UNITED STATES
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 December 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________ .
Commission file number 000-23783
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 |_|
16,861,483 shares of Common Stock, $0.01 par value, were outstanding as of
January 31, 2000.
<PAGE>
MICROMUSE INC.
TABLE OF CONTENTS
Page
----
PART I - Financial Information
Item 1. Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets at December 31, 1999
and September 30, 1999 3
Condensed Consolidated Statements of Operations for the
three months ended December 31, 1999 and 1998 4
Condensed Consolidated Statements of Cash Flows for the
three months ended December 31, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Derivatives and Financial Instruments 27
PART II - Other Information
Item 1. Legal Proceedings 28
Item 2. Changes in Securities and use of Proceeds28
Item 3. Defaults upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information 28
Item 6. Exhibits and Reports on Form 8-K 29
Signature 30
2
<PAGE>
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>
December 31, September 30,
1999 1999
--------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 59,681 $ 35,058
Short-term investments 18,726 34,689
Accounts receivable 11,501 9,613
Prepaid expenses and other current assets 2,956 3,871
Deferred income taxes 359 359
--------- ---------
Total current assets 93,223 83,590
Property and equipment, net 6,834 5,984
Deferred income taxes 1,031 1,031
Goodwill and purchased intangible assets 31,707 --
--------- ---------
$ 132,795 $ 90,605
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 3,300 $ 4,210
Accrued expenses 11,000 4,798
Income taxes payable 2,834 1,919
Deferred revenue 9,841 9,672
--------- ---------
Total current liabilities 26,975 20,599
Stockholders' equity
Preferred stock; $0.01 par value; 5,000 shares authorized
no shares issued and outstanding -- --
Common stock; $0.01 par value; 60,000 shares authorized;
16,813 and 16,163 shares outstanding as of December 31 and
September 30, 1999, respectively 169 162
Additional paid-in capital 118,197 73,747
Deferred compensation (89) (103)
Accumulated other comprehensive losses (351) (286)
Accumulated deficit (12,106) (3,514)
--------- ---------
Total stockholders' equity 105,820 70,006
--------- ---------
$ 132,795 $ 90,605
========= =========
</TABLE>
See accompanying notes to the condensed consolidated financial statements
3
<PAGE>
MICROMUSE INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three months ended
December 31,
1999 1998
-------- --------
<S> <C> <C>
Revenues:
License $ 16,313 $ 8,527
Maintenance and services 6,018 2,301
-------- --------
Total revenues 22,331 10,828
-------- --------
Cost of revenues:
License 848 510
Maintenance and services 2,994 1,307
-------- --------
Total cost of revenues 3,842 1,817
-------- --------
Gross profit 18,489 9,011
-------- --------
Operating expenses:
Sales and marketing 9,803 5,348
Research and development 3,295 1,740
Purchased in-process R&D 11,066 --
Amortization of goodwill and purchased intangible assets 34 --
General and administrative 2,226 1,373
-------- --------
Total operating expenses 26,424 8,461
-------- --------
Income (loss) from operations (7,935) 550
Other income, net 815 916
-------- --------
Income (loss) before income taxes (7,120) 1,466
Income tax provision 1,472 147
-------- --------
Net income (loss) $ (8,592) $ 1,319
======== ========
Per share data:
Basic net income (loss) $ (0.53) $ 0.08
Diluted net income (loss) $ (0.53) $ 0.08
Weighted average shares used in computing:
Basic net income (loss) per share 16,282 15,862
Diluted net income (loss) per share 16,282 17,120
</TABLE>
See accompanying notes to the condensed consolidated financial statements
4
<PAGE>
MICROMUSE INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three months ended
December 31,
--------------------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (8,592) $ 1,319
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 544 362
Amortization of deferred employee compensation 14 14
Purchased in-process R&D 11,066 --
Changes in operating assets and liabilities:
Accounts receivable (1,888) 282
Prepaid expenses and other current assets 974 245
Accounts payable (913) (1,017)
Accrued expenses 6,202 1,046
Income taxes 915 --
Deferred revenue 169 (1,986)
-------- --------
Net cash provided by operating activities 8,491 265
-------- --------
Cash flows from investing activities:
Capital expenditures (1,270) (925)
Proceeds from the sale of investments 15,963 2,355
Acquisition of CAN net assets, net of cash acquired (146) --
-------- --------
Net cash provided by investing activities 14,547 1,430
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 1,650 205
Purchase of treasury stock -- (9,540)
-------- --------
Net cash provided by (used in) financing activities 1,650 (9,335)
-------- --------
Effects of exchange rate changes on cash and cash equivalents (65) (102)
-------- --------
Net increase (decrease) in cash and cash equivalents 24,623 (7,742)
Cash and cash equivalents at beginning of period 35,058 22,798
-------- --------
Cash and cash equivalents at end of period $ 59,681 $ 15,056
======== ========
</TABLE>
See accompanying notes to the condensed consolidated financial statements
5
<PAGE>
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 adjustments) 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 our
Form 10-K and Registration Statement on Form S-3 as filed with the Securities
and Exchange Commission on December 28, 1999 and February 2, 2000, respectively.
The September 30, 1999 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.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the condensed consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from these estimates.
Cash Equivalents
The Company considers all highly liquid instruments with a purchased maturity of
90 days or less to be cash equivalents.
Investments
The Company has invested in certain marketable 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, approximates their respective
carrying value defined as the amount at which the instrument could be exchanged
in a current transaction between willing parties.
Per Share Data
Basic per share amounts are calculated using the weighted-average number of
common shares outstanding during the period. Diluted per share amounts are
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 conversion of the redeemable convertible preferred stock
and the exercise of outstanding options to purchase common stock using the
treasury stock method. Excluded from the computation of the net loss per share
for the three-month period ended December 31, 1999 was a warrant to acquire
26,667 shares of common stock at $29.63 per share, and weighted average options
to acquire approximately 2.4 million shares of common stock, with a weighted
average exercise price of $25.63 per share, 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:
6
<PAGE>
MICROMUSE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Three months ended
December 31,
---------------------
1999 1998
-------- --------
<S> <C> <C>
Numerator for basic and diluted net income (loss)
applicable to holders of common stock $ (8,592) $ 1,319
======== ========
Denominator for basic net income (loss) per
share - weighted-average shares outstanding 16,282 15,862
Dilutive effect of:
common stock options -- 1,258
-------- --------
Denominator for diluted net income (loss) per share 16,282 17,120
======== ========
</TABLE>
Concentration of Revenues
No individual customer accounted for more than 10% of revenues for the quarter
ended December 31, 1999. In the comparable period of the prior year, one
customer accounted for 12.8% of revenues.
Comprehensive Income (Loss)
Effective October 1, 1998, the Company adopted the Financial Accounting
Standards Board's (the "FASB") Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes new rules for the reporting and display of comprehensive income
(loss) and its components; however, the adoption of SFAS 130 had no impact on
our net income (loss) or stockholders' equity. This Statement requires foreign
currency translation adjustments, which prior to adoption were reported
separately in stockholders' equity (deficit), to be included in other
comprehensive income (loss). Prior year financial statements have been
reclassified to conform to the requirements of SFAS 130.
Geographic and Segment Information
During fiscal 1999 the Company adopted the provisions of SFAS No. 131,
Disclosure about Segments of an Enterprise and Related Information. SFAS No. 131
establishes standards for the reporting by public business enterprises of
information about operating segments, products and services, geographic areas,
and major customers. The method for determining what information to report is
based on the way that management organizes the operating segments within the
Company for making operational decisions and assessments of financial
performance.
The Company's chief operating decision-maker is considered to be the Company's
Chief Executive Officer ("CEO"). The CEO reviews financial information presented
on a consolidated basis accompanied by information by geographic region for
purposes of making operating decisions and assessing financial performance.
Therefore, the Company operates as a single operating segment: Fault and Service
Level Management Software.
The Company markets its products primarily from its operations in the United
States. International sales are primarily to customers in France, Germany and
the United Kingdom. Information regarding operations in different geographic
regions is as follows (in thousands):
7
<PAGE>
MICROMUSE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three months ended
December 31,
---------------------------
1999 1998
------- -------
Revenues:
United States $14,319 $ 5,830
International 8,012 4,998
------- -------
Total $22,331 $10,828
======= =======
Income (loss) from operations:
United States $ 933 $ 1,058
International (8,868) (508)
------- -------
Total $(7,935) $ 550
======= =======
December 31, September 30,
1999 1999
-------- -------
Identifiable assets:
United States $84,690 $79,208
International 16,398 11,397
-------- -------
Total $101,088 $90,605
======== =======
Intercompany transfers between geographic areas are accounted for using the
transfer prices in effect for subsidiaries.
Recent Pronouncement
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 addresses the accounting for
derivative instruments, including certain derivative instruments embedded in
other contracts. Under SFAS No. 133, entities are required to carry all
derivative instruments in the balance sheet at fair value. The accounting for
changes in the fair value of a derivative instrument depends on whether it has
been designated and qualifies as part of a hedging relationship and, if so, the
reason for holding it. The Company must adopt SFAS No. 133 by October 1, 2001.
The Company does not anticipate that SFAS No. 133 will have an effect on its
financial statements.
In December 1998, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-9, Software Revenue Recognition, with Respect to
Certain Arrangements ("SOP 98-9"), which requires the recognition of revenue
using the "residual method" in a multiple element arrangement when fair value
does not exist for one or more of the delivered elements in the arrangement.
Under the "residual method", the total fair value of the undelivered elements is
deferred and subsequently recognized in accordance with SOP 97-2. The Company
adopted SOP 98-9 on October 1, 1999 and did not incurr a material change to its
accounting for revenues as a result of the provisions of SOP 98-9
Note 2. Acquisition of Calvin Alexander Networking, Inc.
On November 2, 1999, the Company entered into and subsequently closed, an
agreement to acquire all of the outstanding common and preferred shares of
Calvin Alexander Networking, Inc. ("CAN"), a privately-held company that
develops leading-edge network auto-discovery technology. Under the terms of the
acquisition agreement, the Company issued approximately $43 million worth of its
common stock to acquire CAN. The transaction was accounted for under the
purchase method of accounting and was treated as a tax-free reorganization for
federal income tax purposes. Certain agreements have been made to promote the
retention and motivation of CAN employees. A portion of the consideration for
the transaction is subject to a one-year lock-up agreement and a one-year price
guarantee. The Company received an independent valuation in the first quarter of
fiscal 2000, which validated the valuation of the CAN acquisition.
8
<PAGE>
MICROMUSE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
A summary of the allocation of the purchase price is as follows (in millions):
In-process research and development $11.1
Total tangible assets 0.2
Intangible assets:
Assembled workforce 0.3
Core technology 5.7
Goodwill 25.7
-----
Total intangible assets 31.7
-----
Total $43.0
=====
At the time of the acquisition, the estimated aggregate fair value of CAN's
research and development efforts that had not reached technological feasibility
as of the acquisition date and had no alternative future uses was estimated by
the Company's management to be $11.1 million, and was expensed at the
acquisition date. Goodwill, which represents the excess of the purchase price
over the fair value of identifiable tangible and intangible assets acquired less
liabilities assumed, is being amortized over the estimated life of five years.
The following summary, which was prepared on a pro forma basis, combines the
Company's consolidated results of operations with CAN's results of operations
for the three-months ended December 31, 1999 and 1998, as if the combination had
occurred at the beginning of the periods presented. The table includes the
impact of certain adjustments including the elimination of the charge for
acquired in-process research and development, and the additional amortization
relating to intangible assets acquired (in thousands, except per share data):
Three months ended
December 31,
------------------------
1999 1998
------- -------
Revenues $ 22,331 $ 10,828
======== ========
Net income $ 610 $ 1,308
======== ========
Net income per share:
Basic $ 0.04 $ 0.08
Diluted $ 0.03 $ 0.07
Shares used in per share computations:
Basic 16,711 216,301
Diluted 19,134 17,559
A reconciliation of the numerators and denominators used in the basic and
diluted net income (loss) per share amounts follows:
Three months ended
December 31,
------------------------
1999 1998
------- -------
Numerator for basic and diluted net income (loss)
applicable to holders of common stock $ 610 $ 1,319
======= =======
Denominator for basic net income (loss) per
share - weighted-average shares outstanding 16,711 16,301
------- -------
Dilutive effect of:
common stock options -- 1,258
------- -------
Denominator for diluted net income (loss) per share 19,134 17,559
======= =======
Note 3. Subsequent Event
In January 2000, the Company announced that its Board of Directors has approved
a two-for-one split of its common stock. Stockholders will receive one
additional share for each share of record held at the end of business on
February 3, 2000. Shares resulting from the split are expected to be distributed
by the transfer agent on February 22, 2000.
9
<PAGE>
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 our Form
10-K and Registration Statement on Form S-3 as filed with the Securities and
Exchange Commission on December 28, 1999 and February 2, 2000, respectively.
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 our expectations, beliefs,
hopes, intentions or strategies regarding the future. All forward-looking
statements in this Form 10-Q are based upon information available to us as of
the date hereof, and we assume no obligation to update any such forward-looking
statements. Actual results could differ materially from our current
expectations. Factors that could cause or contribute to such differences
include, but are not limited to: variation in demand for our 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" in our Form 10-K and Registration Statement on Form
S-3 as filed with the Securities and Exchange Commission on December 28, 1999
and February 2, 2000, respectively, and elsewhere in this Quarterly Report.
Overview
Micromuse develops, markets and supports a family of scalable, highly
configurable, rapidly deployable software solutions that enable Fault and
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. Our
principal executive offices are located at 139 Townsend Street, San Francisco,
California 94107, and its telephone number at that address is (415) 538-9090.
10
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MICROMUSE INC.
Results of Operations
The following table sets forth certain items in our consolidated statement of
operations as a percentage of total revenues, except as indicated:
<TABLE>
<CAPTION>
Three months ended
December 31,
------------------
1999 1998
----- -----
<S> <C> <C>
As a Percentage of Total Revenues:
Revenues:
License 73.1% 78.7%
Maintenance and services 26.9 21.3
----- -----
Total revenues 100.0 100.0
----- -----
Cost of revenues:
License 3.8 4.7
Maintenance and services 13.4 12.1
----- -----
Total cost of revenues 17.2 16.8
----- -----
Gross profit 82.8 83.2
----- -----
Operating expenses:
Sales and marketing 43.9 49.4
Research and development 14.8 16.1
Purchased in-process R&D 49.7 --
Amortization of goodwill and purchased intangible assets 0.0 --
General and administrative 10.0 12.7
----- -----
Total operating expenses 118.4 78.2
----- -----
Income (loss) from operations (35.6) 5.0
Other income, net 3.6 8.5
----- -----
Income (loss) before income taxes (32.0) 13.5
Income tax provision 6.6 1.4
----- -----
Net income (loss) (38.6) 12.1
===== =====
As a Percentage of Related Revenues:
Cost of license revenues 5.2% 6.0%
Cost of maintenance and services revenues 49.8% 56.8%
</TABLE>
11
<PAGE>
MICROMUSE INC.
Revenues. Revenues increased to $22.3 million in the quarter ended December 31,
1999, from $10.8 million in the comparable period of the prior year. License
revenues increased to $16.3 million in the quarter ended December 31, 1999, from
$8.5 million in the comparable period of the prior year. The growth of license
revenues was primarily due to an increase in the number of product licenses
sold, reflecting the increased acceptance of Netcool(R)/OMNIbus and the
expansion of our sales organizations and product offering. Maintenance and
services revenues increased to $6.0 million in the quarter ended December 31,
1999, from $2.3 million in the comparable period of the prior year The increase
in maintenance and services revenues was a result of providing maintenance and
services to a larger installed base of customers. License revenues as a
percentage of total revenues decreased to 73% in the quarter ended December 31,
1999, from 79% in the comparable period of the prior year, due primarily to
services revenues returning to historic levels.
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 revenues as a percentage of license revenues decreased to 5.2% in the
quarter December 31, 1999, from 6.0% in the comparable period of the prior year
primarily due to lower third-party royalty costs and 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 decreased to 49.8% in the quarter ended
December 31, 1999, from 56.8% in the comparable period of the prior year. This
improvement, which was principally due to a proportionally greater percentage of
higher-margin maintenance revenues, was partially offset by increased personnel,
facilities, and travel costs associated with expanding the customer support and
technical service organizations.
Sales and Marketing Expenses. Sales and marketing expenses increased to $9.8 in
the quarter ended December 31, 1999, from $5.3 million in the comparable period
of the prior year. This increase was primarily due to the increased personnel
costs associated with the expansion of the sales and technical services
departments and increased facilities costs. Sales and marketing expenses as a
percentage of total revenues declined to 44% in the quarter ended December 31,
1999, from 49% in the comparable period of the prior year. These reductions were
primarily due to the increased scale of operations.
Research and Development Expenses. Research and development expenses increased
to $3.3 million in the quarter ended December 31, 1999, from $1.7 million in the
comparable period of the prior year. This increase was 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 to 15% in the
quarter ended December 31, 1999, from 16% in the same period of the prior year.
These reductions were primarily due to the increased scale of operations.
Purchased in-process Research and Development Expense. The 11.1 million charge
reflects the portion of CAN's research and development efforts that, at the time
of acquisition, had not reached technological feasibility and had no alternative
future uses.
General and Administrative Expenses. General and administrative expenses
increased to $2.2 million in the quarter ended December 31, 1999, from $1.4
million in the comparable period of the prior year. This increase was primarily
due to increased personnel costs, professional fees, facilities costs and
associated expenses to support the increased scale of operations. In addition,
the Company incurred a charge related to the registration of additional shares
related to the CAN acquisition. General and
12
<PAGE>
MICROMUSE INC.
administrative expenses as a percentage of revenues declined to 10% in the
quarter ended December 31, 1999, from 13% in the comparable period of the prior
year. These reductions were primarily due to the increased scale of operations.
Other Income, net. Other income decreased to $0.8 million in the quarter ended
December 31, 1999, from $0.9 million in comparable period of the prior year.
This net decrease was primarily due to a foreign exchange loss incurred during
the quarter ended December 31, 1999, offset partially by an increase in interest
income.
Liquidity and Capital Resources
As of December 31, 1999, we had $59.7 million in cash and cash equivalents and
$18.7 million in marketable securities. The net increase in cash and cash
equivalents in the three months ended December 31, 1999 was due primarily to the
operating net income (excluding the non-cash write-off of in-process R&D), the
increase in accrued expenses, and the proceeds from the sale of marketable
securities and from the issuance of common stock. These sources of cash were
partially offset by the increase in accounts receivable and the purchase of
capital equipment. The increase in accrued expenses is due primarily to the
timing of a payroll tax payment related to exercised stock options and, to a
lesser extent, the growth in the business. The increase in accounts receivable
reflects the growth in the related revenues.
The net use of cash and cash equivalents in the first quarter of fiscal 1999 was
due primarily to the $9.5 million used to purchase treasury stock and the
decline in deferred revenues. The decline in deferred revenues reflects
principally the delivery of previously undelivered product. These uses were
partially offset by net income of $1.3 million and the proceeds from the sale of
investments.
We believe that our current cash balances and the cash flows generated by
operations, if any, will be sufficient to meet our anticipated cash needs for
working capital and capital expenditures for the next 12 months. A portion of
our cash may be used to acquire or invest in complementary businesses or
products or to obtain the right to use complementary technologies. We 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 our stockholders.
Year 2000 Compliance and Euro Conversion
We have designed and tested our products to be Year 2000 compliant. Our
evaluation of Year 2000-related risks and corrective actions in connection with
such third-party applications, internally developed products and local operating
systems is largely completed but will be ongoing. We believe that our products
performed well during the roll-over from 1999 to 2000. Any undetected or
unreported errors or defects associated with Year 2000 date functions could
result in material costs to us. In addition, certain components of our products
process timestamp information from third-party applications or local operating
systems. If such third-party applications or local operating systems are not
Year 2000 compliant, our products that process such timestamp information may
not be Year 2000 compliant.
S
13
<PAGE>
MICROMUSE INC.
In our standard license agreements, we provide certain warranties to licensees
that our software routines and programs are Year 2000 compliant. If any of our
licensees experience Year 2000 problems, such licensees could assert claims for
damages against us. Any such claims or litigation could result in substantial
costs and diversion of our resources even if ultimately decided in our favor.
Some commentators have stated that a significant amount of litigation will arise
out of Year 2000 compliance issues, and we are aware of a growing number of
lawsuits against other software vendors. Because of the unprecedented nature of
such litigation, it is uncertain to what extent we may be affected by it. Based
on work done to date and our best estimates, we have not incurred material costs
and do not expect to incur future material costs in addressing the Year 2000
issue in our systems and products.
Our Year 2000 internal readiness program primarily covers: information
technology-based office facilities, data and voice communications, building
management and security systems, taking inventory of hardware, software and
embedded systems, assessing business and customer satisfaction risks associated
with such systems, creating action plans to address known risks, executing and
monitoring action plans, and contingency planning. Although we do not currently
believe that we will experience material disruptions in our business associated
with preparing our internal systems for the Year 2000, there can be no
assurances that we will not experience serious unanticipated negative
consequences and/or material costs caused by undetected errors or defects in the
technology used in our internal systems, which are composed of third-party
software, third-party hardware that contains embedded software and our own
software products. The most reasonably likely worst case scenarios would
include: (i) corruption of data contained in our internal information systems,
(ii) hardware failure and (iii) the failure of infrastructure services provided
by government agencies and other third parties (e.g., electricity, phone
service, water transport, internet services, etc.). Contingency plans to
include, among other things, manual "work-arounds" for software and hardware
failures, as well as substitution of systems, if necessary.
Various European countries introduced a single currency (known as the Euro) in
January 1999. We have conducted a review of our internal information systems to
identify the systems that could be affected by such Year 2000 and Euro
conversion requirements. Further, to accommodate our recent growth, we 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, we will be required to improve our 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.
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RISK FACTORS
In addition to the other information in this Report, the following risk factors
should be considered carefully in evaluating us and our business. This Form 10-Q
(including without limitation the following Risk Factors) contains
forward-looking statements (within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934) regarding us
and our business, financial condition, results of operations and prospects.
Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks,"
"estimates" and similar expressions or variations of such words are intended to
identify forward-looking statements, but are not the exclusive means of
identifying forward-looking statements in this Form 10-Q. Additionally,
statements concerning future matters such as the development of new products,
enhancements or technologies, possible changes in legislation and other
statements regarding matters that are not historical are forward-looking
statements.
Although forward-looking statements in this Form 10-Q reflect the good faith
judgment of our management, such statements can only be based on facts and
factors we currently know about. Consequently, forward-looking statements are
inherently subject to risks and uncertainties, and actual results and outcomes
may differ materially from the results and outcomes discussed in the
forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include, but are not limited to, those
discussed below and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" as well as those discussed elsewhere in
this Form 10-Q. Readers are urged not to place undue reliance on these
forward-looking statements, which speak only as of the date of the this Form
10-Q. We undertake no obligation to revise or update any forward-looking
statements in order to reflect any event or circumstance that may arise after
the date of the Form 10-Q.
Because we have a limited operating history, it is difficult to predict our
future operating results.
Because we have a limited operating history, it is difficult to predict our
future operating results. We first shipped our Netcool/OMNIbus product in
January of 1995 and therefore have a limited operating history of developing and
providing service level management software. Only recently has our software
business been profitable and as of December 31, 1999 we had an accumulated
deficit of $1.0 million (excluding the $11.1 million charge for in-process R&D).
Our limited operating history and rapidly changing product development,
installation, maintenance and market dynamics make the prediction of future
results of operations difficult. Our prospects must be considered in light of
the risks, costs and difficulties frequently encountered by emerging companies,
particularly companies in the competitive software industry. We intend to
increase our operating expenses to hire experienced senior managers, develop new
distribution channels, increase our sales and marketing efforts, implement and
improve operational, financial and management information systems, broaden
technical services and customer support capabilities, fund higher levels of
research and development and expand administrative resources in anticipation of
future growth. Our operating results will be harmed if these increased
expenditures do not result in increased revenues.
Our operating results may vary from quarter to quarter, causing our stock price
to fluctuate.
Our quarterly revenues and operating results fluctuate and are difficult to
predict. It is possible that in some quarter or quarters our operating results
will be below the expectations of public market analysts
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or investors. In such event, or in the event adverse conditions prevail, or are
perceived to prevail, with respect to our business generally, the market price
of our common stock may decline significantly.
We realize a significant portion of our license revenues in the last month of a
quarter, frequently in the last weeks or even days of a quarter. As a result,
license revenues in any quarter are difficult to forecast because it is
substantially dependent on orders booked and shipped in that quarter. Moreover,
our sales cycle, from initial evaluation to delivery of software, vary
substantially from customer to customer. Further, we base our expense levels in
part on forecasts of future orders and sales, which are extremely difficult to
predict. A substantial portion of our 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. Accordingly, our operating results will be harmed if revenues
fall below our expectations in a particular quarter. In addition, the number and
timing of large individual sales has been difficult for us to predict, and large
individual sales have, in some cases, occurred in quarters subsequent to those
we anticipated, or have not occurred at all. The loss or deferral of one or more
significant sales in a quarter could harm our operating results.
Because of these fluctuations we believe that quarter-to-quarter comparisons of
our operating results are not necessarily meaningful or indicative of our future
performance. A number of other factors are likely to cause these variations,
including:
o changes in the demand for our software products and services and the level
of product and price competition that we encounter;
o the timing of new hires and our ability to attract, retain and motivate
qualified personnel, including changes in our sales incentives;
o the mix of products and services sold, including the mix of sales to new
and existing customers and through third-party distributors and our direct
sales force;
o changes in the mix of, and lack of demand from, distribution channels
through which our products are sold;
o the length of our sales cycles and the success of our new customer
generation activities;
o spending patterns and budgetary resources of our customers on network
management software solutions;
o product life-cycles and the timing of introductions or enhancements of
products, or delays in the introductions or enhancements of our products
and those of our competitors;
o market acceptance of new products;
o changes in the renewal rate of support agreements;
o seasonal variation in revenues because a disproportionate amount of our
annual revenues have historically been generated by sales of our products
during our fourth fiscal quarter and this trend may or may not continue;
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o expansion of international operations, including gains and losses on the
conversion to United States dollars of accounts receivable and accounts
payable arising from international operations and the mix of international
and domestic revenue;
o the extent of market consolidation; and
o software defects and other product quality problems.
Failure to manage our growth may adversely affect our business.
We have grown rapidly, adding customers, personnel and expanding the scope and
geographic area of our operations. Our growth has resulted in new and increased
responsibilities for our management personnel and has placed and will continue
to place a significant strain upon our management and our operating and
financial systems and resources. We have grown from 176 employees on September
30, 1998 to 351 employees on December 31, 1999 and currently plan to recruit
more staff. Moreover, members of our management team, including the Chairman and
Chief Executive Officer, Senior Vice President, General Counsel and Secretary
and Senior Vice President, Human Resources have been in their current positions
with us for a limited period of time.
Failure to improve our infrastructure may adversely affect our business.
We need to continue to implement and improve a variety of operational, financial
and management information systems, procedures and controls. In particular, we
need to improve our 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
require the addition of new management personnel, and we are currently in the
process of recruiting individuals to fill important management positions such as
the Vice President, Marketing. Further, we need to continue to develop a
U.S.-based financial and accounting system. Our business will be harmed if we
are unable to recruit and retain these key personnel, if our current and future
executive officers do not operate effectively, both independently and as a
group, or if we fail to implement improved operational, financial and management
systems.
We need to continue to expand and improve the productivity of our sales force
and our technical services and customer support organization.
We need to continue to hire additional sales personnel. Based on our experience,
such personnel are in high demand, are difficult to recruit and retain and
require nine months, or longer, to become fully productive. Although we
increased the size of our sales organization during fiscal 1999, we experienced
difficulty in recruiting a sufficient number of qualified sales personnel during
the period. Our business will be harmed if we are unable to recruit additional
sales personnel or increase the productivity of our current sales personnel.
Further, because of the recent expansion of the installed base of
Netcool/OMNIbus and the release of our Netcool/Reporter(TM), Netcool/Internet
Service Monitors(TM), Netcool/FireWall-1(TM), Netcool/Fusion(TM),
Netcool/NTSM(TM), and Netcool/Impact(TM), the demands on our technical services
and customer support resources have grown rapidly. We need to significantly
expand our technical services and customer support organizations and similar
third-party capabilities if we are to achieve significant additional revenue
growth. Competition for additional qualified technical personnel to perform the
required functions is intense and such personnel may not be available. If our
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technical services and customer support resources are insufficient to support
our growth our business will be harmed.
We need to continue to expand our distribution channels and retain our existing
third-party distributors.
We need to continue to develop relationships with leading network equipment and
telecommunications providers and to expand our third-party channel of
distribution. We are currently investing, and plan to continue to invest,
significant resources to develop these relationships and channels of
distribution, which could reduce our ability to generate profits. Third-party
distributors accounted for approximately 29%, 34% and 26% of our total revenues
in the quarter ended December 31, 1999, fiscal 1999 and 1998, respectively. Our
business will be harmed if we are not able to attract additional distributors
that market our products effectively. Further, many of our agreements with
third-party distributors are nonexclusive, and many of the companies with which
we have agreements also have similar agreements with our competitors or
potential competitors. Our third-party distributors have significantly greater
sales and marketing resources than we do, and their sales and marketing efforts
may conflict with our direct sales efforts. In addition, although sales through
third-party distributors result in reduced sales and marketing expense with
respect to such sales, we sell our products to third-party distributors at
reduced prices, resulting in lower gross margins on such third-party sales. We
believe that our success in penetrating markets for our fault and service level
management applications depends substantially on our ability to maintain our
current distribution relationships, in particular, those with Cisco Systems,
Lucent Technologies, Unisphere (Siemens) and others. Our business will be harmed
if network equipment and telecommunications providers and distributors
discontinue their relationships with us, compete directly with us or form
additional competing arrangements with our competitors.
We are dependent on the market for software designed for use with advanced
communications services, and the size of this market is unproven.
The market for our products is in an early stage of development and is very
dynamic. Although the rapid expansion and increasing complexity of computer
networks in recent years and the resulting emergence of service level management
has increased the demand for fault and service level management 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.
We are substantially dependent upon telecommunications carriers and internet
service providers continuing to purchase our products.
Telecommunications carriers, including internet service providers, that deliver
advanced communications services to their customers have accounted for
approximately 85%, 79% and 68% of our total revenues in the quarter ended
December 31, 1999, fiscal 1999 and 1998, respectively. In addition, these
providers are the central focus of our sales strategy. If these customers cease
to deploy advanced communications services for any reason, the market for our
products will be harmed. Also, delays in the introduction of advanced services,
such as network management outsourcing, or the failure of such services to gain
widespread market acceptance or the decision of telecommunications carriers and
other service providers not to use our products in the deployment of these
services would harm our business.
We face intense competition, including from larger competitors with greater
resources than our own,
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which could result in our losing market share or experiencing a decline in gross
margins.
We face intense competition in our markets. As we enter new markets, we
encounter additional, market-specific competitors. In addition, because the
software market has relatively low barriers to entry, we are aware of new and
potential entrants in portions of our market space. Increased competition is
likely to result in price reductions and may result in reduced gross margins and
loss of market share.
Further, many of our 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
we do. 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 we can. Existing competitors could also increase their market share by
bundling products having functionality offered by our products with their
current applications. Moreover, our current and potential competitors may
increase their share of the fault and service level management 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 functionality offered by
our products, which could render our products obsolete and unmarketable.
Our current and prospective competitors offer a variety of solutions to address
the fault and service level and enterprise network management markets and
generally fall within the following five categories:
o customer's internal design and development organizations that produce
service level management 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.,
Hewlett-Packard Company and Cabletron Systems, Inc.;
o vendors of network and systems management frameworks including Computer
Associates International, Inc. and International Business Machines
Corporation;
o vendors of network and systems management applications including
Hewlett-Packard Company, BMC Software, Inc, Sun Microsystems, Inc. and
International Business Machines Corporation;
o providers of specific market applications; and
o systems integrators serving the telecommunications industry which
primarily provide programming services to develop customer specific
applications including TCSI Corporation (formerly Teknekron Communications
Systems, Inc.) and Objective Systems Integrators, Inc.
Many of our existing and potential customers and distributors 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 ours. As a result, we must continuously educate
existing and prospective customers as to the advantages of our products versus
internally developed network operations support and management applications.
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If we ship products that contain defects or limitations, the market acceptance
or our products and our reputation will be harmed, and our customers could seek
to recover their damages from us.
If we ship products that contain defects, the market acceptance or our products
and our reputation will be harmed, and our customers could seek to recover their
damages from us. Complex software products frequently contain errors, defects or
limitations, especially when first introduced or when new versions or
enhancements are released. Despite our extensive product testing, we have in the
past released versions of Netcool/OMNIbus with defects and have discovered
software errors in certain of our products after their introduction. For
example, version 3.0 of Netcool/OMNIbus, released in 1996, had a number of
material defects and limitations. Version 1.0 of Netcool/Reporter, released in
1998, had features and performance characteristics that limited market
acceptance. A significant portion of our technical personnel resources were
required to address these defects and limitations. Because of these defects and
limitations we could continue to experience delays in or failure of market
acceptance of products, or damage to our reputation or relationships with our
customers. Any defects, errors or limitations in new versions or enhancements of
our products after commencement of commercial shipments would harm our business.
In addition, because our products are used to monitor and address network
problems and avoid failures of the network to support critical business
functions, any design defects, software errors, misuse of our products,
incorrect data from network elements or other potential problems within or out
of our control that may arise from the use of our products could result in
financial or other damages to our customers. Our customers could seek to have us
pay for these losses. Although we maintain product liability insurance, it may
not be adequate. Further, although our license agreements with our customers
typically contain provisions designed to limit our exposure to potential claims
as well as any liabilities arising from such claims, such provisions may not
effectively protect us against such claims and the liability and costs
associated therewith.
The sales cycle for our software products is long, and the delay or failure to
complete one or more large license transactions in a quarter could cause our
operating results to fall below our expectations.
The sales cycle for our software products can take as long as three to nine
months, and our delay or failure to complete one or more large license
transactions in a quarter could harm our operating results. Our software is
generally used for division-wide 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 us to expend substantial time, effort and money educating
them about the value of our solutions. Licensing of our 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 we have little or no control, may cause potential customers to favor a
particular supplier or to delay or forego a purchase.
We depend on our key personnel, and the loss of any of our key personnel could
harm our business.
Our 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 harm our
business. We do not generally have employment contracts with key personnel. In
addition, will are dependent upon our continuing ability to attract, train and
retain additional highly qualified management, sales, product development,
technical services and
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customer support personnel. We have at times and continue to experience
difficulty in recruiting qualified personnel. Because we face intense
competition in our recruiting activities, we may be unable to attract and/or
retain qualified personnel.
We have acquired another business and we may make additional acquisitions in the
future, which will complicate our management tasks and could result in
substantial expenditures.
We have acquired another business and we may make additional acquisitions in the
future, which will complicate our management tasks and could result in
substantial expenditures. For example, on November 2, 1999, we entered into an
agreement to acquire Calvin Alexander Networking, Inc., a developer of network
auto-discovery software. Because of these part and potential acquisitions, we
will need to integrate distinct products, customers and corporate cultures into
our own. These part and potential acquisitions create numerous risks for us,
including:
o failure to successfully assimilate acquired operations and products;
o diversion of our management's attention from other matters;
o loss of key employees of acquired companies;
o substantial transaction costs; and
o substantial additional costs charged to operations as a result of the
failure to consummate a potential acquisition.
Further, some of the products we may acquire would require significant
additional development before they can be marketed and may not generate revenue
at levels we anticipate. Moreover, our future acquisitions, if any, may result
in issuances of our equity securities which dilute our stockholders, the
incurrence of debt, large one-time write-offs and creation of goodwill or other
intangible assets that could result in amortization expense. It is possible that
our efforts to consummate or integrate acquisitions will not be successful,
which would harm our business.
We have relied and expect to continue to rely on a limited number of products
for a significant portion of our revenues.
All of our revenues have been derived from licenses for our Netcool family of
products and related maintenance, training and consulting services. We currently
expect that Netcool/OMNIbus-related revenues will continue to account for a
substantial percentage of our revenues beyond fiscal 2000 and for the
foreseeable future thereafter. Although we've introduced Netcool/Reporter,
Netcool/Internet Service Monitors, Netcool/FireWall-1, Netcool/Fusion,
Netcool/NTSM, and Netcool/Impact, our 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. Our business will be harmed if Netcool/OMNIbus
does not continue to achieve market acceptance or if we fail to develop and
market improvements to Netcool/OMNIbus or new or enhanced products. 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 our
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 harm our business.
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We have relied and expect to continue to rely on a limited number of customers
for a significant portion of our revenues.
We derive a significant portion of our revenues in any particular period from a
limited number of customers. Although no one customer accounted for more than
10% of revenues in the quarter ended December 31, 1999 and fiscal 1999, entities
affiliated with MCI/WorldCom accounted for 10% and 18% of our total revenue in
fiscal 1998 and 1997, respectively. We expect to continue to derive a
significant portion of our revenues from a limited number of customers in the
future. If a significant customer, or group of customers, cancels or delays
orders for our products, or does not continue to purchase our products at or
above historical levels, our business will be harmed. For example, pre-existing
customers may be part of, or become part of, large organizations that
standardize using a competitive product. The terms of our agreements with our
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, we generally do not have
long-term customer contracts upon which we can rely for future revenues.
Our international sales and operations expose us to currency fluctuation risks
and other inherent risks.
We license our products in foreign countries. In addition, we maintain a
significant portion of our operations, including the bulk of our software
development operations, in the United Kingdom. Fluctuations in the value of
these currencies relative of the United States dollar have adversely impacted
our results in the past and may do so in the future. These fluctuations can
cause our prices to not be competitive or raise our expenses and reduce our
profitability. License, maintenance and service revenues outside of the United
States accounted for 36%, 29% and 39% of our total revenues in the quarter ended
December 31, 1999, fiscal 1999 and 1998, respectively. We expect that
international license, maintenance and consulting revenues will continue to
account for a significant portion of our total revenues in the future. We pay
the expenses of our international operations in local currencies and do not
currently engage in hedging transactions with respect to such obligations.
Our international operations and revenues involve a number of other inherent
risks, including:
o longer receivables collection periods and greater difficulty in accounts
receivable collection;
o difficulty in staffing and managing foreign operations;
o an even lengthier sales cycle than with domestic customers;
o the impact of possible recessionary environments in economies outside the
United States;
o sales in Europe and certain other parts of the world generally are
adversely affected in the quarter ending September 30, as many customers
reduce their business activities during the summer months. If our
international sales become a greater component of total revenue, these
seasonal factors may have a more pronounced effect on our operating
results; and
o 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.
o change in payroll, stock option, employee stock purchase and business
related transaction.
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We intend to enter into additional international markets and to continue to
expand our operations outside of the United States by expanding our direct sales
force and pursuing additional strategic relationships. Such expansion will
require significant management attention and expenditure of significant
financial resources and could adversely affect our ability to generate profits.
If we are unable to establish additional foreign operations in a timely manner,
our growth in international sales will be limited, and our business could be
harmed.
Rapid technological change, including evolving industry standards and
regulations and new product introductions by our competitors, could render our
products obsolete.
Rapid technological change, including evolving industry standards and
regulations and new product introductions by our competitors, could render our
products obsolete. As a result, the life cycles of our products are difficult to
estimate and we must constantly develop, market and sell new and enhanced
products. If we fail to do so, our business will be harmed. For example, the
widespread adoption of the [TMN] [need to write it out] architecture for
managing telecommunications networks would force us to adapt our products to
such standard, which we may be unable to do on a timely basis or 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 our products. Further, the introduction or
announcement of new product offerings by us or one or more of our competitors
may cause our customers to defer licensing of our existing products.
Our products operate on third-party software platforms, and we could lose market
share if our products do not operate on the hardware and software operating
platforms employed by our customers.
Our products operate on third-party software platforms and we could lose market
share if our products do not operate on the hardware and software operating
platforms employed by our customers. Our products are designed to operate on a
variety of hardware and software platforms employed by our customers in their
networks. We must continually modify and enhance our 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
Microsystems, Inc., International Business Machines Corporation, Hewlett-Packard
Company, Cabletron Systems, Inc. and Cisco Systems, Inc. and by vendors of
relational database software, particularly Oracle Corporation and Sybase, Inc.,
could harm our business. For example, we are modifying certain of our products
to operate with the Linux operating system.
Our efforts to protect our intellectual property may not be adequate, or a
third-party could claim that we are infringing its proprietary rights.
We cannot guarantee that the steps we have taken to protect our proprietary
rights will be adequate to deter misappropriation of our intellectual property.
In addition, we may not be able to detect unauthorized use or our intellectual
property and take appropriate steps to enforce our rights. If third parties
infringe or misappropriate our trade secrets, copyrights, trademarks or other
proprietary information or intellectual property, our business could be harmed.
In addition, protection of intellectual property in many foreign countries is
weaker and less reliable than in the United States, so as our international
operations expand, the risk that we will fail to adequately protect our
intellectual property increases. Further, while we believe that our products and
trademarks do not infringe upon the proprietary rights of third parties, other
parties may assert that our products infringe, or may infringe, their
proprietary rights. 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
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or require us 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 us or at all. We expect that software
product developers will be increasingly subject to infringement claims as the
number of products and competitors in our industry segment grows and the
functionality of products in different industry segments overlaps.
We rely on software that we have licensed from third-party developers to perform
key functions in our products.
We rely on software that we license from third parties, including software that
is integrated with internally developed software and used in our products to
perform key functions. We could lose the right to use this software or it could
be made available to us only on commercially unreasonable terms. Although we
believe 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 us until equivalent software could be developed internally or
identified, licensed and integrated, which would harm our business.
Our stock price is volatile.
The market price of our common stock has been and is likely to continue to be
highly volatile. The market price may vary in response to many factors, some of
which are outside our control, including:
o actual or anticipated fluctuations in our operating results;
o announcements of technological innovations, new products or new contracts
by us or our competitors;
o developments with respect to copyrights or proprietary rights;
o adoption of new accounting standards affecting the software industry; and
o 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 our 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 our management's attention and resources that could harm our business.
General economic and market conditions may impair our business.
Segments of the software industry have experienced significant economic
downturns characterized by decreased product demand, price erosion, work
slowdowns and layoffs. Our operation may in the future experience substantial
fluctuations as a consequence of general economic conditions affecting the
timing of orders from major customers and other factors affecting capital
spending. Although we have
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a diverse client base, we target certain market segments. Therefore, any
economic downturns in general or in the targeted segments in particular would
harm our business.
We have various mechanisms in place to discourage takeover attempts.
Certain provisions of our certificate of incorporation and bylaws and certain
provisions of Delaware law could delay or make difficult a change in control of
Micromuse that a stockholder may consider favorable. The provisions include:
o "blank check: preferred stock that could be used by our board of directors
to increase the number of outstanding shares and thwart a takeover
attempt; and
o a classified board of directors with staggered, two-year, terms, which may
lengthen the time required to gain control of the board of directors
In addition, Section 203 of the General Corporation Law of the State of
Delaware, which is applicable to us, and our stock incentive plans, may
discourage, delay or prevent a change of control of Micromuse.
Year 2000 and Euro conversion issues could impair our business.
We have designed and tested our products to be Year 2000 compliant. Our
evaluation of Year 2000-related risks and corrective actions in connection with
such third-party applications, internally developed products and local operating
systems is largely completed but will be ongoing. We believe that our products
performed well during the roll-over from 1999 to 2000 . Any undetected or
unreported errors or defects associated with Year 2000 date functions could
result in material costs to us. In addition, certain components of our products
process timestamp information from third-party applications or local operating
systems. If such third-party applications or local operating systems are not
Year 2000 compliant, our products that process such timestamp information may
not be Year 2000 compliant.
In our standard license agreements, we provide certain warranties to licensees
that our software routines and programs are Year 2000 compliant. If any of our
licensees experience Year 2000 problems, such licensees could assert claims for
damages against us. Any such claims or litigation could result in substantial
costs and diversion of our resources even if ultimately decided in our favor.
Some commentators have stated that a significant amount of litigation will arise
out of Year 2000 compliance issues, and we are aware of a growing number of
lawsuits against other software vendors. Because of the unprecedented nature of
such litigation, it is uncertain to what extent we may be affected by it. Based
on work done to date and our best estimates, we have not incurred material costs
and do not expect to incur future material costs in addressing the Year 2000
issue in our systems and products.
Our Year 2000 internal readiness program primarily covers: information
technology-based office facilities, data and voice communications, building
management and security systems, taking inventory of hardware, software and
embedded systems, assessing business and customer satisfaction risks associated
with such systems, creating action plans to address known risks, executing and
monitoring action plans, and contingency planning. Although we do not currently
believe that we will experience material disruptions in our business associated
with preparing our internal systems for the Year 2000, there can be no
assurances that we will not experience serious unanticipated negative
consequences and/or material costs caused by undetected errors or defects in the
technology used in our internal systems, which are composed of third-party
software, third-party hardware that contains embedded
25
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MICROMUSE INC.
software and our own software products. The most reasonably likely worst case
scenarios would include: (i) corruption of data contained in our internal
information systems, (ii) hardware failure and (iii) the failure of
infrastructure services provided by government agencies and other third parties
(e.g., electricity, phone service, water transport, internet services, etc.).
Contingency plans to include, among other things, manual "work-arounds" for
software and hardware failures, as well as substitution of systems, if
necessary.
Various European countries introduced a single currency (known as the Euro) in
January 1999. We have conducted a review of our internal information systems to
identify the systems that could be affected by such Year 2000 and Euro
conversion requirements. Further, to accommodate our recent growth, we 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, we will be required to improve our 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.
26
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MICROMUSE INC.
Item 3. Quantitative and Qualitative Disclosures about Market Risk Derivatives
and Financial Instruments
Foreign Currency Hedging Instruments
We transact business in various foreign currencies. Accordingly, we are subject
to exposure from adverse movements in foreign currency exchange rates. This
exposure is primarily related to local currency denominated revenues and
operating expenses in the U.K. However, as of December 31, 1999, no hedging
contracts were outstanding.
We currently do not use financial instruments to hedge local currency
denominated operating expenses in the U.K. Instead, we believe that a natural
hedge exists, in that local currency revenues will substantially offset the
local currency denominated operating expenses. We assess the need to utilize
financial instruments to hedge currency exposures on an ongoing basis.
We do not use derivative financial instruments for speculative trading purposes,
nor do we hedge our foreign currency exposure in a manner that entirely offsets
the effects of changes in foreign exchange rates. We regularly review our
hedging program and may as part of this review determine at any time to change
our hedging program.
Fixed Income Investments
Our exposure to market risks for changes in interest rates relate primarily to
investments in debt securities issued by U.S. government agencies and corporate
debt securities. We place our investments with high credit quality issuers and,
by policy, limits the amount of the credit exposure to any one issuer.
Our general policy is to limit the risk of principal loss and ensure the safety
of invested funds by limiting market and credit risk. All highly liquid
investments with a maturity of three months or less at the date of purchase are
considered to be cash equivalents; investments with maturities between three
months or less are considered cash equivalents; investments with maturities
between three and twelve months are considered to be short-term investments;
investments with maturities in excess of twelve months are considered to be
long-term investments. The weighted average pre-tax interest rate on the
investment portfolio is approximately 5.5%. We do not expect any material loss
with respect to our investment portfolio.
27
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MICROMUSE INC.
Part II - OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is not a party to any material legal proceeding.
Item 2. Changes in Securities and Use of Proceeds.
Not applicable.
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.
28
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MICROMUSE INC.
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
Exhibit
Number Description
- -------------- --------------------------------------------------------------
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
+ 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
December 31, 1999.
29
<PAGE>
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 February 14, 2000.
MICROMUSE INC.
(Registrant)
By: /s/ STEPHEN A. ALLOTT
------------------------------------------
Stephen A. Allott
Director, President and Chief Financial Officer
(Principal Financial Officer and Duly
Authorized Officer)
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