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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 March 31, 2000
OR
[ ] Transition report pursuant to section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ____ to ____
Commission File Number 000-26757
NetIQ CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 77-0405505
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5410 Betsy Ross Drive, Santa Clara, CA 95054
(Address of principal executive offices) (Zip Code)
<TABLE>
<S> <C>
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 par value
(Title of Class)
</TABLE>
(408) 330-7000
(Registrant's telephone number, including area code)
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 [ ]
As of April 30, 2000, the Registrant had outstanding 17,962,501 shares of Common
Stock.
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NetIQ Corporation
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR QUARTER ENDED MARCH 31, 2000
<TABLE>
<CAPTION>
Page
PART I FINANCIAL INFORMATION
<S> <C> <C> <C>
ITEM 1 FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of 4
Operations and Comprehensive Income
Condensed Consolidated Statements of Cash 5
Flows
Notes to Condensed Consolidated Financial 6
Statements
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF 10
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 30
PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS 31
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS 31
ITEM 3 DEFAULT UPON SENIOR SECURITIES 31
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
31
ITEM 5 OTHER INFORMATION 31
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 32
SIGNATURES 33
</TABLE>
2
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PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
NetIQ CORPORATION
Condensed Consolidated Balance Sheets
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
March 31,
2000 June 30,
(Unaudited) 1999 (1)
------------------ ------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 5,523 $ 9,634
Short-term investments 147,615 -
Accounts receivable, net of allowance for uncollectible accounts 5,263 6,395
Prepaid expenses 768 764
------------- -------------
Total current assets 159,169 16,793
Property and equipment, net 2,159 1,465
Goodwill and other intangibles, net of accumulated amortization 1,890 -
Other assets 2,680 96
------------- -------------
Total assets $ 165,898 $ 18,354
============ =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt $ - $ 5,144
Accounts payable 713 326
Accrued compensation and related benefits 2,939 1,100
Other liabilities 2,179 1,839
Deferred revenue 6,461 3,941
------------- -------------
Total current liabilities 12,292 12,350
Long-term debt - 205
------------- -------------
Total liabilities 12,292 12,555
------------- -------------
Stockholders' equity:
Convertible preferred stock-$0.001; 5,000,000 shares authorized,
zero outstanding at December 31, 1999; 11,100,000 shares
authorized, 7,399,977 outstanding at June 30, 1999 - 10,955
Common stock-$0.001; 100,000,000 shares authorized,
17,714,786 shares outstanding at March 31, 2000;
30,000,000 shares authorized, 4,115,494 outstanding
at June 30, 1999 158,954 4,909
Deferred stock-based compensation (1,467) (2,122)
Accumulated deficit (3,883) (7,943)
Accumulated other comprehensive income 2 -
------------- -------------
Total stockholders' equity 153,606 5,799
------------- -------------
Total liabilities and stockholders' equity $ 165,898 $ 18,354
============ ===========
</TABLE>
(1) Derived from audited consolidated financial statements.
See notes to condensed consolidated financial statements.
3
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NetIQ CORPORATION
Condensed Consolidated Statements Of Operations And Comprehensive Income
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------- --------------------
2000 1999 2000 1999
-------- -------- ------- -------
<S> <C> <C> <C> <C>
Software license revenue $ 8,377 $ 4,978 $21,977 $13,137
Service revenue 2,523 894 5,631 1,972
-------- ------- ------- -------
Total revenue 10,900 5,872 27,608 15,109
-------- ------- ------- -------
Cost of software license revenue 237 287 566 532
Cost of service revenue 514 334 1,329 894
-------- ------- ------- -------
Total cost of revenue 751 621 1,895 1,426
-------- ------- ------- -------
Gross profit 10,149 5,251 25,713 13,683
Operating expenses:
Sales and marketing 5,382 3,038 14,357 8,027
Research and development 2,166 962 5,754 2,652
General and administrative 865 974 2,371 2,239
Stock-based compensation 172 330 525 1,355
Write-off of acquired in-process
research and development costs 706 - 706 -
Amortization of goodwill and intangibles 18 - 18 -
-------- ------- ------- -------
Total operating expenses 9,309 5,304 23,731 14,273
-------- ------- ------- -------
Income (loss) from operations 840 (53) 1,982 (590)
Interest income (expense):
Interest income 2,205 57 3,488 119
Interest expense and other (4) (25) (33) (30)
Foreign exchange loss (123) - (112) -
-------- ------- ------- -------
Interest income, net 2,078 32 3,343 89
-------- ------- ------- -------
Income (loss) before income taxes 2,918 (21) 5,325 (501)
Income taxes 764 - 1,265 -
-------- ------- ------- -------
Net income (loss) 2,154 (21) 4,060 (501)
-------- ------- ------- -------
Other comprehensive income:
Foreign currency translation adjustments 81 - 82 -
Unrealized loss on short-term investments (109) - (80) -
-------- ------- ------- -------
Comprehensive income (loss) $ 2,126 $ (21) $ 4,062 $ (501)
======== ======= ======= =======
Basic net income (loss) per share $ 0.12 $ (0.01) $ 0.27 $ (0.15)
Shares used to compute basic
net income (loss) per share 17,544 3,582 14,974 3,294
Diluted net income (loss) per share $ 0.11 $ (0.01) $ 0.23 $ (0.15)
Shares used to compute diluted
net income (loss) per share 19,259 3,582 17,584 3,294
</TABLE>
See notes to condensed consolidated financial statements.
4
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NetIQ CORPORATION
Condensed Consolidated Statements Of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
March 31,
--------------------
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 4,060 $ (501)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Write-off of acquired in-process research and development costs 706 -
Depreciation and amortization 613 271
Stock-based compensation 525 1,355
Stock issued in lieu of compensation 80 -
Loss on sale of property and equipment 1 8
Changes in:
Accounts receivable 83 (711)
Prepaid expenses (3) 21
Accounts payable 373 796
Accrued compensation and related benefits 1,835 11
Other liabilities 1,607 542
Deferred revenue 3,584 1,642
--------- --------
Net cash provided by operating activities 13,464 3,434
========= ========
Cash flows from investing activities:
Purchases of property and equipment (1,233) (792)
Proceeds from sales of property and equipment - 11
Purchase of Sirana Software, Inc., net of cash acquired (393) -
Purchases of short-term investments (307,267) -
Proceeds from maturities of short-term investments 159,550 -
Other assets (2,581) (9)
---------- --------
Net cash used in investing activities (151,924) (790)
========== ========
Cash flows from financing activities:
Repayments on short-term debt (1,724) -
Proceeds from borrowings - 5,433
Repayments on long-term debt (349) (48)
Proceeds from sale of common stock, net of expenses 136,353 178
---------- --------
Net cash provided by financing activities 134,280 5,563
---------- --------
Effect of exchange rate changes 69 -
---------- --------
Net increase (decrease) in cash and cash equivalents (4,111) 8,207
Cash and cash equivalents, beginning of period 9,634 3,358
----------- --------
Cash and cash equivalents, end of period $ 5,523 $ 11,565
=========== ========
Noncash investing and financing activities:
Conversion of preferred stock to common stock $ 10,955 $ -
Benefit from disqualifying dispositions of common stock $ 693 $ -
Supplemental disclosure of cash flow information-cash paid for:
Interest $ 125 $ 13
Income taxes $ 191 $ 37
</TABLE>
See notes to condensed consolidated financial statements.
5
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NetIQ CORPORATION
Notes To Condensed Consolidated Financial Statements
Nine Months Ended March 31, 2000 and 1999
(Unaudited)
1. Basis of Presentation
Interim Financial Information - The accompanying unaudited condensed
consolidated financial statements of NetIQ Corporation (the Company) have been
prepared in accordance with generally accepted accounting principles for interim
financial information and the rules and regulations of the Securities and
Exchange Commission for interim financial statements. In the opinion of
management, the condensed consolidated financial statements include all
adjustments (consisting only of normal recurring accruals) that management
considers necessary for a fair presentation of its financial position, operating
results and cash flows for the interim periods presented. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Operating results and cash flows for interim periods are not necessarily
indicative of results for the entire year.
These interim financial statements and notes should be read in conjunction
with the audited consolidated financial statements and notes thereto included in
the Company's Annual Report on Form 10-K for the year ended June 30, 1999.
2. Business Combinations
On March 10, 2000 the Company acquired all outstanding shares of Sirana
Software, Inc. (Sirana) for 27,438 shares of common stock and cash valued at
approximately $2.5 million plus approximately $200,000 of direct merger costs,
for a total purchase price of approximately $2.7 million. Sirana is a developer
of web-based enterprise analysis and reporting solutions for Microsoft
BackOffice.
The acquisition was accounted for as a purchase and, accordingly, the results
of operations of Sirana from the date of acquisition have been included in the
Company's consolidated financial statements. In connection with the
acquisition, intangible assets of approximately $2.6 million were acquired, of
which $706,000 was reflected as a one-time charge to operations for the write-
off of purchased in-process technology that had not reached technological
feasibility and, in management's opinion, had no probable alternative future
use, and is reflected in the Company's condensed consolidated statement of
operations for the three and nine months ended March 31, 2000, within operating
expenses. The remaining intangible assets of approximately $1.9 million, is
comprised primarily of goodwill, and is included in other assets in the
accompanying condensed consolidated balance sheets and is being amortized over
five years.
6
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In connection with the acquisition, net assets acquired were as follows (in
thousands):
<TABLE>
<S> <C>
Current assets $ 20
Property and equipment, net 52
Intangible assets, including in-process research and development costs 2,655
Liabilities assumed (40)
-------
Net assets acquired $ 2,687
=======
</TABLE>
The following unaudited pro forma information shows the results of operations
for the nine months ended March 31, 2000 and 1999, as if the Sirana acquisition
had occurred at the beginning of the earliest period presented and at the
purchase price established in March 2000 (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
Nine Months Ended
March 31,
-----------------
2000 1999
------ ------
<S> <C> <C>
Total revenue $ 27,624 $15,109
Net income (loss) $ 4,247 $ (828)
Basic net income (loss) per share $ 0.28 $ (0.25)
Diluted net income (loss) per share $ 0.24 $ (0.25)
</TABLE>
The pro forma results for the nine months ended March 31, 2000 exclude the
$706,000 charge for purchased in-process technology, as it is a non-recurring
charge and include amortization of intangible assets. The pro forma results for
the nine months ended March 31, 1999 include amortization of intangible assets
though Sirana was incorporated in May 1999.
The pro forma information is presented for illustrative purposes only and is
not necessarily indicative of the operating results that would have occurred if
the acquisition had been consummated at the beginning of the earliest period
presented, nor is it necessarily indicative of future operating results.
Acquisition of Mission Critical Software, Inc.
On February 26, 2000 the Company entered into a merger agreement with Mission
Critical Software, Inc. (Mission Critical) and agreed to issue 0.9413 shares for
each share of Mission Critical common stock. Mission Critical is a provider of
systems administration and operations management software products for corporate
and Internet-based Windows NT and Windows 2000 networks. Shareholders approved
the merger in a special meeting on May 11, 2000 and on May 12, 2000, the merger
was completed and NetIQ issued approximately 18.8 million shares of common stock
for all the outstanding shares of Mission Critical. The merger will be
accounted for as a purchase.
In April 2000, Mission Critical acquired all of the outstanding capital stock
of Ganymede Software Inc. (Ganymede). Ganymede is a developer of network and
application performance management solutions.
7
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(Ganymede) for consideration preliminary valued at $175.4 million, consisting of
Mission Critical common stock and stock options valued at $171.2 million, and
estimated direct acquisition costs of $4.2 million. The acquisition was
completed in April 2000 and was accounted for as a purchase. Ganymede is a
developer of network and application performance management solutions.
3. Short-term Investments
Short-term investments consist primarily of highly liquid debt instruments
purchased with remaining maturity dates of greater than 90 days. Short-term
investments are classified as available-for-sale securities and are stated at
market value with unrealized gains and losses included in stockholders' equity
in accumulated other comprehensive income, net of income taxes.
4. Income Taxes
Deferred tax assets and liabilities are recorded for the expected future tax
consequences of temporary differences between the financial statement carrying
amounts and the tax bases of assets and liabilities. A valuation allowance is
recorded to reduce net deferred tax assets to amounts that are more likely than
not to be recognized. The income tax provision for the period ended March 31,
2000 reflects the expected tax expense based on the projected effective tax rate
for fiscal year 2000.
5. Foreign Currency Translation
Prior to July 1, 1999, the functional currency of our foreign subsidiaries was
the U.S. dollar. For those subsidiaries whose books and records were not
maintained in the functional currency, all monetary assets and liabilities were
remeasured at the current exchange rate at the end of each period reported,
nonmonetary assets and liabilities were remeasured at historical exchange rates
and revenues and expenses were remeasured at average exchange rates in effect
during the period. Transaction gains and losses, which are included in general
and administrative expenses in the accompanying condensed consolidated
statements of operations, have not been significant.
Effective July 1, 1999 the Company determined that the functional currencies
of the foreign subsidiaries changed from the U.S. dollar to the local
currencies. Accordingly, starting July 1, 1999, assets and liabilities of the
foreign subsidiaries are translated to U.S. dollars at the exchange rates in
effect as of the balance sheet date and results of operations for each
subsidiary are translated using average rates in effect for the period
presented. Translation adjustments are included in stockholders' equity as
accumulated other comprehensive income and as part of our comprehensive income
or loss. The effect of the change in functional currencies did not have a
material impact on our consolidated financial position, results of operations or
cash flows.
6. Net Income (Loss) Per Share
Basic net income (loss) per share is computed by dividing net income by the
number of weighted average common shares outstanding. Diluted net income per
share reflects potential dilution from preferred shares and outstanding stock
options using the treasury stock method.
8
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The following is a reconciliation of weighted average shares used in computing
net income (loss) per share for the three- and nine-months ended March 31, 2000
and 1999 (in thousands):
<TABLE>
<CAPTION>
Three months ended Nine months ended
March 31, March 31,
------------------ -----------------
2000 1999 2000 1999
----- ---- ---- ----
<S> <C> <C> <C> <C>
Weighted average common shares
outstanding 17,562 3,761 14,996 3,503
Weighted average common shares
outstanding subject to repurchase (18) (179) (72) (209)
------ ------ ------ -----
Shares used in computing basic
net income (loss) per share 17,544 3,582 14,974 3,294
====== ===== ====== =====
Weighted average common shares
outstanding 17,562 14,996
Dilutive effect of options outstanding 1,697 1,780
Dilutive effect of preferred shares
outstanding -- 780
Dilutive effect of warrants outstanding -- 28
------ ------
Shares used in computing diluted
net income per share 19,259 17,584
====== ======
</TABLE>
The Company had a net loss for the three- and nine-months ended March 31,
2000; therefore shares used in computing diluted net loss per share are equal to
shares used for computing basic net loss per share.
6. Public Offerings
In July 1999, the Company sold 3,000,000 shares of common stock in an
underwritten public offering and in August 1999 sold an additional 450,000
shares through the exercise of the underwriters' over-allotment option for net
proceeds of approximately $40.4 million. Simultaneously with the closing of the
public offering, all 7,399,977 shares of the Company's preferred stock were
converted to common stock on a share for share basis. Additionally, Compuware
Corporation exercised its warrant in full and purchased 280,025 shares of common
stock. Proceeds from the warrant and cash of $1.8 million were used to pay off
the $5.0 million note plus accrued interest due to Compuware and cash of
$349,000 was used to pay off the equipment note to a financial institution.
In December 1999, the Company sold 1,500,000 shares of common stock in an
underwritten offering for net proceeds of approximately $75.5 million.
In January 2000, the underwriters exercised their over-allotment option and
the Company issued 387,000 additional shares for net proceeds of approximately
$19.6 million.
9
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ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with our Condensed
Consolidated Financial Statements and the Notes thereto. This discussion
contains forward-looking statements based upon current expectations that involve
risks and uncertainties, such as our plans, objectives, expectations and
intentions. Our actual results and the timing of events could differ materially
from those anticipated in these forward-looking statements as a result of
several factors, including those set forth in the following discussion and under
"Factors That May Affect Future Results" and elsewhere in this report on Form
10-Q.
Overview
We provide eBusiness infrastructure management software that allows businesses
to optimize the performance and availability of their Windows NT and Windows
2000-based systems and applications.
From our incorporation in June 1995 until the first sales of AppManager in
February 1997, we were principally engaged in development-stage activities,
including product development, sales and marketing efforts and recruiting
qualified management and other personnel. Our total revenue has grown from $0.4
million in fiscal 1997, to $7.1 million in fiscal 1998 and to $21.6 million in
fiscal 1999, and from $5.9 million and $15.1 million in the three and nine
months ended March 31, 1999, to $10.9 million and $27.6 million in the three and
nine months ended March 31, 2000. This rapid revenue growth reflects our
relatively early stage of development, and we do not expect revenue to increase
at the same rate in the future.
Operating expenses grew from $2.7 million in fiscal 1997 to $9.8 million in
fiscal 1998 and to $21.3 million in fiscal 1999, and from $5.3 million and $14.3
million in the three and nine months ended March 31, 1999 to $9.3 million and
$23.7 million in the three and nine months ended March 31, 2000. Our operating
expenses increased as we expanded our operations, including growing our employee
base from 14 at June 30, 1996 to 133 at June 30, 1999 and to 203 at March 31,
2000. Our operating expenses, which include charges for stock-based
compensation and a charge for settlement of litigation in fiscal 1999, together
with cost of revenue have exceeded revenue in every quarter since inception
except the three most recent quarters ended March 31, 2000. This reflects our
strategy to make the investments necessary to capture market share and grow
revenue as quickly as possible, while maintaining a high level of fiscal
control, product quality and customer satisfaction. Our cumulative losses have
resulted in an accumulated deficit of $3.9 million at March 31, 2000.
We have derived the large majority of our revenue from software licenses. We
also derive revenue from sales of annual maintenance service agreements and, to
a lesser extent, consulting and training services. Service revenue has
increased in each quarter as license revenue has increased and as the size of
our installed base has grown. We expect service revenue to increase as a
percentage of total revenue in the future and, as a consequence, our cost of
service revenue to increase in absolute dollars.
10
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The pricing of the AppManager suite is based on the number of systems and
applications managed, although volume and enterprise pricing is also available.
Our customers typically purchase one year of product software maintenance with
their initial license of our products. Thereafter, customers are entitled to
receive software updates, maintenance releases and technical support for an
annual maintenance fee equal to a fixed percentage of the current list price of
the licensed product.
Cost of software license revenue, as a percentage of software license revenue,
has increased from 2% in fiscal 1997 to 4% in fiscal 1998 and fiscal 1999 and
declined from 6% and 4% in each of the three and nine months ended March 31,
1999 to 3% in each of the three and nine months ended March 31, 2000. Cost of
service revenue, as a percentage of service revenue, has declined from 242% in
fiscal 1997 to 87% in fiscal 1998 and 40% in fiscal 1999 and from 37% and 45% in
the three and nine months ended March 31, 1999 to 20% and 24% in the three and
nine months ended March 31, 2000. Although service revenue has increased as a
percentage of total revenue from 5% in fiscal 1997 to 7% in fiscal 1998 to 15%
in fiscal 1999 and from 15% and 13% in the three and nine months ended March 31,
1999 to 23% and 20% in the three and nine months ended March 31, 2000, the
declining cost of service revenue has resulted in an increase in overall gross
margin from 86% in fiscal 1997 to 91% in fiscal 1998 and fiscal 1999 and from
89% and 91% in the three and nine months ended March 31, 1999 to 93% in each of
the three and nine months ended March 31, 2000.
We anticipate that service revenue will increase as a percentage of total
revenue in the future as customers continue to renew maintenance service
contracts and, if we are unable to reduce the costs of service revenue, our
margins may decline.
We sell our products through both our direct sales force, which includes our
field and inside sales personnel, as well as through indirect channels, such as
distributors, value-added resellers and original equipment manufacturers. To
date, the majority of our sales have resulted from the efforts of our field and
inside sales personnel. However, license revenue through our third-party
channel partners represented approximately 10% of total revenue in fiscal 1998
and 32% of total license revenue in fiscal 1999 and 31% of total revenue in the
nine months ended March 31, 2000, and our strategy is to increase sales through
third-party channel partners. Two customers accounted for 45% and 12% of total
revenue in fiscal 1997. During both fiscal 1998 and fiscal 1999 and the nine
months ended March 31, 2000, no single customer accounted for more than 10% of
our total revenue. International sales did not account for any of our revenue
in fiscal 1997, but represented 10% of total revenue in fiscal 1998, 20% of
total revenue in fiscal 1999 and 25% of total revenue in the nine months ended
March 31, 2000. We anticipate that as we expand our international sales
efforts, the percentage of revenue derived from international sources will
continue to increase.
Generally, we sell perpetual licenses and recognize revenue in accordance with
generally accepted accounting principles upon meeting each of the following
criteria:
. Execution of a written purchase order, license agreement or contract;
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. Delivery of software and authorization keys;
. The license fee is fixed and determinable;
. Collectibility of the proceeds within six months is assessed as being
probable; and
. Vendor-specific objective evidence exists to allocate the total fee to
elements of the arrangement.
Vendor-specific objective evidence is based on the price generally charged
when an element is sold separately, or if not yet sold separately, is
established by authorized management. All elements of each order are valued at
the time of revenue recognition. For sales made through our distributors,
resellers and original equipment manufacturers, we recognize revenue at the time
these partners report to us that they have sold the software to the end user and
after all revenue recognition criteria have been met.
Acquisition of Sirana Software, Inc.
On March 10, 2000 the Company acquired all outstanding shares of Sirana
Software, Inc. (Sirana) for 27,438 shares of common stock and cash valued at
approximately $2.5 million plus approximately $200,000 of direct merger costs,
for a total purchase price of approximately $2.7 million. Sirana is a developer
of web-based enterprise analysis and reporting solutions for Microsoft
BackOffice.
Acquisition of Mission Critical Software, Inc.
On February 26, 2000 the Company entered into a merger agreement with Mission
Critical Software, Inc. (Mission Critical) and agreed to issue 0.9413 shares for
each share of Mission Critical common stock. Mission Critical is a provider of
systems administration and operations management software products for corporate
and Internet-based Windows NT and Windows 2000 networks. Shareholders approved
the merger in a special meeting on May 11, 2000 and on May 12, 2000, the merger
was completed and NetIQ issued approximately 18.8 million shares of common stock
for all the outstanding shares of Mission Critical. The merger will be
accounted for as a purchase.
In April 2000, Mission Critical acquired all of the outstanding capital stock
of Ganymede Software Inc. (Ganymede). Ganymede is a developer of network and
application performance management solutions.
Other
In September 1996, Compuware Corporation filed a complaint against us alleging
misappropriation of trade secrets, copyright infringement, unfair competition
and other claims. Compuware asserted these claims after a number of prior
Compuware employees founded our company or later joined us as officers and
employees. A settlement of these claims was reached in January 1999 and final
documentation was entered into and the claims dismissed in March 1999. Prior to
reaching a settlement with Compuware, we incurred significant expenses related
to
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the litigation, primarily relating to legal fees, and management attention
was partially diverted to this litigation matter. As part of the settlement in
March 1999, Compuware loaned us $5.0 million, subordinated to our bank credit
facility, with interest at 6% per year. Additionally, as part of the settlement
in March 1999, we issued Compuware a warrant to purchase 280,025 shares of
common stock at 90% of the per share sale price of shares sold to investors in
our initial public offering. Compuware exercised the warrant in full upon the
closing of our initial public offering, paying $11.70 per share and sold all of
their shares in the follow-on public offering in December 1999. Pursuant to the
completion of our initial public offering we paid approximately $1.8 million to
satisfy our note and interest obligation to Compuware, and the remaining $3.3
million was cancelled in connection with Compuware's exercise of the warrant.
Additionally, as part of our settlement agreement, we agreed not to hire
personnel from Compuware until after December 31, 1999, or release any systems
management software for managing UNIX systems on or before December 31, 1999.
Comparison of the Three and Nine Months Ended March 31, 2000 and 1999
Revenue
Software License Revenue - Software license revenue increased from $5.0 million
and $13.1 million for the three and nine months ended March 31, 1999, to $8.4
million and $22.0 million for the three and nine months ended March 31, 2000,
representing growth of 68% and 67% during the respective periods. This increase
was due primarily to increases in the number of software licenses sold,
reflecting increased acceptance of our AppManager products and expansion of our
field and inside sales organizations and our third-party channel partners.
Service Revenue - Service revenue increased from $894,000 and $2.0 million for
the three and nine months ended March 31, 1999 to $2.5 million and $5.6 million
for the three and nine months ended March 31, 2000, representing growth of 182%
and 186%. This increase was due primarily to maintenance fees associated with
new software licenses. Service revenue also increased as a percentage of total
revenue due to the compounding effect of our base of installed licenses and due
to a significant majority of our customers renewing their maintenance service
agreements.
Cost of Revenue
Cost of Software License Revenue - Cost of software license revenue includes the
costs associated with software packaging, documentation, such as user manuals
and CDs, and production, as well as non-employee commissions and royalties. Our
cost of software license revenue has changed from $287,000 and $532,000, or 6%
and 4% of software license revenue, for the three and nine months ended March
31, 1999, to $237,000 and $566,000, or 3% of software license revenue, for each
of the three and nine months ended March 31, 2000. The increase in absolute
dollar amount was due principally to increases in software license revenue. The
decrease in percentage is due to leveraging the fixed costs over a larger
revenue base.
Cost of Service Revenue - Cost of service revenue consists primarily of
personnel costs and expenses incurred in providing telephonic and on-site
maintenance services, consulting services and training. Cost of
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service revenue was $334,000 and $894,000, and $514,000 and $1,329,000 for the
three and nine months ended March 31, 1999 and 2000, respectively, representing
37% and 45%, and 20% and 24% of service revenue, respectively. The increase in
dollar amount of cost of service revenue is primarily attributable to the growth
in our installed customer base. Cost of service revenue as a percentage of
service revenue declined due primarily to economies of scale achieved as our
revenue and installed base have grown. We expect service revenue to increase as
a percentage of total revenue as our installed license base grows and, as a
consequence, our cost of service revenue to increase in absolute dollars.
Operating Expenses
Sales and Marketing - Sales and marketing expenses consist primarily of
personnel costs, including salaries and commissions, as well as expenses
relating to travel, advertising, public relations, seminars, marketing programs,
trade shows and lead generation activities. Sales and marketing expenses
increased from $3.0 million and $8.0 million for the three and nine months ended
March 31, 1999, to $5.4 million and $14.4 million for the three and nine months
ended March 31, 2000. This increase in dollar amount was due primarily to the
hiring of additional field sales, inside sales and marketing personnel, which
increased from 56 people at March 31, 1999 to 102 people at March 31, 2000, and
expanding our sales infrastructure and third-party channel partners. Sales and
marketing expenses represented 53% and 52% of total revenue for the nine months
ended March 31, 1999 and 2000, respectively. We expect to continue hiring
additional sales and marketing personnel and to increase promotion, advertising
and other marketing expenditures in the future. Accordingly, we expect sales
and marketing expenses will increase in absolute dollars in future periods.
Research and Development - Research and development expenses consist primarily
of salaries and other personnel-related costs, as well as facilities costs,
consulting fees and depreciation. These expenses increased from $962,000 and
$2.7 million or 16% and 18% of total revenue, respectively, for the three and
nine months ended March 31, 1999, to $2.2 million and $5.8 million, or 20% and
21%, of total revenue in the three and nine months ended March 31, 2000. This
increase in dollar amount resulted principally from increases in engineering and
technical writing personnel, which increased from 37 people to 65 people at the
end of each period, together with increases in third party development effort.
To date, all research and development costs have been expensed as incurred in
accordance with Statement of Financial Accounting Standards (SFAS) No. 86 as our
current software development process is essentially completed concurrent with
the establishment of technological feasibility. We expect to continue to devote
substantial resources to product development such that research and development
expenses will increase in absolute dollars in future periods.
General and Administrative - General and administrative expenses consist
primarily of personnel costs for finance and administration, information systems
and human resources, as well as professional services expenses such as legal and
accounting, and costs related to being a public company. General and
administrative expenses changed from $974,000 and $3.2 million for the three and
nine months ended
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March 31, 1999, to $865,000 and $2.4 million for the three and
nine months ended March 31, 2000. General and administrative expenses
represented 17% and 15% of total revenue for the three and nine months ended
March 31, 1999 and 8% and 9% of total revenue for the three and nine months
ended March 31, 2000. The increase in dollar amount was due primarily to
increased staffing necessary to manage and support our growth and expenses
related to being a public company. General and administrative personnel
increased from 13 at March 31, 1999, to 22 at March 31, 2000. Legal expense was
a significant cost for the nine months ended March 31, 1999, amounting to
$897,000 principally due to the Compuware litigation, for which a settlement was
reached in January 1999 and final documentation was entered into and the claims
dismissed in March 1999. The decrease in general and administrative expense as
a percentage of total revenue was due primarily to the growth in total revenue
and the decline in legal expense to $186,000 for the nine months ended March 31,
2000. We believe that our general and administrative expenses will increase in
absolute dollars as we expand our administrative staff, add new financial and
accounting software systems, and incur additional costs related to being a
public company, such as expenses related to directors' and officers' liability
insurance, investor relations, stock administration programs and increased
professional fees.
Stock-Based Compensation - During the three and nine months ended March 31,
1999, we recorded deferred stock-based compensation of $767,000 and $2.7 million
relating to stock option grants to employees and non-employees. No deferred
stock-based compensation was recorded in the three and nine months ended March
31, 2000. However, due to employee attrition, approximately $4,000 and $130,000
of the deferred stock-based compensation was reversed in the three and nine
months ended March 31, 2000. The deferred stock-based compensation is being
amortized over the vesting periods of the granted options, which is generally
four years for employees. During the three and nine months ended March 31, 1999
and 2000, we recognized stock-based compensation expense of $330,000,
$1,355,0000, $172,000 and $525,000, respectively. At March 31, 2000, total
deferred stock-based compensation was $1.5 million. We expect to amortize
approximately $172,000 of deferred stock-based compensation each quarter through
March 31, 2003.
Interest Income (Expense), net - Interest income (expense), net, represents
interest income earned on our cash and cash equivalent balances, interest
expense on our equipment loans and loan subordinated to our bank line of credit,
and loss on foreign exchange transactions. For the three and nine months ended
March 31, 1999 and 2000, interest income (expense), net, was $32,000 and
$89,000, and $2.1 million and $3.3 million, respectively. The increase in
interest income (expense), net is the result primarily of increased cash and
cash equivalent balances due to the proceeds from our public offerings in July
and December 1999.
Income Taxes - We incurred net operating losses during the three and nine months
ended March 31, 1999 and consequently paid no federal, state or foreign income
taxes. We recorded income tax expense of $764,000 and $1.3 million for the
three and nine months ended March 31, 2000, representing the expected effective
tax rate for fiscal year 2000.
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Liquidity and Capital Resources
We have funded our operations through June 30, 1999 primarily through private
sales of preferred equity securities, totaling $11.0 million and, to a lesser
extent, through capital equipment leases and sales of common stock.
In July 1999, we sold 3,000,000 shares of common stock in an underwritten
public offering and in August 1999 sold an additional 450,000 shares through the
exercise of underwriters' over-allotment option for aggregate net proceeds of
approximately $40.4 million.
Proceeds from the initial public offering were used to pay off the short-term
and long-term debts to Compuware and a financial institution.
In December 1999, the Company sold 1,500,000 shares of common stock in an
underwritten offering for net proceeds of approximately $75.5 million. In
January 2000, the underwriters exercised their over-allotment option and the
Company issued 387,000 additional shares for net proceeds of approximately $19.6
million.
Operating activities resulted in net cash inflows of $3.4 million and $13.5
million during the nine months ended March 31, 1999 and 2000, respectively. For
the nine months ended March 31, 1999, net cash provided by operating activities
is attributable to the net loss and increase in accounts receivable being off-
set by depreciation and amortization, stock-based compensation and increased in
accounts payable, other liabilities and deferred revenue. For the nine months
ended March 31, 2000, net cash provided by operating activities is attributable
to net income, increases in accrued compensation, other liabilities, deferred
revenue and write-off of acquired in-process research and developments costs,
depreciation and amortization and stock-based compensation.
Investing activities resulted in net cash outflows, principally related to the
acquisition of capital assets, of $792,000 in the nine months ended March 31,
1999. During the nine months ended March 31, 2000, investing activities
resulted in cash outflows of $147.7 million for net purchases of short-term
investments, acquisition of capital assets of $1.2 million and payment of merger
related expenses of $2.6 million.
Financing activities provided cash of $5.6 million in the nine months ended
March 31, 1999, from Compuware debt of $5.0 million, the equipment loan and the
exercise of stock options. Financing activities provided net cash of $134.3
million in the nine months ended March 31, 2000 principally from our public
offerings, net of cash paid to Compuware and a financial institution to retire
short-term and long-term debt.
At March 31, 2000 we do not have any significant commitments outstanding.
We believe that the net proceeds from our public offerings, together with our
cash balances and cash flow generated by operations will be sufficient to
satisfy our anticipated cash needs for working capital and capital expenditures
for the next 12 months. Thereafter, we may require additional funds to support
our working capital requirements, or for other purposes, and may seek to raise
such additional funds
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through public or private equity financings or from other
sources. We may not be able to obtain adequate or favorable financing at that
time. 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.
From time to time, in the ordinary course of business, we may evaluate potential
acquisitions of businesses, products or technologies.
Factors That May Affect Future Results
Risks Related To Our Merger With Mission Critical Software (MCS)
We may not achieve the benefits we expect from the merger, which may have a
material adverse effect on our business, financial condition and operating
results and/or could result in loss of key personnel.
We will need to overcome significant issues in order to realize any benefits
or synergies from the merger, including the timely, efficient and successful
execution of a number of post-merger events. Key events include:
. Integrating the operations of the two companies
. Retaining and assimilating the key personnel of each company
. Offering the existing products of each company to the other company's
customers
. Retaining existing customers and strategic partners of each company
. Developing new products that utilize the assets and resources of both
companies
. Creating uniform standards, controls, procedures, policies and information
systems.
The successful execution of these post-merger events will involve considerable
risk and may not be successful. These risks include:
. The potential disruption of our ongoing business and distraction of its
management
. The difficulty of incorporating acquired technology and rights into our
products and services
. Unanticipated expenses related to technology integration
. The impairment of relationships with employees and customers as a result of
any integration of new management personnel
. Potential unknown liabilities associated with the merger
We may not succeed in addressing these risks or any other problems encountered
in connection with the merger.
The merger could adversely affect the combined financial results.
We expect to incur direct transaction costs of approximately $19.0 million in
connection with the merger, plus approximately $4.0 million in connection with
the acquisition of Ganymede. If the benefits of the merger do not exceed the
costs associated with the merger, including any dilution to the stockholders of
both companies resulting from the issuance of shares in connection with the
merger, our financial
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results, including earnings per share, could be adversely affected. The
acquisition is being accounted for using the purchase method of accounting. The
purchase price will be allocated to assets and liabilities of MCS and Ganymede
and such assets and liabilities will be recorded at their respective fair values
upon completion of the valuation study. A portion of the purchase price may be
identified as in-process research and development. This amount, if any, will be
charged to our operations in the fourth quarter of fiscal 2000 as the
acquisition accounting and valuation amounts are finalized. The remaining
purchase price will be reflected as goodwill and other intangible assets, which
will be amortized to expense over several years. The results of operations and
cash flows of MCS and Ganymede will be included in our financial statements
prospectively as of the consummation of the merger.
The market price of our common stock may decline as a result of the merger.
The market price of our common stock may decline as a result of the merger for
a number of reasons including if:
. The integration with MCS is unsuccessful;
. We do not achieve the perceived benefits of the merger as rapidly or to the
extent anticipated by financial or industry analysts; or
. The effect of the merger on our financial results is not consistent with the
expectations of financial or industry analysts.
Risks Related To The Combined Companies
We may not be able to sustain the revenue growth rates previously experienced by
MCS and us individually.
Although MCS' and our revenues have grown rapidly in recent years, it is not
anticipated that on a combined basis we will experience this rate of revenue
growth because of the difficulty of maintaining high percentage increases as the
base of revenue increases. In addition, growing competition, the incremental
manner in which customers convert their networks to Windows NT and Windows 2000
("Windows NT/2000") and our relatively small sales organizations could also
affect our revenue growth. If our revenue does not increase at or above the
rate analysts expect, the trading price for our common stock may decline.
Additionally, our efforts to expand our software product suites, sales and
marketing activities, direct and indirect distribution channels and maintenance
and support functions and to pursue strategic relationships or acquisitions may
not succeed or may prove more expensive than our anticipation. As a result, we
cannot predict the company's future operating results with any degree of
certainty and the our quarterly operating results may vary significantly from
quarter to quarter. We also believe that our future growth rates will depend on
our ability to expand our penetration of existing markets, which will require
significant expenses that we may not have sufficient resources to undertake.
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MCS and we each have a history of losses and we may experience losses in the
future.
Since the inceptions of MCS and us, both have incurred significant net losses.
MCS has achieved only marginal profitability in the fiscal year ended June 30,
1999 and the three most recent quarters ended March 31, 2000. We have achieved
only marginal profitability in the three most recent quarters ended March 31,
2000. It is expected that we will continue to incur significant sales and
marketing, product development and administrative expenses, as well as
significant amortization of goodwill created in the merger. As a result, we
will need to generate significant revenue to maintain profitability before
amortization of goodwill, and it is unlikely to generate profits after inclusion
of the goodwill amortization until the goodwill is fully amortized. We cannot
be certain that we will achieve, sustain or increase profitability in the
future, with or without goodwill amortization. Any failure to significantly
increase our revenue as we implement our product and distribution strategies
would materially adversely affect our business, operating results and financial
condition.
Unanticipated fluctuations in our quarterly operating results due to such
factors as change in the demand for our AppManager and MCS' OnePoint products
and changes in the market for Windows NT/2000 and related products could affect
our stock price.
We believe that quarter-to-quarter comparisons of each of our individual
financial results are not necessarily meaningful indicators of our future
operating results and should not be relied on as an indication of our future
performance. If our quarterly operating results fail to meet the expectations
of analysts, the trading price of our common stock could be negatively affected.
Each of MCS' and our quarterly operating results have varied substantially in
the past and those of we may vary substantially in the future depending upon a
number of factors described below, including many that are beyond our control.
These factors include:
. Changes in demand for AppManager and OnePoint products or for applications
management software solutions generally, including any changes in demand for
Windows NT/2000-based systems and applications
. Increased competition in general and any changes in our pricing policies,
relative to the historical policies of MCS and NetIQ individually, that may
result from increased competitive pressures
. Varying budgeting cycles of our customers and potential customers
. Varying size, timing and contractual terms of enterprise-wide orders for our
products
. Our ability to develop and introduce on a timely basis new or enhanced
versions of its products
. Potential downturns in our customers' businesses in the domestic or
international economies
. Changes in the mix of revenue attributable to domestic and international
sales
. Software defects and other product quality problems
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. Changes in the mix of revenue attributable to higher-margin software license
revenue as opposed to substantially lower-margin service revenue
. The rate of expansion of our sales and support organizations and
Changes in the historically strong relationships of MCS and NetIQ with
Microsoft
We cannot be certain that our business strategy will be successful or that it
will successfully manage these risks. If we fail to address adequately any of
these risks or difficulties, our business would likely suffer.
New competitors could emerge and this could impair our ability to grow our
business and sell its products.
We believe the principal factors that will draw end-users to a systems
management software product include: a depth of product functionality; the
ability to work natively with Windows NT/2000; scalability; product quality and
performance, conformance to industry standards, competitive price and customer
support. To be competitive, we must respond promptly and effectively to the
challenges of technological change, evolving standards and its competitors'
innovations by continuing to enhance its products and sales channels.
We may face competition in the future from established companies who have not
previously entered the market for applications management software for
optimizing the performance, availability and security of Windows NT/2000-based
systems and applications as well as from emerging companies. Barriers to entry
in the software market are relatively low. Established companies may not only
develop their own Windows NT/2000-based applications management solutions, but
they may also acquire or establish cooperative relationships with our expected
competitors. It is possible that new competitors or alliances among competitors
may emerge and rapidly acquire significant market share. If those future
competitors are successful, we is likely to lose market share and its revenue
would likely decline.
We may also face competition from Microsoft in the future. Microsoft may
enter the market for managing the performance, availability and security of
Windows NT/2000-based systems and applications in the future. This could
materially adversely affect our competitive position and hurt our ability to
sell our products. As part of its competitive strategy, Microsoft could bundle
applications management software with its Windows NT/2000 operating system
software, which could discourage potential customers from purchasing our
products. We also believe that Microsoft, or systems management software
vendors, each of which is also currently competing with them, could enhance
their products to include the functionality that we will provide in our
products. If these vendors include such functionality as standard features of
their products, our software solutions could become obsolete. Even if the
standard features of future Microsoft operating system software were more
limited than those of our products, a significant number of customers or
potential customers might elect to accept more limited functionality in lieu of
purchasing additional software. Moreover, competitive pressures resulting from
this type of bundling could lead to price reductions for our products, which
would reduce its profit margins.
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Potential third party competition could also create bundling or compatibility
issues and adversely affect our ability to sell its products. In addition to
Microsoft, other potential competitors may bundle their products or incorporate
applications management software for optimizing the performance, availability
and security of Windows NT/2000-based systems and applications into existing
products, including for promotional purposes. In addition, our ability to sell
our products will depend, in part, on the compatibility of our products with
other third party products, such as messaging, Internet and database
applications. Some of these third party software developers may change their
products so that they will no longer be compatible with our products. If our
competitors bundled their products in this manner or made their products
incompatible with ours, this could materially adversely affect our ability to
sell our products and could lead to price reductions for our products that could
reduce our profit margins.
New product introductions and pricing strategies by our competitors could
adversely affect our ability to sell our products or could result in pressure to
price our products in a manner that reduces our margins.
We may not be able to compete successfully against our competitors and this
could impair our ability to sell our products. The market for applications
management software to help optimize the performance, availability and security
of Windows NT/2000-based systems and applications is new, rapidly evolving and
highly competitive, and we expects competition in this market to persist and
intensify. New products for this market are frequently introduced and existing
products are continually enhanced. Competition may also result in changes in
pricing policies by us or our competitors that could hurt our ability to sell
our products and could adversely affect our profits. Many of our anticipated
competitors have greater financial, technical, marketing, professional services
and other resources than us. As a result, they may be able to respond more
quickly to new or emerging technologies and changes in customer requirements.
They may also be able to devote greater resources to the development, promotion
and sale of their products than we can. Many of these companies have an
extensive customer base and broad customer relationships, including
relationships with many of our current and potential customers. If we are
unable to respond as quickly or effectively to changes in customer requirements
as our competition, our ability to grow our business and sell our products will
be negatively affected.
We will need to expand our field sales and inside sales organizations and
increase our channel partners to grow our business and increase sales of our
products.
Because we rely heavily on our field sales and inside sales organizations, any
failure to expand those organizations could limit our ability to sell our
products and expand our market share. Our products and maintenance services
will require a sophisticated sales effort targeted at people within our
customers' information technology departments. It is expected that we will
significantly expand our field sales efforts in the U.S. and internationally.
Despite these efforts, we may experience difficulty in recruiting and retaining
qualified field and inside sales personnel. To date, MCS has not significantly
utilized systems integrators or consulting service
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providers in its selling efforts for its software products. It is expected that
we will explore relationships with systems integrators and explore cross-selling
products into NetIQ's consulting service provider partner network, but we have
little or no experience negotiating agreements with systems integrators and no
test marketing of MCS' products has been done to date with NetIQ's consulting
service provider partners. Our business and sales may suffer if we fail to enter
into agreements with systems integrators or fail to achieve significant sales
through our consulting service provider partners or if we fail to successfully
and profitably negotiate and perform our obligations under new and existing
agreements. In addition, our revenue could decline if selling our products
through systems integrators or consulting service providers results in lower
margins per license and those sales replace a substantial portion of our direct
sales.
Our success will depend on the expansion of our distribution channels.
Our ability to sell our products in new markets and to increase our share of
existing markets will be impaired if we fail to significantly expand our
distribution channels. Our sales strategy requires establishing multiple
indirect marketing channels in the United States and internationally through
value added resellers, systems integrators, distributors and original equipment
manufacturers, and requires that we increase the number of customers licensing
our products through these channels. Moreover, our channel partners must market
our products effectively and be qualified to provide timely and cost-effective
customer support and service. If they are unable to do so, this could harm our
ability to increase revenue.
Currently, our North American resellers order our products through Tech Data
Corporation, which is currently our sole North American distributor. As a
combined company, we intend to add additional U.S. and international
distributors, but may not be able to do so and may not be able to maintain our
existing relationship with Tech Data. Sales of our products through Tech Data
accounted for approximately $1,163,000, or 6%, of software license revenue for
fiscal 1999 and $2.0 million, or 9% of software license revenue for nine months
ended March 31, 2000, respectively. Our agreement with Tech Data is for
successive one-year terms that expire each June, but is subject to automatic
one-year renewals unless either party provides a termination notice prior to the
renewal date. Either party to the distribution agreement may terminate the
contract upon 30 days written notice to the other party. Our current agreement
with Tech Data does not prevent Tech Data from selling products of other
companies, including those of our competitors, and does not require that Tech
Data purchase minimum quantities of our products. Tech Data and any of our
future distributors could give higher priority to the products of other
companies than they would give to our products. As a result, any significant
reduction in sales volume through any of our future distribution partners could
lower our revenue. In addition, sales through these channels generally have
lower costs than direct sales and any significant decrease in sales through
these channels could also lower our gross margins. Furthermore, our
relationships with our distribution partners may not generate enough revenue to
offset the significant resources used to develop these channels.
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If the markets for Windows NT/2000 and applications management software for
these systems and applications do not continue to develop as we anticipate, our
ability to grow our business and sell our products will be adversely affected.
Windows NT/2000. AppManager and OnePoint are designed to support Windows
NT/2000-based systems and applications and it is anticipated that our products
will be dependent on the Windows market for the foreseeable future. If the
market for Windows 2000 does not develop or develops more slowly than we
currently anticipate, this would materially adversely affect our ability to grow
our business, sell our products, and maintain profitability. In addition, users
of previous versions of Windows NT may decide to migrate to an operating system
other than Windows 2000 due to improved functionality of some other vendor's
operating system. Windows 2000 may address more of the needs of its customers
for systems administration and operations management, in which case our
customers would not need to purchase our products to perform those functions.
Although the market for Windows NT/2000-based systems has grown rapidly in
recent periods, this growth may not continue at the same rate, or at all.
If there is broader acceptance of other existing or new operating systems that
provide enhanced capabilities or offer similar functionality to Windows NT/2000
at a lower cost, our business would likely suffer.
Applications Management Software for Windows NT/2000. The market for
applications management software for optimizing the performance and availability
of Windows NT/2000-based systems and applications may not develop or may grow
more slowly than we anticipate, and this could materially adversely affect our
ability to grow our business, sell our products, and achieve and maintain
profitability. The rate of acceptance of our products is dependent upon the
increasing complexity of businesses' Windows NT/2000 environments as these
businesses deploy additional servers and applications using this operating
system. Many companies have been addressing their applications management needs
for Windows NT/2000-based systems and applications internally and only recently
have become aware of the benefits of third-party solutions as their needs have
become more complex. Our future financial performance will depend in large part
on the continued growth in the number of businesses adopting third party
applications management software products and their deployment of these products
on an enterprise-wide basis.
The lengthy sales cycle for our products makes our revenues susceptible to
fluctuations.
The delay or failure to complete sales, especially large, enterprise-wide
sales, in a particular quarter or calendar year could reduce our quarterly and
annual revenue. We have traditionally focused sales of our products to
workgroups and divisions of a customer, resulting in a sales cycle ranging
between 90 and 180 days. The sales cycle associated with the purchase of our
products is subject to a number of significant risks over which we has little or
no control, including:
. Customers' budgetary constraints and internal acceptance procedures
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. Concerns about the introduction or announcement of our or our competitors'
new products, including product announcements by Microsoft relating to
Windows NT/2000
. Customer requests for product enhancements
It is expected that we will offer a broader range of products that may require
increased selling effort for the customer's entire enterprise than has
historically been true of either MCS or NetIQ. The sales cycle for these
enterprise-wide sales typically can be significantly longer than the sales cycle
for smaller-sized departmental sales. Enterprise-wide sales of our products
require an extensive sales effort throughout a customer's organization because
decisions to license and deploy this type of software generally involves the
evaluation of the software by many people, in various functional and geographic
areas, each of whom may have specific and conflicting requirements. This
evaluation process often requires significant efforts to educate information
technology decision-makers about the benefits of our products for the Windows
NT/2000 environment. In addition, enterprise-wide deployments could also erode
per-user license fees even though average sales prices might increase.
We have each experienced significant growth in our respective businesses in
recent periods and our ability to manage this growth and any future growth will
affect our ability to maintain profitability.
Our ability to maintain profitability will depend in part on our ability to
implement and expand operational, customer support and financial control systems
and to train and manage our employees. We may not be able to augment or improve
existing systems and controls or implement new systems and controls in response
to future growth, if any. In addition, we will need to expand our facilities to
accommodate the growth in our personnel. Any failure to manage growth could
divert management attention from executing our business plan and hurt our
ability to successfully expand our business. Our historical growth has placed,
and any further growth is likely to continue to place, a significant strain on
our resources. Our productivity and the quality of our products may be
adversely affected if we do not retain, integrate and train our new employees
quickly and effectively. We also cannot be sure that our revenues will grow at
a sufficient rate to absorb the costs associated with a larger overall
headcount, as well as recruiting-related expenses. It is expected that we will
implement new financial and accounting systems and to be successful, we will
need to expand our other infrastructure programs, including implementing
additional management information systems, improving our operating and
administrative systems and controls, training new employees and maintaining
close coordination among our executive, engineering, accounting, finance,
marketing, sales, operations and customer support organizations. In addition,
our future growth will result in increased responsibilities for management
personnel. Managing this growth will require substantial resources that we may
not have.
We will need to recruit and retain additional qualified personnel to
successfully manage its business.
Our future success will likely depend in large part on its ability to attract
and retain experienced sales, research and development, marketing, technical
support and management personnel. New employees
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generally require substantial training in the use of our products, which in turn
requires significant resources and management attention. If we does not attract
and retain such personnel, this could materially adversely affect its ability to
grow its business.
Moreover, the complexity of distributed computing systems requires highly
trained customer service and technical support personnel to assist customers
with installation and deployment of our products. MCS and NetIQ each currently
have a small customer service and support organization and will need to increase
the staff to support new customers and the expanding needs of their existing
customers. The labor market for these persons is very competitive due to the
limited number of people available with the necessary technical skills and
understanding of the Windows NT/2000 operating environments. MCS and NetIQ
Corporation have each experienced difficulty in recruiting qualified personnel,
especially technical and sales personnel. There is a risk that even if we
invests significant resources in attempting to attract, train and retain these
qualified personnel, it will not be successful in its efforts.
To achieve its business objectives, we may recruit and employ skilled
technical professionals from other countries to work in the United States.
Limitations imposed by federal immigration laws and the availability of visas
could materially adversely affect our ability to attract necessary qualified
personnel. This may have a negative effect on our business and future operating
results.
Our executive officers and other key personnel will be critical to our business
and they may not remain with us in the future which could hurt our ability to
grow our business.
Our success will depend to a significant extent on the continued services of
our executive officers and other key employees, including key sales, consulting,
technical and marketing personnel. If we lose the services of one or more of
our executives or key employees, including if one or more of our executives or
key employees decided to join a competitor or otherwise compete directly or
indirectly with us, this could harm our business and could affect our ability to
successfully implement our business objectives.
We will depend on our marketing, product development and sales relationship with
Microsoft, and if this relationship suffers, our customers would likely purchase
other vendors' systems management software products.
We believe that our success in penetrating our target markets depends in part
on our ability to maintain strong strategic marketing, product development and
sales relationships with Microsoft. The relationship with Microsoft will be
important in order to validate our technology, facilitate broad market
acceptance of our products and enhance our sales, marketing and distribution
capabilities.
We currently rely heavily on our relationship with Microsoft and attempt to
coordinate our product offerings with the future releases of Microsoft's
operating systems. It is possible that Microsoft may not notify us of feature
enhancements to its products prior to new releases of its operating systems in
the future. In that case, we may not be able to introduce products on a timely
basis that capitalize on new operating system releases and feature enhancements.
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If we are unable to successfully expand our international operations, this could
adversely affect our ability to grow our business.
International sales outside of North America accounted for approximately 23%
of MCS' license revenue and 24% of NetIQ's license revenue for the three months
ended March 31, 2000. We expect to expand the scope of our existing
international operations. If we are unable to expand our international
operations successfully and in a timely manner, this could materially adversely
affect our ability to increase revenue. Our continued growth and profitability
will require continued expansion of our international operations, particularly
in Europe and the Asia-Pacific region. We have only limited experience in
developing, marketing, selling and supporting our products internationally and
may not succeed in expanding our international operations. The following
factors may adversely affect our ability to achieve and maintain profitability
and our ability to sell our products internationally:
. Longer payment cycles and difficulty in collecting accounts receivable
. Seasonal reductions in business activity during the summer months in Europe
and other parts of the world
. Increases in tariffs, duties, price controls or other restrictions on
foreign currencies or trade barriers imposed by foreign countries
. Difficulties in localizing our products for foreign markets
. Fluctuations in currency exchange rates
. Recessionary environments in some foreign economies
. Potentially adverse tax consequences
. Burden of complying with complex and changing regulations
. Difficulties in staffing and managing international operations
. Limited or unfavorable intellectual property protection
If we do not respond adequately to the industry's evolving technology standards
or do not continue to meet the sophisticated needs of our customers, sales of
our products may decline.
The systems management software market is characterized by rapid technological
change, frequent new product introductions and enhancements, uncertain product
life cycles, changes in customer demands and evolving industry standards. Our
products could be rendered obsolete if other products based on new technologies
are introduced or new industry standards emerge.
Our future success will depend on our ability to address the increasingly
sophisticated needs of our customers by supporting existing and emerging
technologies, including technologies related to the development of the Windows
NT/2000 operating system generally. If we do not enhance our products to meet
these evolving needs, this could materially adversely affect our ability to
remain competitive and sell our products. We will have to develop and introduce
new products and enhancements to our existing products on a timely basis to keep
pace with technological developments, evolving industry standards, changing
customer requirements and competitive products that may render existing
26
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products and services obsolete. In addition, because our products are currently
dependent upon Windows NT/2000, we will need to continue to respond to
technology advances in these operating systems. If our introduction of new
systems management software products for Windows NT/2000-based systems and
applications is not successful, our revenues could decline. Product advances
could rapidly erode our position in our existing markets. Consequently, the
life cycles of our products are difficult to estimate. We expect that our
product development efforts will continue to require substantial investments
that we may not have the resources to make.
In addition, if we are unable, for technological or other reasons, to develop
and introduce new and improved products in a timely manner, this could affect
our ability to introduce new products, maintain our competitive position and
grow our business and maintain profitability. We have experienced product
development delays in new versions and update releases in the past and may
experience similar or more significant product delays in the future. To date,
none of these delays has materially affected our business. However, future
delays may have a material adverse effect on our business. Difficulties in
product development could delay or prevent the successful introduction or
marketing of new or improved products or the delivery of new versions of our
products to its customers.
Our revenue may suffer if customers demand extensive consulting or other support
services with our software products because we will not have a consulting staff
as our products are designed to require little external support or consulting to
be installed and used successfully.
Our products are designed to require little or no support to be implemented
quickly and effectively by our customers. Many competitors offer extensive
consulting services in addition to software products. If we introduced a
product that required extensive consulting services for installation and use, or
if our customers wanted to purchase from a single vendor a menu of items that
includes extensive consulting services, we would be required to change our
business model and would be required to hire and train consultants, outsource
the consulting services or enter into a joint venture with another company that
could provide those services. If these events were to occur, our revenue may
suffer because customers would choose another vendor or we would incur the added
expense of hiring and retaining consulting personnel.
Our future revenue could decline substantially if our existing customers do not
continue to purchase additional licenses.
In the fiscal year ended June 30, 1999 and the three months ended March 31,
2000, additional sales to existing customers represented approximately 50% and
57%, respectively, of MCS' license revenue and 41% and 57%, respectively, of
NetIQ's revenue. If our current customers do not purchase additional products,
this would reduce our revenue substantially. In order to increase software
license revenue, our sales efforts are expected to target our existing customer
base to expand these customers' use of our products. We will also depend on our
installed customer base for future revenue from maintenance renewal fees. The
terms of our standard license arrangements provide for a one-time license fee
and a prepayment of one year of software maintenance. These maintenance
agreements are renewable annually at
27
<PAGE>
the option of our customers but there are no minimum payment obligations or
obligations to license additional software.
Errors in our products could result in significant costs to us and could impair
our ability to sell our products.
Because our software products are complex, they may contain errors, or "bugs,"
that can be detected at any point in a product's life cycle. These errors could
materially adversely affect our reputation, which could result in significant
costs to us and could impair our ability to sell our products in the future.
The costs we may incur in correcting any product errors may be substantial and
could decrease our profit margins. While we expect that we will continually
test our products for errors and work with customers through our customer
support organization to identify and correct bugs, errors in our products may be
found in the future. Testing for errors is complicated in part because it is
difficult to simulate the highly complex computing environments in which our
customers use these products as well as because of the increased functionality
of our product offerings. Detection of any significant errors may result in,
among other things, loss of, or delay in, market acceptance and sales of our
products, diversion of development resources, injury to our reputation, or
increased service and warranty costs. Moreover, because our products will
support Windows NT/2000-based systems and applications, any software errors or
bugs in the Windows NT/2000 operating server software or the systems and
applications that our products operate with may result in errors in the
performance of our software.
We may be subject to product liability claims that could result in significant
costs.
We may be subject to claims for damages related to product errors in the
future. A material product liability claim could materially adversely affect
our business because of the costs of defending against these types of lawsuits,
diversion of key employees' time and attention from the business and potential
damage to our reputation. Our license agreements with our customers typically
contain provisions designed to limit exposure to potential product liability
claims. Some of our licensing agreements state that if our products fail to
perform, our will correct or issue replacement software. Our standard licenses
also state that we will not be liable for indirect or consequential damages
caused by the failure of our products. Limitation of liability provisions like
these, however, may not be effective under the laws of some jurisdictions if
local laws treat those types of warranty exclusions as unenforceable. Although
we have not experienced any product liability claims to date, the sale and
support of our products involves the risk of such claims.
We may acquire technologies or companies in the future which could cause
disruption of our business or other risks.
We may acquire technologies or companies or make investments in complementary
companies, products or technologies. Such acquisitions entail many risks, any
of which could materially harm our business. These risks include
. Difficulty in assimilating the acquired company's personnel and operations
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. Diversion of management's attention
. Loss of our or the acquired business's key personnel
. Dilution to our stockholders as a result of issuing equity securities
. Assumption of liabilities of the acquired company and
. Increased expenses as a result of the transaction
We will face risks associated with the acquisition of Ganymede.
In April MCS acquired Ganymede Software Inc. We could have difficulty in
assimilating Ganymede's personnel and operations. In addition, the key
personnel of Ganymede may decide not to work for us.
If we fail to protect our intellectual property rights, competitors may be able
to use our technology or trademarks and this could weaken our competitive
position, reduce our revenue and increase costs.
Our success is heavily dependent upon proprietary technology. We expects to
rely primarily on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights and prevent competitors from using our technology in their
products. These laws and procedures provide only limited protection. We each
have a small patent portfolio. These patents may not provide sufficiently broad
protection or they may not prove to be enforceable in actions against alleged
infringers. Our ability to sell our products and prevent competitors from
misappropriating our proprietary technologies, trademarks and trade names is
dependent upon protecting our intellectual property. Despite precautions that
we take, it may be possible for unauthorized third parties to copy aspects of
our current or future products or to obtain and use information that we regard
as proprietary. In particular, we may provide our licensees with access to
proprietary information underlying our licensed applications. Additionally, our
competitors may independently develop similar or superior technology or design
around the copyrights and trade secrets we own. Policing unauthorized use of
software is difficult and some foreign laws do not protect proprietary rights to
the same extent as United States laws. Litigation may be necessary in the
future to enforce our intellectual property rights, to protect our trade secrets
or to determine the validity and scope of the proprietary rights of others.
Litigation could result in substantial costs and diversion of resources and
could materially adversely affect our business, future operating results and
financial condition.
We license our software products primarily under "shrink-wrap" licenses, which
are licenses included as part of the product packaging. Shrink-wrap licenses
are not negotiated with or signed by individual customers and purport to take
effect upon the opening of the product package. Despite efforts to protect
proprietary rights, unauthorized parties may attempt to copy or otherwise obtain
and use our products or technology. Policing unauthorized use of our products
is difficult, and we cannot be certain that the steps we have taken will prevent
misappropriation of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as those in the United
States. Our means of protecting our proprietary rights may be inadequate.
29
<PAGE>
Third parties could assert that our products infringe their intellectual
property rights. Such claims could injure our reputation and adversely affect
our ability to sell our products.
Third parties may claim that our current or future products infringe their
proprietary rights, and these claims, whether they have merit or not, could harm
our business by increasing our costs or reducing our revenue. We have
previously litigated a claim with Compuware alleging that we had infringed a
third party's intellectual property rights, and although this claim has been
settled and no other claims of this nature are currently pending, any future
claims could affect our relationships with existing customers and may prevent
future customers from licensing our products. The intensely competitive nature
of our industry and the important nature of technology to our competitors'
businesses may contribute to the likelihood of being subject to third party
claims of this nature. Any such claims, with or without merit, could be time
consuming, result in potentially significant litigation costs, including costs
related to any damages we may owe resulting from such litigation, cause product
shipment delays or require us to enter into royalty or licensing agreements.
Royalty or license agreements may not be available on acceptable terms or at
all. We expect that software product developers will increasingly be subject to
infringement claims as the number of products and competitors in the software
industry grows and the functionality of products in different industry segments
overlaps.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not use derivative financial instruments in our investment portfolio and
have no foreign exchange contracts. Our financial instruments consist of cash
and cash equivalents, short-term investments, trade accounts and contracts
receivable, accounts payable, and long-term obligations. We consider
investments in highly liquid instruments purchased with a remaining maturity of
90 days or less at the date of purchase to be cash equivalents. Our exposure to
market risk for changes in interest rates relates primarily to our short-term
investments and short-term obligations, thus, fluctuations in interest rates
would not have a material impact on the fair value of these securities.
Our business is principally transacted in the United States dollar. During
the nine months ended March 31, 2000, 9% of our invoices were in currencies
other than the United States dollar. Accordingly, we are subject to exposure
from adverse movements in foreign currency exchange rates. This exposure is
primarily related to local currency denominated revenue and operating expenses
in Australia, Germany, Japan, Singapore and the United Kingdom. We believe that
a natural hedge exists in local currencies, as local currency denominated
revenue will substantially offset the local currency denominated operating
expenses. We assesses the need to utilize financial instruments to hedge
currency exposures on an ongoing basis. However, as of March 31, 2000, we had
no hedging contracts outstanding.
At March 31, 2000 we had $5.5 million in cash and cash equivalents and $147.6
million in short-term investments. A hypothetical 10 percent increase or
decrease in interest rates would not have a material impact on our earnings or
loss, or the fair market value or cash flows of these instruments.
30
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PART II OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
Not applicable.
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
In July 1999, the Company completed the sale of 3,000,000 shares of its Common
Stock at a per share price of $13.00 in a firm commitment underwritten public
offering. Credit Suisse First Boston, BancBoston Robertson Stephens and
Hambrecht & Quist LLC underwrote the offering. In August 1999, the underwriters
exercised an over-allotment option granted by the Company to the underwriters
for the purchase of up to 450,000 additional shares of the Company's Common
Stock in full.
The Company received aggregate gross proceeds of $44.8 million in connection
with its initial public offering. Of such amount, approximately $3.1 million
was paid to the underwriters in connection with underwriting discounts, and
approximately $1.3 million was paid by the Company in connection with offering
expenses, including legal, accounting, printing, filing and other fees. The net
proceeds to the Company after deduction of such commissions and expenses were
approximately $40.4 million. There were no direct or indirect payments to
officers or directors of the Company or any other person or entity. None of the
offering proceeds have been used for the construction of plants, building or
facilities or other purchase or installation of machinery or equipment, for the
purchase of real estate, or for the acquisition of other businesses.
Cash of approximately $1.8 million was paid to Compuware Corporation in
partial repayment of the Company's indebtedness to Compuware in connection with
the settlement of a lawsuit filed by Compuware against the Company. The
remaining portion of the our indebtedness to Compuware, in the amount of
approximately $3.3 million, was cancelled in exchange for the issuance by the
Company of 280,025 shares of the Company's Common Stock to Compuware upon the
exercise of a warrant issued to Compuware in March 1999.
Approximately $349,000 of the proceeds was paid to a bank in full repayment of
the Company's long-term debt for equipment purchases.
The Company currently is investing the remaining net offering proceeds for
future use as additional working capital. Such remaining net proceeds may be
used for potential strategic investments or acquisitions that complement the
Company's products, services, technologies or distribution channels.
ITEM 3 DEFAULT UPON SENIOR SECURITIES
Not applicable.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5 OTHER INFORMATION
Not applicable.
31
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ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a)
Exhibit
Number Description
- ------ -----------
27.1 Financial Data Schedule
(b) Reports on Form 8-K: On March 6, 2000, we filed a current report on Form 8-K
related to the merger with Mission Critical Software, Inc.
32
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SIGNATURES
Pursuant to the requirements of the Securities Act, NetIQ Corporation has duly
caused this Quarterly Report on Form 10-Q to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Santa Clara, State of
California, on the 11th day of May, 2000.
NETIQ CORPORATION
By: /s/ Ching-Fa Hwang
------------------------------------------------------
Ching-Fa Hwang, President and Chief Executive Officer
By: /s/ James A. Barth
-------------------------------------------------------
James A. Barth, Vice President, Finance and Chief Financial
Officer (Principal Financial and Accounting Officer)
33
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Quarterly
Report on Form 10-Q for the period ended March 31, 2000 and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-END> MAR-31-2000
<CASH> 5,523
<SECURITIES> 147,615
<RECEIVABLES> 5,263
<ALLOWANCES> 650
<INVENTORY> 0
<CURRENT-ASSETS> 159,169
<PP&E> 2,159
<DEPRECIATION> 1,276
<TOTAL-ASSETS> 165,898
<CURRENT-LIABILITIES> 12,292
<BONDS> 0
0
0
<COMMON> 158,954
<OTHER-SE> (5,348)
<TOTAL-LIABILITY-AND-EQUITY> 165,898
<SALES> 0
<TOTAL-REVENUES> 10,900
<CGS> 0
<TOTAL-COSTS> 751
<OTHER-EXPENSES> 9,309
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4
<INCOME-PRETAX> 2,918
<INCOME-TAX> 764
<INCOME-CONTINUING> 2,154
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,154
<EPS-BASIC> 0.12
<EPS-DILUTED> 0.11
</TABLE>
