsidiaries of the Registrant.
27.1 Financial Data Schedule
</TABLE>
+ Incorporated by reference from the exhibit of the same number in the
Registrant's Registration Statement on Form S-1 (Registration No.
333-42177) as filed with the SEC on February 12, 1998.
++ Incorporated by reference from the exhibit of the same number in the
Registrant's Registration Statement on Form S-1 (Registration No.
333-58975) as filed with the SEC on July 28, 1998.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND THE CONSOLIDATED STATEMENTS OF OPERATIONS FOUND
ON PAGE 19 OF THE COMPANY'S FORM S-1 FOR THE YEAR TO DATE AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 23,503
<SECURITIES> 20,254
<RECEIVABLES> 5,463
<ALLOWANCES> 77
<INVENTORY> 0
<CURRENT-ASSETS> 10,237
<PP&E> 5,362
<DEPRECIATION> 2,638
<TOTAL-ASSETS> 53,267
<CURRENT-LIABILITIES> 10,237
<BONDS> 0
0
0
<COMMON> 55,603
<OTHER-SE> (12,573)
<TOTAL-LIABILITY-AND-EQUITY> 53,267
<SALES> 14,672
<TOTAL-REVENUES> 18,617
<CGS> 945
<TOTAL-COSTS> 17,777
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1
<INTEREST-EXPENSE> 304
<INCOME-PRETAX> (1,688)
<INCOME-TAX> 50
<INCOME-CONTINUING> (1,738)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,072)
<EPS-PRIMARY> (0.29)
<EPS-DILUTED> (0.29)
</TABLE>
