<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 March 31, 1998
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 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 [ ]
14,872,251 shares of Common Stock, $0.01 par value, were outstanding as of
April 30, 1998.
<PAGE> 2
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 March 31, 1998 and
September 30, 1997 3
Condensed Consolidated Statements of Operations for the three and
six months ended March 31, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows for the six
months ended March 31, 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 8
PART II - Other Information
Item 1. Legal Proceedings 23
Item 6. Exhibits and Reports on Form 8-K 23
Signature 24
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MICROMUSE INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)
ASSETS
<TABLE>
<CAPTION>
March 31, September 30,
1998 1997
--------- -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 36,085 $ 13,741
Short-term investments 6,883 --
Accounts receivable 4,773 4,461
Prepaid expenses and other current assets 1,116 935
Related party loan -- 1,153
-------- --------
Total current assets 48,857 20,290
Property and equipment, net 2,657 2,450
-------- --------
$ 51,514 $ 22,740
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 1,784 $ 2,654
Accrued expenses 3,484 3,133
Deferred revenues 3,310 1,322
-------- --------
Total current liabilities 8,578 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; 18,500 shares authorized;
6,706 and 14,872 shares outstanding as of September 30, 1997
and March 31, 1998, respectively 149 67
Additional paid-in capital 55,489 2,390
Treasury stock, at cost: 120 shares at September 30, 1997 -- (300)
Deferred compensation (187) (215)
Cumulative translation adjustment (54) 52
Accumulated deficit (12,461) (9,228)
-------- --------
Total stockholders' equity (deficit) 42,936 (7,234)
-------- --------
$ 51,514 $ 22,740
======== ========
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
3
<PAGE> 4
MICROMUSE INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
March 31, March 31,
1998 1997 1998 1997
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Revenues:
License $ 4,914 $ 1,095 $ 8,649 $ 1,897
Maintenance and services 1,281 616 2,375 1,040
-------- ------- -------- -------
Total revenues 6,195 1,711 11,024 2,937
-------- ------- -------- -------
Cost of revenues:
License 312 108 627 169
Maintenance and services 802 180 1,564 346
-------- ------- -------- -------
Total cost of revenues 1,114 288 2,191 515
-------- ------- -------- -------
Gross profit 5,081 1,423 8,833 2,422
-------- ------- -------- -------
Operating expenses:
Sales and marketing 3,489 1,951 6,633 2,955
Research and development 1,337 383 2,406 686
General and administrative 1,011 1,553 1,903 2,020
-------- ------- -------- -------
Total operating expenses 5,837 3,887 10,942 5,661
-------- ------- -------- -------
Loss from operations (756) (2,464) (2,109) (3,239)
Other income (expense) 160 (450) 210 (424)
-------- ------- -------- -------
Loss from continuing operations (596) (2,914) (1,899) (3,663)
Income (loss) from discontinued operations -- 18 -- (102)
-------- ------- -------- -------
Net loss (596) (2,896) (1,899) (3,765)
Accretion on redeemable convertible
preferred stock (444) (89) (1,334) (89)
-------- ------- -------- -------
Net loss applicable to holders of
common stock $ (1,040) $(2,985) $ (3,233) $(3,854)
======== ======= ======== =======
Per share of common stock:
Basic and diluted net loss $ (0.10) $ (0.49) $ (0.40) $ (0.63)
Pro forma basic and diluted net loss $ (0.04) $ (0.15)
Weighted average shares used in calculation of:
Basic and diluted net loss 10,443 6,100 8,127 6,100
Pro forma basic and diluted net loss 13,293 12,466
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
4
<PAGE> 5
MICROMUSE INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six months ended
March 31,
1998 1997
-------- -------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (1,899) $(3,765)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Depreciation and amortization 573 459
Deferred compensation expense 28 --
Changes in operating assets and liabilities:
Accounts receivable (312) 1,005
Inventories -- (563)
Prepaid expenses and other current assets (181) (934)
Related party loan 1,153 159
Accounts payable (870) 1,211
Accrued expenses 351 56
Deferred revenues 1,988 797
-------- -------
Cash provided by (used in) operating activities 831 (1,575)
-------- -------
Cash flows from investing activities:
Capital expenditures (780) (356)
Purchase of short-term investments (6,883) --
-------- -------
Cash used in investing activities (7,663) (356)
-------- -------
Cash flows from financing activities:
Payment of bank overdraft -- (781)
Proceeds from short-term notes -- 2,500
Payment of short-term notes -- (3,578)
Payment of long-term notes -- (54)
Proceeds from issuance of common stock, net 34,282 --
Proceeds from issuance of preferred stock -- 6,151
Purchase of treasury stock (5,000) --
-------- -------
Cash provided by financing activities 29,282 4,238
Effects of exchange rate changes on cash and cash
equivalents (106) (13)
-------- -------
Net increase in cash and cash equivalents 22,344 2,294
-------- -------
Cash and cash equivalents at beginning of period 13,741 594
-------- -------
Cash and cash equivalents at end of period $ 36,085 $ 2,888
======== =======
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
5
<PAGE> 6
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 Statement on Form S-1 as filed with the Securities and
Exchange Commission on February 12, 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.
Certain reclassifications have been made to the prior year consolidated
financial statements to conform to the current year's presentation. These
reclassifications had no effect on previously reported net loss or stockholders'
equity (deficit).
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 Loss Per Share
Pro forma basic and diluted net loss per share is computed using the weighted
average number of shares of common stock and redeemable convertible preferred
stock outstanding on an as-if converted basis. Excluded from the computation of
diluted loss per share and pro forma diluted loss per share were options to
acquire 1.7 million shares of common stock with a weighted average exercise
price of $3.88 per share because their effects would be anti-dilutive.
Recent Pronouncements
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income".
SFAS No. 130 establishes standards for reporting and displaying comprehensive
income and its components in the consolidated financial statements. It does not,
however, require a specific format for the statement, but requires the Company
to display an amount representing total comprehensive income for the period in
that financial statement. The Company is in the process of determining its
preferred format. This statement is effective for fiscal years beginning after
December 15, 1997.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". SFAS No. 131 establishes standards for the
way public business enterprises report information about operating segments in
annual financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports issued to
stockholders. SFAS No. 131 is effective for financial statements for periods
beginning after December
6
<PAGE> 7
MICROMUSE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
15, 1997. The Company has not yet determined whether it has any separately
reportable business segments.
NOTE 2. REGISTRATION STATEMENT
In February 1998, the Company raised $34.3 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, the Series A warrant was converted into 1.5 million shares
of common stock.
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 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 six-month period ended March 31, 1998.
7
<PAGE> 8
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 Statement on Form S-1 as filed with the Securities and
Exchange Commission on February 12, 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.
8
<PAGE> 9
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 Six months ended
March 31, March 31,
1998 1997 1998 1997
----- ----- ----- ------
<S> <C> <C> <C> <C>
Revenues:
License 79.3% 64.0% 78.5% 64.6%
Maintenance and services 20.7 36.0 21.5 35.4
----- ----- ----- ------
Total revenues 100.0 100.0 100.0 100.0
Cost of revenues:
License 5.0 6.3 5.7 5.7
Maintenance and services 13.0 10.5 14.2 11.8
----- ----- ----- ------
Total cost of revenues 18.0 16.8 19.9 17.5
----- ----- ----- ------
Gross profit 82.0 83.2 80.1 82.5
Operating expenses:
Sales and marketing 56.3 114.0 60.2 100.6
Research and development 21.6 22.4 21.8 23.4
General and administrative 16.3 90.8 17.2 68.8
----- ----- ----- ------
Total operating expenses 94.2 227.2 99.2 192.8
----- ----- ----- ------
Loss from operations (12.2) (144.0) (19.1) (110.3)
Other income (expense) 2.6 (26.3) 1.9 (14.4)
----- ----- ----- ------
Loss from continuing operations (9.6) (170.3) (17.2) (124.7)
Income (loss) from discontinued
operations -- 1.0 -- (3.5)
----- ----- ----- ------
Net loss (9.6) (169.3) (17.2) (128.2)
Accretion on redeemable convertible
preferred stock (7.2) (5.2) (12.1) (3.0)
----- ----- ----- ------
Net loss applicable to holders of
common stock (16.8) (174.5) (29.3) (131.2)
===== ===== ===== ======
</TABLE>
Revenues. The Company's revenues increased from $1.7 million for the quarter
ended March 31, 1997 to $6.2 million for the quarter ended March 31, 1998. Net
revenues also increased from $2.9 million for the first six months of fiscal
1997 to $11.0 for the first six months of fiscal 1998. License revenues
increased from $1.1 million and $1.9 million for the quarter and six months
ended March 31, 1997, respectively, to $4.9 million and $8.6 million for the
quarter and six months ended March 31, 1998, respectively. These increases in
license revenues were primarily due to an increase in the number of product
licenses sold, reflecting increased acceptance of Netcool/OMNIbus and expansion
of the Company's direct sales organizations. Maintenance and services revenues
increased from $616,000 and $1.0 million for the quarter and six months ended
March 31, 1997, respectively, to $1.3 million and $2.4 million for the quarter
and six months ended March 31, 1998, respectively. These 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 15 and 14
percentage points in the second quarter and first six months of fiscal 1998,
9
<PAGE> 10
MICROMUSE INC.
respectively, when compared to the second quarter and first six months of fiscal
1997. These increases were 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 the cost of software
media, packaging and production. Cost of license revenue as a percentage of
license revenues decreased to 6% in the second quarter and 7% in the first half
of fiscal 1998 from 10% in the second quarter and 9% in the first half 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
increased as a percentage of maintenance and services revenues to 63% in the
second quarter and 66% in the first half of fiscal 1998 from 29% in the second
quarter and 33% in the first half of fiscal 1997 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 $2.0
million and $3.0 million for the quarter and six-month period ended March 31,
1997, respectively, to $3.5 million and $6.6 million for the quarter and
six-month period ended March 31, 1998, respectively. The increase in sales and
marketing expenses in the second quarter and first six months of fiscal 1998 was
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 114% and 101% for the second quarter and first six-months of fiscal 1997,
respectively, to 56% and 60% 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 second quarter of fiscal 1997
included compensation expense related to the issuance of stock options.
Research and Development Expenses. Research and development expenses increased
from $383,000 and $686,000 for the quarter and six-month period ended March 31,
1997, respectively, to $1.3 million and $2.4 million for the quarter and
six-month period ended March 31, 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 remained constant at 22% for the second quarter of fiscal 1998 and
fiscal 1997 and declined slightly from 23% for the six-month period ended March
31, 1997 to 22% for the six-month period ended March 31, 1998.
General and Administrative Expenses. General and administrative expenses
decreased from $1.6 million and $2.0 million for the quarter and six-month
period ended March 31, 1997, respectively, to $1.0 million and $1.9 million for
the quarter and six-month period ended March 31, 1998, respectively. These
decreases were primarily due to professional fees incurred in the prior year
related primarily to the reorganization of the Company and the transfer of the
Company's headquarters from London to San Francisco. These reductions in
spending were partially offset by increased 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
91% and 69% for the quarter and six-month period ended March 31, 1997,
respectively, to 16% and 17% for the comparable periods of fiscal 1998 due to
the increase in total revenues and the reduction in professional fees.
10
<PAGE> 11
MICROMUSE INC.
Other Income (Expense). Interest expense for the quarter and six-month period
ended March 31, 1997 was $450,000 and $424,000, respectively, as compared with
interest income of $160,000 and $210,000 for the quarter and six-month period
ended March 31, 1998, respectively. This change was primarily due to interest
earned on the proceeds from the Company's initial public offering during the
quarter ended March 31, 1998 which offset imputed interest related to the
issuance of the Series A Warrant.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1998, the Company had $36.1 million in cash and cash equivalents
and $6.9 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 $34.3 million. This increase in cash and cash equivalents was
partially offset by the purchase of treasury stock and the funding of operating
losses.
The Company believes that the net proceeds received by the Company from the IPO,
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
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.
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
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
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 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
The following information should be read in conjunction with the 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 Statement on Form S-1 as filed with the Securities and Exchange
Commission on February 12, 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.
11
<PAGE> 12
MICROMUSE INC.
LIMITED OPERATING HISTORY AS A SOFTWARE COMPANY; ANTICIPATED CONTINUING LOSSES;
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. The Company
does not expect to achieve profitability for the next several quarters, and
there can be no assurance that it will be profitable thereafter, or that the
Company will sustain any such profitability if achieved. 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 the substantial additional revenue
growth on a quarterly or annual basis necessary for the Company to become
profitable, 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
March 31, 1998, the Company had accumulated net losses of $12.5 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 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
12
<PAGE> 13
MICROMUSE INC.
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's software products are typically shipped when orders are received,
and consequently, license backlog at the beginning of any quarter has typically
represented only a small portion of that quarter's expected revenue. In
addition, 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, license revenue in any quarter is difficult to
forecast because it is substantially dependent on orders booked and shipped in
that quarter. Moreover, the Company's sales cycles, from initial evaluation to
delivery of software, vary substantially from customer to customer. In addition,
the Company's expense levels are based in part on its expectations of future
orders and sales, which, given the Company's limited operating history, are
extremely difficult to predict. A substantial portion of the Company's operating
expenses is related to personnel, facilities, and sales and marketing programs.
The level of spending for such expenses cannot be adjusted quickly and is,
therefore, relatively fixed in the short term. If revenue falls below the
Company's expectations in a particular quarter, the Company's operating results
could be materially adversely affected.
Based on all of the foregoing, the Company believes that future revenue,
expenses and operating results are likely to vary significantly from
quarter-to-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 57 employees
on March 31, 1997 to 147 employees on March 31, 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 Senior Vice President, Finance, Senior Vice
President, Sales and Corporate 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, human resources director and managers for research and development
projects. Further, as a consequence of the Reorganization, the Company will need
to implement a U.S.-based financial and accounting system.
13
<PAGE> 14
MICROMUSE INC.
The Company's future success will depend to a significant extent on the
recruitment and retention of these key personnel, particularly a Vice President,
Marketing, 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.
NEED TO EXPAND AND IMPROVE PRODUCTIVITY OF SALES FORCE, TECHNICAL SERVICES AND
CUSTOMER SUPPORT ORGANIZATION. Based on the Company's experience, it takes at
least six months, if not longer, for a salesperson to become fully productive.
There can be no assurance that the Company will be successful in 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, the demands on the Company's technical services and customer
support resources have grown rapidly. 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 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 20% of the Company's total revenues in fiscal 1997 and the
six-month period ended March 31, 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 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
14
<PAGE> 15
MICROMUSE INC.
discontinue their relationships with the Company, compete directly with the
Company or form additional competing 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 40% of the Company's software revenues to date
have been derived from the sale of its products to telecommunications carriers,
such as ISPs, 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.
15
<PAGE> 16
MICROMUSE INC.
In addition, because there are relatively low barriers to entry in the software
market, the Company 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.
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.
16
<PAGE> 17
MICROMUSE INC.
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, including without limitation
a Chief Financial Officer. 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.
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.
Although the Company did not have any customers that contributed over 10% of
total revenues during the quarter ended March 31, 1998, during the quarter ended
December 31, 1997, Deutsche Bank AG, an entity affiliated with Deutsche Morgan
Grenfell, 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. 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
17
<PAGE> 18
MICROMUSE INC.
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.
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 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 has recently modified 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
evolving versions of hardware and software platforms and database environments
18
<PAGE> 19
MICROMUSE INC.
employed by customers could have a material adverse effect on the Company's
business, operating results or financial condition.
RISK OF 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. The Company
has in the past had to use a significant portion of its technical personnel's
time to address such defects without additional revenue commensurate with such
services. Moreover, both Netcool/Reporter and Netcool/Internet Service Monitors
are currently in their first release, and the Company may have to spend
considerable resources in the foreseeable future to enhance or upgrade such
products. To the extent future product defects require the allocation of a
significant portion of the Company's technical personnel's time, the Company's
business, operating results or financial condition could be materially adversely
affected. 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 after commencement of commercial
shipments, resulting in loss of revenues, delay in market acceptance or damage
to the Company's reputation, any of 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, 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. Furthermore, the Company does not
maintain product liability insurance. 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.
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
19
<PAGE> 20
MICROMUSE INC.
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 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 INTERNATIONAL LICENSING AND OPERATIONS. License,
maintenance and service revenue outside of the United States accounted for 76%,
55%, 48% and 31% of the Company's total revenue in fiscal 1995, 1996 and 1997,
respectively, and in the six months ended March 31, 1998. 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. 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. Currency exchange fluctuations in countries in
which the Company licenses its products or conducts operations historically have
and in the future could 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. 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.
20
<PAGE> 21
MICROMUSE INC.
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.
POTENTIAL VOLATILITY OF STOCK PRICE. The market price of the shares of the
Company's Common Stock is likely 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
stocks 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 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.
21
<PAGE> 22
MICROMUSE INC.
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 March 31, 1998, 59% 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 will be 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.
22
<PAGE> 23
MICROMUSE INC.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not involved in any legal proceedings that are material to its
business or financial condition.
Item 6.
(a) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended March 31, 1998.
23
<PAGE> 24
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 May 13, 1998.
MICROMUSE INC.
(Registrant)
By: /s/ STEPHEN A. ALLOTT
--------------------------------------
Stephen A. Allott
Senior Vice President, Finance
(Duly Authorized Officer and Principal
Financial Officer)
24
<PAGE> 25
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS AND THE CONDENSED CONSOLIDATED STATEMENTS
OF OPERATIONS FOUND ON PAGES 3 AND 4 OF THE COMPANY'S FORM 10-Q 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> 6-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> MAR-31-1998
<CASH> 36,085
<SECURITIES> 6,883
<RECEIVABLES> 4,849
<ALLOWANCES> 76
<INVENTORY> 0
<CURRENT-ASSETS> 48,857
<PP&E> 5,017
<DEPRECIATION> 2,360
<TOTAL-ASSETS> 51,514
<CURRENT-LIABILITIES> 8,578
<BONDS> 0
0
0
<COMMON> 55,638
<OTHER-SE> (12,702)
<TOTAL-LIABILITY-AND-EQUITY> 51,514
<SALES> 8,649
<TOTAL-REVENUES> 11,024
<CGS> 627
<TOTAL-COSTS> 10,942
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 23
<INTEREST-EXPENSE> 301
<INCOME-PRETAX> (1,899)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,899)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,899)
<EPS-PRIMARY> (0.40)
<EPS-DILUTED> (0.40)
</TABLE>
