<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------
FORM 10-Q
-----------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission file number: 000-26205
MISSION CRITICAL SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 76-0509513
(State or other jurisdiction of (I.R.S. Employer
incoropration or organization) Identification No.)
13939 NORTHWEST FREEWAY
HOUSTON, TEXAS 77040
(Address of principal executive offices)
(713) 548-1700
(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 No X
--- ---
As of November 1, 1999 there were 14,010,930 shares of the Registrant's Common
Stock outstanding.
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<PAGE>
MISSION CRITICAL SOFTWARE, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page No.
<S> <C>
Index............................................................................................. 1
Part I - Financial Information.................................................................... 2
Item 1 - Financial Statements
Condensed Balance Sheets....................................................................... 3
Statements of Operations....................................................................... 4
Statement of Stockholders' Equity (Deficit).................................................... 5
Statements of Cash Flows....................................................................... 6
Notes to Condensed Financial Statements........................................................ 7
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations... 11
Item 3 - Quantitative and Qualitative Disclosures About Market Risk.............................. 21
Part II - Other Information....................................................................... 22
Item 1 - Legal Proceedings....................................................................... 22
Item 2 - Changes In Securities and Use of Proceeds............................................... 22
Item 3 - Defaults Upon Senior Securities......................................................... 23
Item 4 - Submission of Matters to a Vote of Security Holders..................................... 23
Item 5 - Other Information....................................................................... 23
Item 6 - Exhibits and Reports on Form 8-K........................................................ 39
Signatures........................................................................................ 40
Index to Exhibits................................................................................. 41
</TABLE>
1
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
2
<PAGE>
MISSION CRITICAL SOFTWARE, INC.
CONDENSED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
JUNE 30, SEPTEMBER 30,
1991(1) 1999
---------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $11,031 $62,187
Receivables, net 3,299 3,320
Other current assets 758 311
------- -------
Total current assets 15,088 65,818
Property and equipment, net 2,048 3,322
Acquired technology, net 607 515
Other assets 43 45
------- -------
Total assets $17,786 $69,700
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 918 $ 1,622
Accrued liabilities 5,429 5,576
Current maturities of long-term notes payable 265 257
Deferred revenue 4,300 6,121
------- -------
Total current liabilities 10,912 13,576
Deferred revenue, less current portion 838 483
Long-term notes payable, less current maturities 81 -
------- -------
Total liabilities 11,831 14,059
Redeemable convertible preferred stock, Series A, $0.001 par
value, 868,650 and no shares authorized and outstanding,
respectively 179 -
Redeemable convertible preferred stock, Series B, $0.001 par
value, 2,650,000 and no shares authorized and outstanding,
respectively 2,650 -
Redeemable convertible preferred stock, Series C, $0.001 par
value, 3,450,000 and no shares authorized and outstanding,
respectively 10,350 -
Preferred Stock, $0.001 par value, 5,000,000 shares authorized,
no shares issued or outstanding - -
Common stock, $0.001 par value, 50,000,000 shares authorized,
3,307,511 and 14,007,567 shares outstanding, respectively 3 14
Additional paid-in capital 3,290 64,401
Deferred stock compensation (2,315) (1,590)
Accumulated deficit (8,202) (7,184)
------- -------
Total stockholders' equity (deficit) (7,224) 55,641
------- -------
Total liabilities and stockholders' equity (deficit) $17,786 $69,700
======= =======
</TABLE>
(1) Derived from the Company's audited financial statements as of June 30, 1999.
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
MISSION CRITICAL SOFTWARE, INC.
STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------------------------------
1998 1999
------------------ ------------------
<S> <C> <C>
(UNAUDITED)
Revenue:
License $4,052 $7,442
Maintenance 613 1,578
------------------ ------------------
Total revenues 4,665 9,020
------------------ ------------------
Cost of revenue:
Cost of license 96 90
Cost of maintenance 226 256
------------------ ------------------
Total cost of revenue 322 346
------------------ ------------------
Gross margin 4,343 8,674
------------------ ------------------
Operating expenses:
Sales and marketing 2,479 4,774
Research and development 1,223 2,161
General and administrative 576 958
Amortization of deferred stock compensation 32 290
Abandoned lease costs (recovery) - (295)
------------------ ------------------
Total operating expenses 4,310 7,888
------------------ ------------------
Operating income 33 786
------------------ ------------------
Interest income 59 420
Interest expense (19) (9)
Other income, net 3 1
------------------ ------------------
Income before income taxes 76 1,198
Income tax expense - 180
------------------ ------------------
Net income 76 1,018
Increase in dividends in arrears on redeemable
convertible preferred stock (264) -
------------------ ------------------
Net income (loss) applicable to common stockholders $ (188) $1,018
================== ==================
Earnings (loss) per common share:
Basic $(0.07) $0.10
Diluted $(0.07) $0.06
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
MISSION CRITICAL SOFTWARE, INC.
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(unaudited)
(in thousands, except share data)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL DEFERRED
-------------------------- PAID-IN STOCK ACCUMULATED
NUMBER AMOUNT CAPITAL COMPENSATION DEFICIT TOTAL
----------- -------- --------- ------------- ------------ --------
<S> <C> <C> <C> <C> <C> <C>
Balance at June 30, 1999 $ 3,307,511 $ 3 $ 3,290 $(2,315) $(8,202) $(7,224)
----------- ---- ------- ------- ------- -------
Amortization of deferred
stock compensation 725 725
Common stock issued upon
exercise of stock options 175,573 138 138
Common stock issued upon
exercise of stock warrants 243,333 1 315 316
Common stock issued in
iniitla public offering, net 3,312,500 3 47,486 47,489
Conversion of preferred stock 6,968,650 7 13,172 13,179
Net income 1,018 1,018
----------- ---- ------- ------- ------- -------
Balance at September 30, 1999 $14,007,567 $14 $64,401 $(1,590) $(7,184) $55,641
=========== ==== ======= ======= ======= =======
</TABLE>
5
<PAGE>
MISSION CRITICAL SOFTWARE, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------------------------
1998 1999
------------ -----------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 76 $ 1,018
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization 198 277
Noncash compensation expense 32 725
Gain on disposal of assets (1) -
Changes in operating assets and liabilities:
Accounts receivable 544 (21)
Prepaid and other current assets 32 447
Other assets 80 (2)
Accounts payable (30) 704
Accrued liabilities and other 650 147
Deferred revenue 242 1,466
------- -------
Net cash provided by operating activities 1,823 4,761
Cash flows from investing activities:
Proceeds from sale of property and equipment 6 27
Purchase of property and equipment (211) (1,486)
------- -------
Net cash used in investing activities (205) (1,459)
Cash flows from financing activities:
Payments on long-term debt (65) (66)
Repayment of capital lease (2) (23)
Exercised options, net 75 138
Exercised warrants, net - 316
Proceeds from initial stock offering, net - 47,489
------- -------
Net cash provided by financing activities 8 47,854
------- -------
Net increase in cash and cash equivalents 1,626 51,156
------- -------
Beginning cash and cash equivalents 4,575 11,031
------- -------
Ending cash and cash equivalents $6,201 $62,187
====== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE>
MISSION CRITICAL SOFTWARE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
September 30, 1999
(unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial reporting
and in accordance with Form 10-Q and Rule 10.01 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the opinion
of management, the unaudited financial statements contained in this report
reflect all adjustments, consisting of only normal recurring adjustments
considered necessary for a fair presentation of the financial position and the
results of operations for the interim periods presented. Operating results for
interim periods are not necessarily indicative of results for the full year.
These unaudited financial statements, footnote disclosures and other information
should be read in conjunction with the financial statements and the notes
thereto included in the Company's audited financial statements for the year
ended June 30, 1999 which are included in the Company's Registration Statement
filed on Form S-1, as amended, on August 4, 1999 (Reg. No. 333-79501).
2. STOCKHOLDERS' EQUITY
In the period July 1, 1999 through September 30, 1999, options to purchase
175,573 shares of common stock at exercise prices of $0.50 to $2.50 per share
were exercised. At September 30, 1999, there were options outstanding to
purchase 4,520,363 shares of common stock.
In August 1999, the Company completed an initial public offering in which the
Company sold a total of 3,312,500 shares of its common stock for net proceeds to
the Company of $47.5 million. Upon closing of the initial public offering, all
outstanding Series A, B, and C Redeemable Convertible Preferred Stock were
converted to 6,968,650 shares of common stock.
The Company recorded deferred stock compensation of $475,000 in connection with
options granted to three former directors who became consultants when they
resigned from our board of directors in the quarter ended June 30, 1999. In the
three months ended September 30, 1999, the Board of Directors vested the options
that would have vested during the remaining term of the consulting agreement. As
a result of the Board of Director's action, the Company recognized the remaining
$436,000 of stock compensation expense during the quarter.
7
<PAGE>
MISSION CRITICAL SOFTWARE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
2. STOCKHOLDERS' EQUITY (CONTINUED)
For the periods ended September 30, 1998 and 1999, comprehensive income was the
same as net income.
3. INCOME TAXES
The provision for income tax expense for the three months ended September 30,
1999 was 15% of pre-tax income. The difference in the effective rate versus the
statutory U.S. tax rate is primarily due to the impact of tax benefits
associated with the anticipated utilization of net operating loss carryforwards
during fiscal 2000.
The Company did not record a provision for income taxes in the three month
period ended September 30, 1998, because it had generated net operating loss
carryforwards of approximately $3.5 million since the Company's inception. A
full valuation allowance was recorded due to the uncertainty of its ability to
recognize the future benefits of such losses. The net operating loss
carryforwards begin to expire in 2012 and may be subject to various IRS code
limitations.
4. EARNINGS PER SHARE
The Company follows the provisions of SFAS No. 128, Earnings Per Share. Basic
net income (loss) per share is computed by dividing net income (loss) applicable
to common stockholders by the weighted average number of shares of common stock
outstanding during the period. Diluted net income (loss) per share is computed
by dividing net income (loss) applicable to common stockholders by the weighted
average number of shares of common stock outstanding, adjusted to reflect common
stock equivalents, such as convertible preferred stock, stock options and
warrants to purchase common stock, to the extent they are dilutive, less the
number of shares that could have been repurchased with the exercise proceeds
using the treasury stock method.
8
<PAGE>
MISSION CRITICAL SOFTWARE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
4. EARNINGS PER SHARE (CONTINUED)
The following table presents the calculation of basic and diluted net income
(loss) per share and pro forma basic and diluted net income per share (in
thousands, except share and per share data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30
------------------------------------
1998 1999
----------- -----------
<S> <C> <C>
Net income $ 76 $ 1,018
Increase in dividends in arrears on redeemable convertible
preferred stock (264) -
----------- -----------
Net income (loss) applicable to common stockholders $ (188) $ 1,018
=========== ===========
Pro forma net income applicable to common stockholders $ 76
===========
Shares used in computing:
Basic net income (loss) per share 2,549,240 9,948,991
=========== ===========
Diluted net income (loss) per share 2,549,240 16,031,298
=========== ===========
Pro forma basic net income per share 9,517,890
===========
Pro forma diluted net income per share 12,171,729
===========
Computation of:
Basic net income (loss) per share applicable to common
stockholders $ (0.07) $ 0.10
=========== ===========
Diluted net income (loss) per share applicable to common
stockholders $ (0.07) $ 0.06
=========== ===========
Pro forma basic net income per share $ 0.01
===========
Pro forma diluted net income per share $ 0.01
===========
</TABLE>
The Company's historical capital structure is not indicative of its prospective
structure due to the automatic conversion of all shares of redeemable
convertible preferred stock into common stock concurrent with the closing of the
Company's initial public offering. Accordingly, a pro forma calculation for the
three month period ended September 30, 1998 assuming the conversion of all
outstanding shares of redeemable convertible preferred stock into common stock
upon the Company's initial public offering using the
9
<PAGE>
MISSION CRITICAL SOFTWARE, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
4. EARNINGS PER SHARE (continued)
if-converted method from their respective dates of issuance is presented. As the
pro forma calculation results in net income applicable to common stockholders,
the shares used in computing pro forma diluted net income per share include
2,653,839 common stock equivalents using the treasury stock method.
5. SEGMENT REPORTING
Effective July 1, 1998, the Company adopted SFAS No. 131 Disclosures About
Segments of an Enterprise and Related Information. The adoption of SFAS 131 did
not have a significant effect on the disclosure of segment information as the
Company continues to consider its business activities to be in a single segment.
6. LITIGATION
The Company received correspondence from Commerce Funding Corporation, one of
its stockholders, alleging that the Company failed to give it proper notice of
its right of first refusal with respect to the proposed resale of 250,000 shares
of its common stock by two of its stockholders. The Company filed a petition
seeking a declaratory judgment that the Company has no liability with respect to
Commerce Funding Corporation's claims on July 1, 1999. On August 2, 1999, the
Company, its Chief Executive Officer and Chief Financial Officer were named as
defendants in a complaint filed by Commerce Funding Corporation. The parties to
these actions are now conducting discovery. The Company believes that Commerce
Funding Corporation's claims are without merit and intends to vigorously defend
the claim. The ultimate outcome of this claim is not expected to have a material
adverse effect on the financial statements, operating results or financial
conditions. If Commerce Funding Corporation were to be awarded a judgment in its
complaint or the Company were unable to obtain the relief the Company has
requested, the Company would be required to indemnify its officers with respect
to legal fees, pay its legal expenses and possibly those of Commerce Funding
Corporation.
7. STOCK OFFERING
On November 10, 1999, the Company sold 1,500,000 shares of its common stock and
existing stockholders of the Company sold 2,500,000 shares of common stock
pursuant to a Regisration Statement (No. 333-89635), as amended, as filed with
the Securities and Exchange Commission and declared effective on November 10,
1999.
10
<PAGE>
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 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
certain events could differ materially from those anticipated in these forward-
looking statements as a result of certain factors, including those set forth in
Part II Item 5 under "Factors that May Affect Future Results" and elsewhere in,
or incorporated by reference into, this report. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential," "continue" or the negative of these terms or other comparable
terms. It is important that the discussion below be read together with the
attached condensed financial statements and the notes thereto.
OVERVIEW
We provide systems administration and operations management software products
for corporate and Internet-based Windows NT networks. Our OnePoint product suite
is designed to improve the reliability, performance and security of even the
most complex computing environments by simplifying and automating key systems
management functions. Our products can be deployed quickly, are based on an open
and extensible architecture and are easy to use.
We derive our revenue from the sale of software product licenses and
maintenance. Currently, all of our product license revenue is derived from our
OnePoint suite and principally our OnePoint Administrator products. In the three
months ended September 30, 1999, sales of OnePoint Administrator products
accounted for approximately 74% of our license revenue, respectively. We expect
that these products will continue to account for a large portion of our license
revenue for the foreseeable future.
Any factors adversely affecting the pricing of, demand for or market acceptance
of our OnePoint product suite, such as competition or technological change,
could materially adversely affect our business, operating results and financial
condition. Of particular importance is the continued acceptance of Windows NT as
a server operating system in corporate and Internet-based networks. We believe
that Windows NT and Windows 2000 Server, once released, will continue to be an
integral part of the corporate and Internet-based client/server environments.
Since our inception in 1996, we have incurred substantial costs to develop our
technology and products, to recruit and train personnel for our engineering,
sales and marketing and technical support departments, and to establish an
administrative organization. We anticipate that our operating expenses will
increase substantially in the future as we increase our sales and marketing
operations, develop new distribution channels, fund greater levels of research
and development, broaden our technical support and improve our operational and
financial systems. Accordingly, we will need to generate significant
11
<PAGE>
quarterly revenues to maintain profitability. In addition, our limited operating
history makes it difficult for us to predict future operating results and,
accordingly, there can be no assurance in future quarters that we will achieve
or sustain revenue growth or profitability.
Total revenue was $9.0 million in the three months ended September 30, 1999,
attributable primarily to sales in North America. In the three months ended
September 30, 1999, license revenue attributable to sales outside of North
America accounted for approximately 18% of our total license revenue,
respectively. We plan to expand our international operations significantly as we
believe international markets represent a significant growth opportunity.
Consequently, we anticipate that international revenue will increase as a
percentage of total revenue in the future. If international revenue continues to
increase as a percentage of total revenue, we may experience a corresponding
increase in cost of sales, because of higher personnel costs for overseas
locations and commission expenses related to distributions that may impact our
operating results. Our sales are generally denominated in United States dollars
and as a result our current exposure to foreign exchange fluctuations is
minimal. As our international sales and operations expand, we anticipate that
our exposure to foreign currency fluctuations will increase.
In the three months ended September 30, 1999, maintenance revenue comprised 18%
of our total revenue. We expect maintenance revenue to continue to increase as a
percentage of total revenue if our number of customers increases and if the
number of customers entering into annual maintenance agreements increases. If
maintenance revenue increases as a percentage of total revenue, our gross margin
as a percentage of total revenue will decrease because of lower margins on
maintenance revenue due to incremental maintenance support costs.
In the three months ended September 30, 1999, approximately 65% of our license
revenue was derived from additional purchases by existing customers. If we fail
to sell additional licenses to our existing customers, we could experience a
material decline in total revenue.
In view of the rapidly changing nature of our business and our limited operating
history, we believe that period to period comparisons of our revenue and
operating results are not necessarily meaningful and should not be relied upon
as indications of our future performance. Additionally, despite our revenue
growth for all but one quarter since inception, we do not believe that
historical growth rates are necessarily sustainable or indicative of future
growth.
During fiscal 1999, we recorded deferred stock compensation of $2.8 million in
connection with certain stock option grants. We amortize deferred stock
compensation over the vesting period of the related award. We record this
amortization as a noncash expense in accordance with Accounting Principles Board
Opinion No. 25. This charge included $475,000 related to stock option grants to
three former directors. These directors resigned from our board of directors in
the quarter ended June 30, 1999 and became consultants. In the three months
ended September 30, 1999, the Board of
12
<PAGE>
Directors vested these options in full. We consequently recognized the remaining
$436,000 of deferred stock compensation during the quarter. Such compensation
expense was allocated to sales and marketing, research and development, and
general and administrative expenses.
We had 193 employees at September 30, 1999, a substantial increase from 95 at
September 30, 1998. This rapid growth has placed significant demands on our
management and operational resources. In order to manage our growth effectively,
we must implement and improve our operational systems, procedures and controls
on a timely basis. In addition, we expect that future expansion will continue to
challenge our ability to hire, train, motivate and manage our employees.
Competition is intense for highly qualified technical, sales and marketing and
management personnel. If our total revenue does not increase relative to our
operating expenses, our management systems do not expand to meet increasing
demands, we fail to attract, assimilate and retain qualified personnel or our
management otherwise fails to manage our expansion effectively, we would
experience a decline in our revenue and operating results.
On November 10, 1999, we sold 1,500,000 shares in a public offering pursuant to
an effective Registration Statement with the Securities and Exchange Commission.
Our existing stockholders sold 2,500,000 shares in the offering. We raised $81.7
million, net of the underwriters discounts and commissions. We did not receive
any of the proceeds of the sale of shares by the Selling Stockholders.
RESULTS OF OPERATIONS
The following table sets forth the results of our operations expressed as a
percentage of total revenues. Our historical operating results are not
necessarily indicative of the results for any future period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------
1998 1999
------ ------
<S> <C> <C>
Revenue:
License 86.9% 82.5%
Maintenance 13.1 17.5
----- -----
Total revenue 100.0 100.0
Cost of revenue:
Cost of license 2.1 1.0
Cost of maintenance 4.8 2.8
----- -----
Total cost of revenue 6.9 3.8
----- -----
Gross margin 93.1 96.2
Operating expenses:
Sales and marketing 53.1 52.9
Research and development 26.2 24.0
General and administrative 12.3 10.6
Amortization of deferred stock
compensation 0.7 3.2
Abandoned lease costs (recovery) - (3.2)
Acquired in-process research and
development - -
----- -----
Total operating expenses 92.4 87.5
----- -----
Operating income (loss) 0.7 8.7
</TABLE>
13
<PAGE>
<TABLE>
<S> <C> <C>
Other income, net 0.9 4.6
------ ------
Income (loss) before income taxes 1.6 13.3
Income tax expense (benefit) - 2.0
------ ------
Net income (loss) 1.6% 11.3%
====== ======
</TABLE>
Revenue
Our revenue was $4.7 million and $9.0 million for the three months ended
September 30, 1998 and 1999, respectively, representing an increase of $4.3
million or 93% from the three months ended September 30, 1998 to the three
months ended September 30, 1999. This increase was attributable to an increase
in our customer base resulting in substantial growth in product license and
maintenance revenue, as well as additional sales to our existing customers.
License. License revenue was $4.1 million and $7.4 million for the three months
ended September 30, 1998 and 1999, respectively. License revenue represented
86.9% and 82.5% of total revenue for the three months ended September 30, 1998
and 1999, respectively. License revenue increased 84% from the three months
ended September 30, 1998 to the three months ended September 30, 1999. The
increase in license revenue in absolute dollars was primarily attributable to
increased unit sales of our products. The decrease of license revenue as a
percentage of total revenue was primarily due to an increase in first year
maintenance sold with the product licenses and, to a lesser extent, the number
of renewal maintenance agreements purchased.
Maintenance. Maintenance revenue was $613,000 and $1.6 million for the three
months ended September 30, 1998 and 1999, respectively. Maintenance revenue
represented 13.1% and 17.5% of total revenue for the three months ended
September 30, 1998 and 1999, respectively. Maintenance revenue increased 157%
from the three months ended September 30, 1998 to the three months ended
September 30, 1999. This increase resulted primarily from the growth in software
license revenue, as new software licenses are generally sold with one year of
maintenance, and, to a lesser extent, renewals of maintenance agreements by
existing customers.
Cost of Revenue
License. License costs consist primarily of the amortization of acquired
technology and to a lesser extent the expenses incurred to manufacture, package
and ship our products. License costs were $96,000 and $90,000 in the three
months ended September 30, 1998 and 1999, respectively. License costs
represented 2.4% and 1.2% of license revenue in the three months ended September
30, 1998 and 1999, respectively. Acquired technology is being expensed over
periods ranging from three to five years. The 6.3% decrease in absolute dollars
was attributable to a reduction in amortization cost as acquired technology
became fully amortized. The decrease as a percentage of revenue was primarily a
result of increased growth of revenue in relation to amortization expense for
acquired technology, which remained basically unchanged from period to period.
We expect license costs to decrease in the future due to the reduction in
amortization expense as acquired technology becomes fully amortized.
14
<PAGE>
Maintenance. Maintenance costs include salary expense and other related costs
for our technical support. Maintenance costs were $226,000 and $256,000 in the
three months ended September 30, 1998 and 1999, respectively. Maintenance costs
represented 36.9% and 16.2% of maintenance revenue in the three months ended
September 30, 1998 and 1999, respectively. The 13.3% increase in absolute
dollars was attributable to the increase of our average headcount from 8 to 13
in our technical support department. The decrease in maintenance costs as a
percentage of maintenance revenue was primarily attributable to increased growth
of revenue in relation to maintenance costs and increased utilization of our
technical support staff. We expect maintenance costs to increase in the future
as we continue to expand our customer base.
Operating Expenses
Sales and Marketing Expenses. Sales and marketing expenses consist primarily of
salaries, commissions, payroll taxes and employee benefits as well as travel,
entertainment and discretionary marketing expenses. Sales and marketing expenses
were $2.5 million and $4.8 million in the three months ended September 30, 1998
and 1999, respectively. Sales and marketing expenses represented 53.1%, and
52.9% of total revenue in the three months ended September 30, 1998 and 1999,
respectively. The increases in the absolute dollar level of sales and marketing
expenses were primarily due to increases in sales and marketing personnel, which
increased from 43 as of September 30, 1998 to 98 at September 30, 1999 and
commission expense as a result of our revenue growth. To a lesser extent,
increases in marketing expenditures for tradeshows and marketing brochures and
related materials also contributed to the absolute dollar increases.
Discretionary marketing expense for the three months ended September 30, 1999
increased 27% from the three months ended September 30, 1998 as compared to our
revenue increases of 93% for the same respective periods. The decreases in sales
and marketing expenses as a percentage of total revenue reflected the increased
productivity of our sales force. We expect sales and marketing expenses to
increase as we continue to hire additional sales and marketing personnel.
Research and Development Expenses. Research and development expenses consist
primarily of salaries, bonuses, payroll taxes, employee benefits and other costs
attributable to research and development activities. Research and development
expenses were $1.2 million and $2.2 million in the three months ended September
30, 1998 and 1999, respectively. Research and development expenses represented
26.2% and 24.0% of total revenue in the three months ended September 30, 1998
and 1999, respectively. The increases in the absolute dollar level of research
and development expense were attributable to recruiting costs, salaries and
benefits associated with hiring of additional research and development staff,
which increased from 28 as of September 30, 1998, to 61 at September 30, 1999.
To a lesser extent, the absolute dollar level of research and development
expense increased as a result of additional infrastructure, such as office
space, computer equipment and development software to support these employees.
The infrastructure cost increased by 89% from the three months ended September
30, 1998 to the three months ended September 30, 1999 compared to an overall
increase in research and development expense of 77% for the same respective
periods. The declines in research and development expense as a percentage of
total revenue reflected the increase
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of revenue at a faster rate than the increase in research and development
expenses. We expect research and development expenses to increase as we continue
to hire additional research and development personnel to develop new OnePoint
products and to develop products for Windows 2000 Server.
General and Administrative Expenses. General and administrative expenses consist
primarily of salaries, bonuses, payroll taxes, employee benefits and certain
non-allocable administrative costs. General and administrative expenses were
$576,000, and $958,000 in the three months ended September 30, 1998 and 1999,
respectively. General and administrative expenses represented 12.3% and 10.6% of
total revenue in the three months ended September 30, 1998 and 1999,
respectively. The absolute dollar increase was primarily related to
approximately $200,000 in consulting cost associated with vesting of deferred
stock compensation and costs associated with expansion and relocation of our
facilities and related infrastructure and the recruiting costs, salaries and
benefits associated with the hiring of additional administrative personnel to
support our increased sales, marketing and development activities. General and
administrative personnel increased from 16 as of September 30, 1998 to 21 at
September 30, 1999. The decreases in general and administrative expenses as a
percentage of total revenue reflected increased absorption of fixed costs over a
larger revenue base. We expect general and administrative expenses to increase
as we expand our infrastructure and incur additional costs as a result of being
a public company.
Amortization of Deferred Stock Compensation. We amortized approximately $32,000
and $290,000 of deferred employee stock compensation in the three months ended
September 30, 1998 and 1999, respectively. We expect to amortize the remaining
$1.6 million of deferred stock compensation through fiscal 2003.
Abandoned Lease Costs (Recovery). During fiscal 1999, we took a charge of
$1,034,000 for the abandonment of an office facility leased through January 2003
and write-off of its related infrastructure. This charge was primarily for the
future lease costs and required exit fees. At the time of the charge, it was
determined that potential recovery or avoidance of these costs would be remote.
On September 15, 1999, we were released from a portion of the lease and
consequently reduced the amount accrued by $295,000 for amounts no longer due.
Other Income, Net
Other income, net is generated primarily from the interest earned on cash and
cash equivalents. Other income, net was $43,000 and $412,000 in the three months
ended September 30, 1998 and 1999, respectively. The growth in other income, net
was primarily the result of increased cash and cash equivalent balances from the
proceeds of our initial public offering.
Income Taxes
We did not record a provision for income taxes in the three months ended
September 30, 1998, because we had generated net operating loss carryforwards of
approximately $3.5 million since our inception. A full valuation allowance was
recorded due to the
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uncertainty of our ability to recognize the future benefits of such losses. Our
net operating loss carryforwards begin to expire in 2012. In the future, our
utilization of the net operating loss carryforwards may be subject to
substantial annual limitations due to the ownership change regulations contained
in the Internal Revenue Code of 1986 and similar state provisions. These annual
limitations may result in the expiration of the net operating loss carryforwards
and other tax credits before we are able to use them.
The provision for income tax expense for the three months ended September 30,
1999 was $180,000, or 15% of pre-tax income. The difference in the effective
rate versus the statutory U.S. tax rate is primarily due to the impact of tax
benefits associated with the anticipated utilization of net operating loss
carryforwards during fiscal 2000.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations primarily from license revenue received from
inception to September 30, 1999 and the proceeds of approximately $61.1 million
from the sale of common stock, preferred stock and warrants. At September 30,
1999, we had cash and cash equivalents of $62.2 million. As of September 30,
1999, we had an accumulated deficit of $7.2 million and working capital of $58.4
million, net of a short-term component of deferred revenue of $6.1 million.
Our operating activities provided net cash of $4.8 million in the three months
ended September 30, 1999, primarily due to increased revenue, improved accounts
receivable collection efforts and increased liabilities. The increase in
liabilities for the three months ended September 30, 1999 was primarily due to
increases in deferred maintenance and accounts payable. Deferred maintenance
increases are due to higher revenues which typically include initial maintenance
and increased amounts of renewal maintenance due to larger amount of cumulative
licenses revenue. Accounts payable increases related to costs associated with
our new office facility and our initial public offering which had not been paid
as of September 30, 1999.
Our investing activities used net cash of $1.5 million in the three months ended
September 30, 1999, consisting primarily of net purchases of property and
equipment.
Our financing activities provided cash of $47.9 million in the three months
ended September 30, 1999, consisting primarily of net proceeds from our initial
public offering.
We anticipate spending at least $1.1 million for office lease payments and
approximately $3.0 million for capital expenditures over the next 12 months. We
expect capital expenditures to increase over the next several years as we expand
facilities and acquire equipment to support our planned expansion in sales and
marketing and research and development. We expect to utilize cash resources to
purchase additional equipment over the next 12 months.
In January 1998, we obtained a revolving credit facility of $3.0 million from a
commercial bank. We renewed this credit facility in March 1999 and it expires on
February 5, 2000. Borrowings under the credit facility bear interest at the
bank's prime rate. Under the terms of the loan agreement, all borrowings are
collateralized by
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substantially all of our assets, and we must maintain certain financial ratios
and comply with other covenants. At September 30, 1999, we had no borrowings
outstanding under the credit facility, and the entire facility was available,
subject to a pre-established funding formula, through February 5, 2000. We were
in compliance with all covenants as of September 30, 1999, but we cannot assure
you that we will be able to continue to comply with our loan covenants in the
future.
We intend to continue to invest heavily in the development of new products and
enhancements to our existing products. Our future liquidity and capital
requirements will depend upon numerous factors, including the costs and timing
of expansion of product development efforts and the success of these development
efforts, the costs and timing of expansion of sales and marketing activities,
the extent to which our existing and new products gain market acceptance, market
developments, the costs involved in maintaining and enforcing intellectual
property rights, the level and timing of license revenue, available borrowings
under line of credit arrangements and other factors. We believe that the
proceeds from the November 1999 public stock offering, together with our current
cash and investment balances and any cash generated from operations and from
available or future debt financing, will be sufficient to meet our operating and
capital requirements for at least the next 12 months. However, it is possible
that we may require additional financing within this period. We have no current
plans, and we are not currently negotiating, to obtain additional financing. The
factors described in this paragraph will affect our future capital requirements
and the adequacy of our available funds. We may be required to raise additional
funds through public or private financing, strategic relationships or other
arrangements. We cannot ensure that such funding, if needed, will be available
to us on terms attractive to us, or at all. Furthermore, any additional equity
financing may be dilutive to stockholders, and debt financing, if available, may
involve restrictive covenants. Strategic arrangements, if necessary to raise
additional funds, may require us to relinquish our rights to certain of our
technologies or products. If we fail to raise capital when needed, our failure
could have a negative impact on our operating results and financial condition.
YEAR 2000 READINESS
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As a result, software that
records only the last two digits of the calendar year may not be able to
distinguish whether "00" means 1900 or 2000. This may result in software
failures or the creation of erroneous results.
Our products. We have completed a review of the current versions of our products
to determine Year 2000 compliance. We have reviewed the software code for each
of these applications and believe that we have identified all instances where
date specific information is required. We have further investigated whether
these date fields contain two or four digits, and have completed efforts to
upgrade our software when date fields that contain only two digits were
discovered. Based on our review and the results of limited testing, we believe
that our OnePoint product suite, when configured and used in accordance with its
instruction manual, correctly recognizes date codes after 1999 and functions
with four digit date codes. We intend to conduct further tests on all of our new
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applications to identify areas of deficiency and to develop action plans to
correct and upgrade our software code.
We have finalized our assessment of our Year 2000 readiness. Despite preliminary
investigation and testing by us and our partners, our software applications and
the underlying hardware systems and protocols running the software may contain
undetected errors or defects associated with Year 2000 date functions. Our
software applications operate in complex network environments and directly and
indirectly interact with a number of other hardware and software systems. We are
unable to predict to what extent our business may be affected if our software or
the systems that operate in conjunction with our software experience a material
Year 2000 failure. Known or unknown errors or defects that affect the operation
of our software could result in:
. delay or loss of revenue;
. cancellation of customer contracts;
. diversion of development resources;
. damage to our reputation;
. increased service and warranty costs; and
. litigation costs,
any of which could adversely affect our business, financial condition and
results of operation.
Our software products run on several hardware platforms and the Windows NT and
pre-release version of Windows 2000 operating systems. In addition, our software
operates in accordance with several external Windows NT protocols, such as http
and nntp. Our software is therefore dependent upon the correct processing of
dates by these systems and protocols. We have reviewed information made publicly
available by our hardware platform partners regarding Year 2000 compliance and
researched the date handling capabilities of applicable Windows NT protocols.
Based on this research, we do not believe that the underlying systems and
protocols that operate in conjunction with our software products contain
material Year 2000 deficiencies. However, we have not conducted our own tests to
determine to what extent our software running on any of our hardware platforms
and in accordance with any of our supported Windows NT protocols fails to
properly recognize Year 2000 dates.
Our state of readiness. Our business depends on the operation of numerous
systems that could potentially be impacted by Year 2000 related problems. The
systems include:
. computer and communications hardware and software systems used to deliver
services;
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. computer and communications hardware and software systems we use internally
to manage our business;
. communications networks such as the Internet and private intranets; and
. non-information technology systems and services we use to manage our
business, such as telephone, security and building management systems.
Based on an analysis of all systems potentially impacted by conducting business
in the year 2000 and beyond, we pursued a phased approach to making our systems
and our operations ready for the year 2000. Beyond an awareness of the issue and
scope of systems involved, we have:
. identified third party product reliance and documented their use in our Year
2000 compliance tests;
. completed a review of the third-party product for potential date related
issues; and
. validated and tested technologically-compliant Year 2000 solutions.
The table below provides a summary of the status and timing of our internal
readiness activities:
IMPACTED SYSTEMS STATUS
- -------------------------------------------------------------------------------
Hardware and software systems used to develop our products Completed
Hardware and software systems used to manage our business Completed
Communication networks used to develop our products Completed
Non-information technology systems and services Completed
We use multiple software systems for internal business purposes, including
accounting, email, development, human resources, customer service and support
and sales tracking systems. All of these applications have been purchased within
the preceding 18 months. We conducted research with the vendors about the
systems and software that we believe are critical to our business regarding
their Year 2000 readiness of the vendors and their products. Each of these
vendors has indicated through publicly available information and through their
web sites that the vendor believes the vendor's applications are Year 2000
compliant. We have completed operational testing on those systems which are
reported to be Year 2000 compliant, and they appear to pass these Year 2000
tests. We updated all systems for which we could not prove Year 2000 readiness
with systems which are reported to be Year 2000 compliant which appear to pass
our Year 2000 tests.
Costs to Address Year 2000 Issues. To date, the costs for conducting our
assessment have not been material, and with total costs incurred in connection
with our Year 2000 project being less than $100,000. We cannot be sure that Year
2000 issues will not be discovered
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in our products or internal software systems. If any issues are discovered, we
cannot be sure that the costs of making such products and systems Year 2000
ready will not harm our business and financial conditions. We believe that it is
not possible to determine with complete certainty that all Year 2000 problems
affecting us have been identified or corrected. The number of devices and the
interactions among these devices are simply too numerous. In addition, no one
can accurately predict how many Year 2000 problem-related failures will occur or
the severity, duration or financial consequences of these perhaps inevitable
failures. As a result, we believe some of the following consequences are
possible:
. we, our customers or our suppliers may experience a significant number of
operational inefficiencies that could divert our or their management's time
and attention or resources from ordinary business activities;
. we may become involved in disputes and claims for pricing adjustments or
penalties due to Year 2000 problems with our suppliers or customers; and
. our customers could allege that we failed to comply with the terms of
contracts or industry standards, and these allegations could result in the
customer canceling our contract or filing litigation against us.
Contingency Plans. We are developing contingency plans for handling Year 2000
problems that are not detected and corrected prior to their occurrence. Now that
we have completed Year 2000 testing and implementation activities, we will be
able to assess areas requiring contingency planning and we expect to institute
appropriate contingency planning at that time. Any failure to address any
unforeseen Year 2000 issues could harm our business. Depending on our systems
affected, our Year 2000 contingency plans could include:
. accelerated replacement of affected equipment or software, resulting in
higher equipment expense and depreciation;
. short to medium term use of backup equipment and software;
. increased work hours for our staff, resulting in higher compensation expense
and possibly higher employee turn-over; and
. use of contract personnel to correct any Year 2000 problems that arise or to
develop manual work arounds for information systems, each on an accelerated
schedule.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS
We do not use derivative financial instruments in our investment portfolio and
have no foreign exchange contracts. Our financial instruments consist of cash,
cash equivalents, short-term investments, trade accounts receivable and accounts
payable. Our exposure to market risk for changes in interest rates relates
primarily to our short-term investments
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and obligations; thus, fluctuations in interest rates would not have a material
effect on the fair value of these securities.
Sales to customers in foreign countries accounted for approximately 18% of total
revenue during the quarter ended September 30, 1999. We invoice certain of
these sales in United States dollars and do not currently engage in currency
hedging activities. Although exposure to currency fluctuations to date has been
insignificant, future fluctuations in currency exchange rates may adversely
affect our future revenue from international sales.
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
We received correspondence from Commerce Funding Corporation, one of our
stockholders, alleging that we failed to give it proper notice of its right of
first refusal with respect to the proposed resale of 250,000 shares of our stock
by two of our stockholders. We filed a petition seeking a declaratory judgment
that Mission Critical has no liability with respect to Commerce Funding
Corporation's claims on July 1, 1999. On August 2, 1999, Mission Critical, our
Chief Executive Officer and Chief Financial Officer were named as defendants in
a complaint filed by Commerce Funding Corporation. The parties to these actions
are now conducting discovery. We believe that Commerce Funding Corporation's
claims are without merit and intend to vigorously defend the complaint. If
Commerce Funding Corporation were to be awarded a judgment in its complaint or
we were unable to obtain the relief we have requested, we would be required to
indemnify our officers with respect to legal fees, pay our legal expenses and
possibly those of Commerce Funding Corporation. In addition, even if Commerce
Funding Corporation's claims are denied, this litigation could distract our
officers and directors from the day to day management of our business and cause
us to incur substantial legal expenses.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
In August 1999, Mission Critical Software completed the sale of 3,750,000 shares
of Common Stock, including 1 million shares on behalf of selling stockholders,
at a per share price of $16.00 in a firm commitment underwritten initial public
offering pursuant to a Registration Statement on Form S-1 (Registration No. 333-
79501), which the Securities and Exchange Commission declared effective on
August 4, 1999. Mission Critical Software's managing underwriters for the
offering were Hambrecht & Quist LLC, BancBoston Robertson Stephens Inc.,
SoundView Technology Group, Inc. and Charles Schwab & Co., Inc. In August 1999,
an over-allotment option granted by Mission Critical Software to the
underwriters for the purchase of up to 562,500 additional shares of Mission
Critical Software's Common Stock was exercised in full by the underwriters.
Concurrent with the sale, all of the outstanding redeemable convertible
preferred stock was converted to 6,968,650 shares of Common Stock.
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Mission Critical Software realized net proceeds from the offering of
approximately $47.5 million after deducting the underwriting discounts and
expenses of the offering, including legal, accounting, printing, filing and
other fees. Mission Critical Software is currently investing the net offering
proceeds in interest-bearing, investment-grade securities for future use as
additional working capital. Proceeds may be used for working capital and
general corporate purposes, as well as estimated capital expenditures of $3.0
million over the next twelve months to support our increased global sales and
marketing headcount and increased research and development headcount. In
addition, proceeds may be used for further development of our product lines
through acquisitions of or investments in products, technologies and businesses.
Between July 1, 1999 and September 30, 1999, Mission Critical Software issued
175,573 shares of unregistered common stock upon the exercise of outstanding
options to 38 employees at an average exercise price of $0.79 per share. Between
July 1, 1999 and September 30, 1999, Mission Critical Software issued 243,333
shares of unregistered common stock upon the exercise of outstanding warrants to
2 persons at an average exercise price of $1.29 per share. The sale of the above
securities was deemed to be exempt from registration under the Securities Act of
1933, as amended (the "Securities Act"), in reliance on Rule 701 promulgated
under Section 3(b) of the Securities Act, and Section 4(2) of the Securities
Act, respectively, as transactions not involving a public offering or
transactions pursuant to compensatory benefit plans and contracts relating to
compensation as provided under Rule 701 and sales or accredited investors
pursuant to Section 4(2). Each recipient had adequate access, through his or her
relationship with Mission Critical Software, to information about Mission
Critical Software.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4 - SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5 - OTHER INFORMATION
FACTORS THAT MAY AFFECT FUTURE RESULTS
This report on Form 10-Q, including Management's Discussion and Analysis of
Financial Condition and Results of Operations, contains forward-looking
statements and other prospective information relating to future events. These
forward-looking statements and other information are subject to certain risks
and uncertainties that could cause results to differ materially from historical
results or anticipated results, including the following:
Our business and prospects are difficult to evaluate because we have a limited
operating history
Our company was founded in July 1996. We have a limited operating history. An
investor in our common stock must consider the risks and difficulties we may
encounter as an early stage company in a new and rapidly evolving market. These
risks and difficulties include our:
. ability to develop competitive products;
. need to expand our sales and support organizations;
. reliance on our strategic relationship with Microsoft;
. competition;
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. need to manage changing operations;
. dependence upon key personnel; and
. general economic conditions.
We cannot be certain that our business strategy will be successful or that we
will successfully manage these risks. If we fail to address adequately any of
these risks or difficulties, our business would likely suffer.
WE HAVE A HISTORY OF LOSSES AND MAY EXPERIENCE LOSSES IN THE FUTURE
Since our inception, we have incurred significant net losses and only achieved
marginal profitability in the fiscal year ended June 30, 1999 and the three
months ended September 30, 1999. We expect to continue to incur significant
sales and marketing, product development and administrative expenses. As a
result, we will need to generate significant revenue to maintain profitability.
We cannot be certain that we will achieve, sustain or increase profitability in
the future.
We anticipate that our expenses will increase substantially in the foreseeable
future as we:
. increase our direct sales and marketing activities, by expanding our North
American and international direct sales forces and extending our telesales
efforts;
. develop our technology, expand our OnePoint product suite and create and
market products that operate with the commercial release version of Windows
2000;
. expand our indirect distribution channels; and
. pursue strategic relationships and acquisitions.
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.
WE MAY NOT BE ABLE TO SUSTAIN OUR CURRENT REVENUE GROWTH RATES
Although our revenue has grown rapidly in recent years, we do not believe that
we will maintain 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 our inexperience in selling our products to
small organizations could also affect our revenue growth. 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 we anticipate. As a result, we cannot predict our future
operating results with any degree of certainty and our quarterly operating
results may vary significantly from quarter to quarter.
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OUR ABILITY TO ACCURATELY FORECAST OUR QUARTERLY SALES IS LIMITED AND OUR COSTS
ARE RELATIVELY FIXED IN THE SHORT-TERM, SO OUR QUARTERLY OPERATING RESULTS AND
OUR STOCK PRICE MAY FLUCTUATE
Our ability to accurately forecast our quarterly sales is limited, which makes
it difficult to predict the quarterly revenue that we will recognize. As a
result, we believe that quarter to quarter comparisons of our financial results
are not necessarily meaningful, and investors should not rely on them as an
indication of our future performance.
Historically, a majority of our revenue has been attributable to the licensing
of our software products. Changes in the mix of our revenue, including the mix
between higher margin software products and somewhat lower margin maintenance,
could adversely affect our operating results for future quarters.
As a result of our limited operating history, we cannot forecast operating
expenses based on historical results. If we have a shortfall in revenue in
relation to our expenses, we may be unable to reduce our expenses quickly enough
to avoid lower quarterly operating results. Many of our costs are fixed in the
short-term. For example, in September 1999 we moved to a new 70,000 square feet
office in Houston, Texas for which we have a five year lease. We do not know
whether our business will grow rapidly enough to absorb the costs of this
facility. In either case, lower quarterly results could adversely affect the
market price of our common stock.
WE HAVE RELIED AND EXPECT TO CONTINUE TO RELY ON SALES OF LICENSES FOR OUR
ONEPOINT ADMINISTRATOR PRODUCTS FOR OUR REVENUE AND A DECLINE IN SALES OF THIS
PRODUCT COULD CAUSE OUR REVENUES TO FALL
Historically, we have derived the substantial majority of our license revenue
from the sale of our OnePoint Administrator products. During the fiscal years
ended June 30, 1998 and 1999 and the three months ended September 30, 1999,
sales of OnePoint Administrator products accounted for approximately 88%, 82%
and 74% of our license revenue, respectively. We expect that these products will
continue to account for a large portion of our license revenue for the
foreseeable future. Our future operating results depend on the continued market
acceptance of our OnePoint Administrator products and future enhancements to our
OnePoint Administrator products. Any factors adversely affecting the pricing of,
demand for or market acceptance of our OnePoint Administrator products,
including competition or technological change, could cause our revenue to
decline and our business to suffer.
We introduced a new version of our OnePoint Operations Manager product in
October 1999. To date, this product has accounted for only a limited portion of
our revenue. However, our future growth and profitability will depend on our
ability to increase sales of our OnePoint Operations Manager product.
OUR REVENUE COULD DECLINE SUBSTANTIALLY IF OUR EXISTING CUSTOMERS DO NOT
CONTINUE TO PURCHASE ADDITIONAL LICENSES FROM US
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We rely on sales of additional licenses for our products to our existing
customers. In the fiscal year ended June 30, 1999 and the three months ended
September 30, 1999, additional sales to our existing customers represented
approximately 50% and 65% of our license revenue. If we fail to sell additional
licenses for our products and maintenance to our existing customers, we would
experience a material decline in total revenue. Even if we are successful in
selling our products to new customers, the rate of growth of our revenue could
be materially and adversely affected if our existing customers do not continue
to purchase a substantial number of additional product licenses from us.
RISKS RELATED TO MICROSOFT
OUR BUSINESS IS DEPENDENT ON THE ADOPTION OF WINDOWS NT AND WINDOWS 2000 TO
RUN CORPORATE AND INTERNET-BASED COMPUTER NETWORKS AND A DECREASE IN THEIR
RATES OF ADOPTION COULD CAUSE OUR REVENUES TO DECLINE
For the foreseeable future, we expect substantially all of our revenue to
continue to come from sales of our Windows NT systems management products. As a
result, we depend on the growing use of Windows NT for corporate and Internet-
based networks. If the role of Windows NT does not increase as we anticipate, or
if it in any way decreases, our revenues would decline. In addition, if users do
not accept Windows 2000, or if there is a wide acceptance of other existing or
new operating systems that provide enhanced capabilities, our business would
likely suffer.
Windows 2000 may not gain market acceptance if its launch is delayed beyond its
expected release date. In addition, users of previous versions of Windows NT may
decide to migrate to another operating system due to the delays or to improved
functionality of some other vendor's operating system. Windows 2000 may address
more of the needs of our customers for systems administration and operations
management, in which case our customers would not need to purchase our products
to perform those functions. In addition, we cannot be sure that we will be able
to successfully redevelop our products to work with Windows 2000 at the same or
better levels of functionality than our products work with the current version
of Windows NT. Even if we successfully develop products for Windows 2000, our
customers may not choose our products for technical, cost, support or other
reasons. If users of large corporate and Internet-based Windows 2000 networks do
not widely adopt and purchase our products, our revenues and business will
suffer.
IF OUR INTRODUCTION OF NEW SYSTEMS MANAGEMENT SOFTWARE PRODUCTS FOR WINDOWS 2000
IS NOT SUCCESSFUL, OUR REVENUES COULD DECLINE
We are currently expanding our OnePoint product suite to support the commercial
release version of the Windows 2000 operating system, which has been announced
by Microsoft but is not currently available. Our OnePoint product suite
currently supports the current pre-release version of Windows 2000 Server. If we
do not successfully develop, market and sell products that support the
commercial release version of Windows 2000, our business and future operating
results would suffer. In addition, we must introduce new versions of our
products to support the commercial release version of Windows 2000 shortly after
its release by Microsoft. If we fail to introduce our new products within a
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short time after the commercial release of Windows 2000, the delay may cause
customers to forego purchases of our products and purchase those of our
competitors.
WE 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 our strategic marketing, product development and sales
relationship with Microsoft. We believe our relationship with Microsoft is
important in order to validate our technology, facilitate broad market
acceptance of our products and enhance our sales, marketing and distribution
capabilities. If we are unable to maintain and enhance our existing relationship
with Microsoft or develop a similar relationship with another major operating
system vendor, we may have difficulty selling our products.
We rely heavily on our relationship with Microsoft and attempt to coordinate our
product offerings with the future releases of Microsoft's operating systems,
particularly the commercial release version of Windows 2000. 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. We have entered into several agreements with Microsoft
Corporation. For example in June 1999, Microsoft indicated its intention to use
our Windows NT 4.0 to Windows 2000 migration tools in its Windows 2000
offerings, and we also work with Microsoft to provide coordinated technical
support to Microsoft's enterprise customers. Federal and state regulatory
authorities have recently initiated broad antitrust actions against Microsoft.
We cannot predict to what extent these antitrust actions may affect our
relationship with Microsoft, although these actions may narrow the scope of
Windows NT sites and applications where Microsoft may incorporate our products
designed to support Windows 2000.
RISKS RELATED TO OUR SALES EFFORTS
IF WE EXPERIENCE ANY INCREASE IN THE LENGTH OF OUR SALES CYCLE, OUR QUARTERLY
OPERATING RESULTS COULD BECOME MORE UNPREDICTABLE AND OUR STOCK PRICE MAY
DECLINE AS A RESULT
To date, our customers have taken an average of three months to evaluate our
products. Our customers tend to deploy our products by purchasing licenses for
one product at a time and for use with a small number of servers and clients. We
anticipate that the sales cycle for other OnePoint products will be similar to
the sales cycle we previously experienced for OnePoint Administrator products
and OnePoint Operations Manager. If customers begin to evaluate our products for
an enterprise-wide initial deployment, our sales cycle could lengthen and our
license revenue and operating results might vary significantly from period to
period. In addition, enterprise-wide initial deployments could also erode per-
user license fees even though our average sales price might increase.
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IF WE ARE UNABLE TO EXPAND OUR SALES OPERATIONS, WE MAY NOT BE ABLE TO EXPAND
OUR BUSINESS
In order to increase market awareness and sales of our products, we will need to
substantially expand our direct and indirect sales operations, both domestically
and internationally. To date, we have relied primarily on our direct sales force
to sell our products. Our products and maintenance require a sophisticated sales
effort targeted at several people within our prospective customers' information
technology departments. We have recently expanded our direct sales force and
plan to hire additional sales personnel. Competition for qualified sales people
is intense, and we might not be able to hire the kind and number of sales people
we are targeting.
WE MAY NOT BE ABLE TO EXPAND OUR BUSINESS IF WE DO NOT SUCCESSFULLY UTILIZE
SYSTEMS INTEGRATORS OR CONSULTING SERVICE PROVIDERS IN OUR SELLING EFFORTS
To date, we have not yet significantly utilized systems integrators or
consulting service providers in our selling efforts for our software products.
We intend to explore relationships with systems integrators but have little or
no experience negotiating agreements with systems integrators and consulting
service providers, engaging in joint selling activities with systems integrators
and consulting service providers or providing support to their end-user
customers. Our business and sales may suffer if we fail to enter into agreements
with systems integrators and/or consulting service providers or if we fail to
successfully and profitably perform our obligations under those 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.
IF WE ARE UNABLE TO EXPAND OUR CUSTOMER SERVICE AND SUPPORT ORGANIZATION, WE
MAY NOT BE ABLE TO RETAIN OUR CUSTOMERS AND ATTRACT NEW CUSTOMERS
The complexity of distributed computing systems requires highly trained customer
service and support personnel to assist the customer with installation and
deployment. We currently have a small customer service and support organization
and will need to increase our staff to support new customers and the expanding
needs of our existing customers. Hiring customer service and support personnel
is very competitive in our industry due to the limited number of people
available with the necessary technical skills and understanding of the Windows
NT and Windows 2000 operating environments.
OUR EXPANSION TO INTERNATIONAL MARKETS COULD REDUCE OUR OPERATING MARGINS DUE
TO THE HIGHER COSTS OF STATIONING EMPLOYEES ABROAD OR COMMISSIONS PAID TO
FOREIGN DISTRIBUTORS TO MAKE IT PROFITABLE FOR THEM TO SELL OUR PRODUCTS
We must expand the number of distributors who sell our products or our direct
international sales presence to increase our international sales. We may
experience reduced operating margins if we incur the higher costs of stationing
employees overseas without realizing corresponding improvements in international
revenues. In addition, we cannot be certain that we will be able to attract
distributors that market our products effectively or provide timely and cost-
effective customer support and service. We cannot
28
<PAGE>
be certain that any distributor will continue to represent our products or that
our distributors will devote a sufficient amount of effort and resources to
selling our products in their territories. We may also experience lower
operating margins due to the different cost structure of our direct sales model
versus an indirect commission or discount based model if international revenue
increases as a percentage of our total revenue.
To date, we have entered into agreements with only a small number of
distribution partners and have only recently begun to employ direct sales staff
outside North America. We are expanding our indirect distribution channels
outside of North America. If we are unable to generate increased international
sales through an indirect distribution model, we will incur higher personnel
costs by hiring direct sales staff. We may not realize corresponding increases
in revenue from a direct international sales staff, and our operating margins
may decline. If we elect to establish more direct sales staff outside the United
States, varying employment policies and regulations among countries may reduce
our flexibility in managing headcount and, in turn, managing personnel-related
expenses.
Even if we are able to successfully expand our direct and indirect international
selling efforts, we cannot be certain that we will be able to create or increase
international market demand for our products. We also expect that if we increase
our sales in Europe, our operating results may be lower in our quarters ending
September 30 due to the summer slowdown in Europe.
OUR BUSINESS AND PROSPECTS ARE DIFFICULT TO EVALUATE, BECAUSE WE MAY CLOSE A
LARGE NUMBER OF TRANSACTIONS IN A GIVEN QUARTER WITH THE EFFECT OF REDUCING
SELLING OPPORTUNITIES IN THE FOLLOWING QUARTER OR BECAUSE THERE ARE FEWER
SELLING OPPORTUNITIES IN THE SUMMER MONTHS
In the quarter ended September 30, 1998, our revenue and operating results were
lower relative to the prior quarter. We believe this decline resulted from the
substantial number of transactions our sales staff closed in the prior quarter,
our fourth fiscal quarter, and because there were fewer selling opportunities in
the summer months. If this seasonality were to continue in the future, our
quarter to quarter operating results could be unpredictably affected.
OUR REVENUES MAY SUFFER IF CUSTOMERS DEMAND EXTENSIVE CONSULTING OR OTHER
SUPPORT SERVICES WITH OUR SOFTWARE PRODUCTS BECAUSE WE DO 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 from us to be
implemented quickly and effectively by our customers. Many of our 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. We 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
29
<PAGE>
revenue would likely suffer because customers would choose another vendor or we
would incur the added expense of hiring and retaining consulting personnel.
RISKS RELATED TO COMPETITION WITHIN OUR INDUSTRY
If we fail to compete successfully in our highly competitive industry, including
against some of Microsoft's products, our revenues may decline
We face competition from different sources, and we must compete effectively
against other current and future competitors to retain and expand our customer
base. If we fail to retain and expand our customer base, our revenues could
decline substantially.
We believe the principal factors that will draw end-users to a systems
management software product include:
. depth of product functionality;
. ability to work natively with Windows NT and Windows 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 our competitors' innovations by
continuing to enhance our products and sales channels. Any pricing pressures or
loss of market share resulting from our failure to compete effectively could
reduce our revenue.
We also believe that Microsoft, or systems management software vendors, each of
which are also currently competing with us, could enhance their products to
include the functionality that we currently 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 functionality of the
standard features of these products is more limited than ours, we face a
substantial risk that a significant number of customers would elect to keep this
limited functionality rather than purchase additional software.
We may face competition in the future from established companies that have not
previously entered the Windows NT systems management software market or from
emerging software companies. Barriers to entry in the software market are
relatively low. Increased competition may negatively affect our business and
future operating results due to price reductions, higher selling expenses and a
reduction in our market share.
OUR REVENUE COULD BE REDUCED IF OUR INDUSTRY CONSOLIDATES FURTHER OR OUR
PRODUCTS ARE NOT COMPETITIVE WITH LARGER SUITES
Microsoft and systems management software vendors may not only develop their own
systems management solutions, but they may also acquire or establish cooperative
30
<PAGE>
relationships with our current competitors, including smaller private companies.
Because Microsoft and these vendors have significant financial and
organizational resources available, they may be able to quickly penetrate the
Windows NT systems management software market by leveraging the technology and
expertise of smaller companies and utilizing their extensive distribution
channels. We expect that the software industry and providers of systems
management solutions, in particular, will continue to consolidate. It is
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share.
OUR PRODUCTS MAY BECOME OBSOLETE IF OTHER VENDORS' PRODUCTS ARE NO LONGER
COMPATIBLE WITH OURS OR OTHER VENDORS BUNDLE THEIR PRODUCTS WITH THOSE OF OUR
COMPETITORS
Our ability to sell our products also depends, in part, on the compatibility of
our products with other vendors' software and hardware products, particularly
those provided by Microsoft. Developers of these products may change their
products so that they will no longer be compatible with our products. These
other vendors may also decide to bundle their products with other systems
management products for promotional purposes. If that were to happen, our
business and future operating results may suffer as we may be priced out of the
market or no longer be able to offer commercially viable products.
WE MAY NOT SUCCEED IN DEVELOPING AND MARKETING NEW PRODUCTS FOR OUR ONEPOINT
SUITE, AND OUR OPERATING MARGINS MAY DECLINE AS A RESULT
We are planning the release of additional products for our OnePoint suite that
function with Windows NT and the commercial release version of Windows 2000.
Developing these capabilities and other required features for the release of new
products will require significant additional expenses and development resources.
For example, we cannot be certain that our entry into the file administration
segment of the systems management software market with our OnePoint Operations
Manager or OnePoint File Administrator products will be successful or that our
customers will widely accept and adopt these products.
RISKS RELATED TO OUR PRODUCTS' DEPENDENCE ON INTELLECTUAL PROPERTY
SYSTEMS MANAGEMENT SOFTWARE PRODUCTS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE
DUE TO CHANGING OPERATING SYSTEM SOFTWARE AND NETWORK HARDWARE AND SOFTWARE
CONFIGURATIONS, AND OUR PRODUCTS COULD BE RENDERED OBSOLETE BY NEW TECHNOLOGIES,
SUCH AS WINDOWS 2000
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 products based on new technologies are
introduced or new industry standards emerge. For example, our products will
become obsolete if we do not develop and distribute products that operate with
Windows 2000 and provide functionality beyond the native Windows 2000
functionality.
31
<PAGE>
Client/server computing environments are inherently complex. As a result, we
cannot accurately estimate the life cycles of our software products. New
products and product enhancements can require long development and testing
periods, which depend significantly on our ability to hire and retain
increasingly scarce and technically competent personnel. Significant delays in
new product releases or significant problems in installing or implementing new
product releases could seriously damage our business. We have, on occasion,
experienced delays in the scheduled introduction of new and enhanced products
and cannot be certain that we will avoid similar delays in the future.
Our future success depends upon our ability to enhance existing products,
develop and introduce new products, satisfy customer requirements and achieve
market acceptance. We cannot be certain that we will successfully identify new
product opportunities and develop and bring new products to market in a timely
and cost-effective manner.
OUR SOFTWARE PRODUCTS RELY ON OUR INTELLECTUAL PROPERTY, AND ANY FAILURE BY US
TO PROTECT OUR INTELLECTUAL PROPERTY COULD ENABLE OUR COMPETITORS TO MARKET
PRODUCTS WITH SIMILAR FEATURES THAT MAY REDUCE DEMAND FOR OUR PRODUCTS
Our success and ability to compete are substantially dependent upon our
internally developed technology that is incorporated in the source code for our
products. We protect our intellectual property through a combination of
copyright, trade secret and trademark law. However, to date we have not
registered any of our trademarks under applicable law. We generally enter into
confidentiality or license agreements with our employees, consultants and
corporate partners, and generally control access to our source code and other
intellectual property and the distribution of our software, documentation and
other proprietary information. We believe that such measures afford only limited
protection. Others may develop technologies that are similar or superior to our
technology or design around the copyrights and trade secrets we own. 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 our efforts to protect our
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.
OUR PRODUCTS EMPLOY TECHNOLOGY THAT MAY INFRINGE THE PROPRIETARY RIGHTS OF
OTHERS, AND WE MAY BE LIABLE FOR SIGNIFICANT DAMAGES
Substantial litigation regarding intellectual property rights exists in the
software industry. We expect that software products may be increasingly subject
to third-party infringement claims as the number of competitors in our industry
segment grows and the functionality of products in different industry segments
overlaps. We are not aware that our products employ technology that infringes
any proprietary rights of third parties. However, third
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<PAGE>
parties may claim that we infringe their intellectual property rights. Any
claims, with or without merit, could:
. be time-consuming to defend;
. result in costly litigation;
. divert our management's attention and resources;
. cause product shipment delays; or
. require us to enter into royalty or licensing agreements.
These royalty or licensing agreements may not be available on terms acceptable
to us, if at all. A successful claim of product infringement against us or our
failure or inability to license the infringed or similar technology could
adversely affect our business because we would not be able to sell the impacted
product without redeveloping it or incurring significant additional expenses.
WE HAVE EXPERIENCED SIGNIFICANT GROWTH AND CHANGE IN OUR BUSINESS AND OUR
FAILURE TO MANAGE THIS GROWTH AND ANY FUTURE GROWTH COULD HARM OUR BUSINESS
We continue to increase the scope of our operations and have grown our headcount
substantially. At June 30, 1998 we had a total of 92 employees, at June 30, 1999
we had a total of 163 employees and at September 30, 1999 we had a total of 193
employees. Our productivity and the quality of our products may be adversely
affected if we do not integrate and train our new employees quickly and
effectively. We also cannot be sure that our revenues will continue to grow at a
sufficient rate to absorb the costs associated with a larger overall headcount,
as well as recruiting-related expenses.
WE FACE RISKS FROM OUR INTERNATIONAL OPERATIONS DUE TO OUR LIMITED
INTERNATIONAL EXPERIENCE
In the fiscal year ended June 30, 1999 and the three months ended September 30,
1999, customers outside North America accounted for 22% and 18% of our license
revenue. We plan to increase our international sales activities, but we have no
experience in developing foreign language translations of our products and
little experience marketing and distributing our products internationally.
We conduct direct sales activities in England, France and Germany and indirect
activities in Europe, Australia and Brazil. Our international operations are
subject to other inherent risks, including:
. the impact of recessions in economies outside the United States;
. greater difficulty in accounts receivable collection and longer collection
periods;
. unexpected changes in regulatory requirements;
33
<PAGE>
. difficulties and costs of staffing and managing foreign operations;
. reduced protection for intellectual property rights in some countries;
. potentially adverse tax consequences; and
. political and economic instability.
OUR REVENUE MAY BE EXPOSED TO EXCHANGE RATE FLUCTUATIONS, AND OUR PRODUCTS MAY
NOT BE COMPETITIVE DUE TO EXCHANGE RATE INSTABILITY
Our international sales are generally denominated in the United States dollar.
We do not currently engage in currency hedging activities. Although exposure to
currency fluctuations to date has been insignificant, future fluctuations in
currency exchange rates may adversely affect our future revenue from
international sales. We may also be less competitive than a vendor whose
products are sold in the local currency during times of exchange rate
instability. We expect that if our international sales operations increase
substantially, we will be required to price our products and pay our expenses in
foreign currencies and may be subject to currency exchange risk.
WE HAVE COMPLETED OUR INITIAL ASSESSMENT OF OUR YEAR 2000 READINESS AND ANY YEAR
2000 PROBLEMS WITH OUR PRODUCTS OR OUR INTERNAL SYSTEMS AND SOFTWARE COULD
RESULT IN THIRD PARTY CLAIMS
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. As a result, software that
records only the last two digits of the calendar year may not be able to
determine whether "00" means 1900 or 2000. This may result in software failures
or the creation of erroneous results.
We have completed our initial assessment of our Year 2000 readiness. We have
concluded our investigation and performed testing to determine whether each
component of our OnePoint product suite and our products in development are Year
2000 compliant. Our software products operate in complex system environments and
directly and indirectly interact with a number of other hardware and software
systems. Despite the investigation and testing by us and our partners, our
software products and the underlying systems and protocols running our products
may contain errors or defects associated with Year 2000 date functions. We are
unable to predict to what extent our business may be affected if our software or
the systems that operate in conjunction with our software experience a material
Year 2000 failure. Known or unknown errors or defects that affect the operation
of our software could result in:
. delay or loss of revenue, cancellation of customer contracts;
. diversion of development resources;
. damage to our reputation;
. increased maintenance and warranty costs; and
34
<PAGE>
. litigation costs,
any of which could adversely affect our business, financial condition and
results of operations.
Despite investigation and testing by us, our internal systems and/or software
may contain errors or defects associated with Year 2000 date functions. We are
unable to predict to what extent our core business functions may be affected if
our internal systems or software experience a material Year 2000 failure. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operation - Year 2000 Readiness" for a description of our Year 2000 readiness
efforts.
WE MUST CONTINUE TO HIRE AND RETAIN SALES AND RESEARCH AND DEVELOPMENT STAFF TO
SUSTAIN OUR REVENUE GROWTH
We intend to hire a significant number of additional sales, support, marketing
and research and development personnel in calendar 1999 and 2000. Competition
for these individuals is intense, and we may not be able to attract, assimilate
or retain additional highly qualified personnel in the future. Our future
success and ability to sustain our revenue growth also depend upon the continued
service of our executive officers and other key sales, marketing and support
personnel, particularly since we have experienced disruption from the turnover
of senior management in the past. In addition, our products and technologies are
complex and we are substantially dependent upon the continued service of our
existing engineering personnel, and especially Thomas P. Bernhardt, one of our
founders and our Chief Technology Officer. The loss of any of our key employees
could adversely affect our business and slow our product development processes
particularly since neither our Chief Executive Officer nor our Chief Financial
Officer is bound by a noncompetition or nonsolicitation agreement. We do not
have key person life insurance policies covering any of our employees.
To achieve our 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.
ERRORS IN OUR PRODUCTS OR THE FAILURE OF OUR PRODUCTS TO CONFORM TO
SPECIFICATIONS COULD RESULT IN OUR CUSTOMERS DEMANDING REFUNDS FROM US OR
ASSERTING CLAIMS FOR DAMAGES AGAINST US
Because our software products are complex, they could contain errors or bugs
that can be detected at any point in a product's life cycle. While we
continually test our products for errors and work with customers through our
customer support services to identify and correct bugs in our software, we
expect that errors in our products will continue to be found in the future.
Although many of these errors may prove to be immaterial, any of these errors
could be significant. Detection of any significant errors may result in:
. the loss of or delay in market acceptance and sales of our products;
35
<PAGE>
. diversion of development resources;
. injury to our reputation; or
. increased maintenance and warranty costs.
These problems could harm our business and future operating results. In the past
we have discovered errors in some of our products and have experienced delays in
the shipment of our products during the period required to correct these errors.
These delays have principally related to new versions and product update
releases. To date none of these delays has materially affected our business.
However, product errors or delays in the future could be material, including any
product errors or delays associated with the introduction of our new products or
the versions of our products that support Windows 2000. Occasionally, we have
warranted that our products will operate in accordance with specified customer
requirements. If our products fail to conform to these specifications, customers
could demand a refund for the software license fee paid to us or assert claims
for damages.
Moreover, because our products administer critical distributed computing systems
services, we may receive significant liability claims if our products do not
work properly. Our agreements with customers typically contain provisions
intended to limit our exposure to liability claims. However, these limitations
may not preclude all potential claims. Liability claims could require us to
spend significant time and money in litigation or to pay significant damages.
Any such claims, whether or not successful, could seriously damage our
reputation and our business.
WE WILL FACE RISKS IF WE UNDERTAKE ACQUISITIONS
We may make investments in complementary companies, products or technologies. If
we buy a company, we could have difficulty in assimilating that company's
personnel and operations. In addition, the key personnel of the acquired company
may decide not to work for us. If we make other types of acquisitions, we could
have difficulty in assimilating the acquired technology or products into our
operations.
These difficulties could disrupt our ongoing business, distract our management
and employees and increase our expenses. We also expect that we would incur
substantial expenses if we acquired other businesses or technologies.
Furthermore, we may use the proceeds of this offering, incur debt or issue
equity securities to pay for any future acquisitions. If we issue additional
equity securities, our stockholders could experience dilution. As of the date of
this prospectus, we have no agreements or understandings regarding any future
acquisitions.
RISKS RELATED OUR SECURITIES
OUR STOCK WILL LIKELY BE SUBJECT TO SUBSTANTIAL PRICE AND VOLUME FLUCTUATIONS
DUE TO A NUMBER OF FACTORS, MANY OF WHICH WILL BE BEYOND OUR CONTROL, THAT MAY
PREVENT OUR STOCKHOLDERS FROM RESELLING OUR COMMON STOCK AT A PROFIT
36
<PAGE>
The securities markets have experienced significant price and volume
fluctuations and the market prices of the securities of software companies have
been especially volatile. This market volatility, as well as general economic,
market or political conditions, could reduce the market price of our common
stock in spite of our operating performance. In addition, our operating results
could be below the expectations of public market analysts and investors, and in
response the market price of our common stock could decrease significantly.
Investors may be unable to resell their shares of our common stock at or above
the offering price. In the past, companies that have experienced volatility in
the market price of their stock have been the object of securities class action
litigation. If we were the object of securities class action litigation, it
could result in substantial costs and a diversion of management's attention and
resources.
OUR OFFICERS AND PERSONS AFFILIATED WITH OUR DIRECTORS INFLUENCE OUR BUSINESS
AND HOLD A SUBSTANTIAL PORTION OF OUR STOCK AND COULD REJECT MERGERS OR OTHER
BUSINESS COMBINATIONS THAT A STOCKHOLDER MAY BELIEVE ARE DESIRABLE
We anticipate that our directors, officers and individuals or entities
affiliated with our directors will beneficially own approximately 32.0% of our
outstanding common stock as a group after the proposed stock offering closes.
Acting together, these stockholders would be able to significantly influence all
matters that our stockholders vote upon, including the election of directors and
mergers or other business combinations.
THE PROVISIONS OF OUR CHARTER DOCUMENTS MAY INHIBIT POTENTIAL ACQUISITION BIDS
THAT A STOCKHOLDER MAY BELIEVE IS DESIRABLE, AND THE MARKET PRICE OF OUR COMMON
STOCK MAY BE LOWER AS A RESULT
Our board of directors has the authority to issue up to 5,000,000 shares of
preferred stock. The board of directors can fix the price, rights, preferences,
privileges and restrictions of the preferred stock without any further vote or
action by our stockholders. The issuance of shares of preferred stock may delay
or prevent a change in control transaction. As a result, the market price of our
common stock and the voting and other rights of our stockholders may be
adversely affected. The issuance of preferred stock may result in the loss of
voting control to other stockholders. We have no current plans to issue any
shares of preferred stock.
Our charter documents contain anti-takeover devices including:
. only one of the three classes of directors is elected each year;
. the ability of our stockholders to remove directors without cause is limited;
. the right of stockholders to act by written consent has been eliminated;
. the right of stockholders to call a special meeting of stockholders has been
eliminated; and
. a requirement of advance notice to nominate directors or submit proposals for
consideration at stockholder meetings.
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<PAGE>
These provisions could discourage potential acquisition proposals and could
delay or prevent a change in control transaction. They could also have the
effect of discouraging others from making tender offers for our common stock. As
a result, these provisions may prevent the market price of our common stock from
increasing substantially in response to actual or rumored takeover attempts.
These provisions may also prevent changes in our management.
DELAWARE LAW MAY INHIBIT POTENTIAL ACQUISITION BIDS; THIS MAY ADVERSELY AFFECT
THE MARKET PRICE OF OUR COMMON STOCK, DISCOURAGE MERGER OFFERS AND PREVENT
CHANGES IN OUR MANAGEMENT
Section 203 of the Delaware General Corporation Law may inhibit potential
acquisition bids for our company. We are subject to the antitakeover provisions
of the Delaware General Corporation Law, which regulate corporate acquisitions.
Delaware law will prevent us from engaging, under certain circumstances, in a
"business combination" with any "interested stockholder" for three years
following the date that the interested stockholder became an interested
stockholder unless our board of directors or a supermajority of our uninterested
stockholders agree. For purposes of Delaware law, a "business combination"
includes a merger or consolidation involving us and the interested stockholder
and the sale of more than 10% of our assets. In general, Delaware law defines an
"interested stockholder" as any holder beneficially owning 15% or more of the
outstanding voting stock of a corporation and any entity or person affiliated
with or controlling or controlled by the holder. Under Delaware law, a
corporation may opt out of the foregoing antitakeover provisions. We do not
intend to opt out of the antitakeover provisions of Delaware Law.
The substantial number of shares that will be eligible for sale in the near
future could cause our common stock price to fall.
Our current stockholders hold a substantial number of shares, which they will be
able to sell in the public market in the near future. Sales of a substantial
number of shares of our common stock could cause our stock price to fall. In
addition, the sale of these shares could impair our ability to raise capital
through the sale of additional stock.
WE MAY BE SUBJECT TO DAMAGES OR BE REQUIRED TO INDEMNIFY OUR OFFICERS AND
DIRECTORS IF CURRENT LITIGATION BY ONE OF OUR STOCKHOLDERS IS DECIDED AGAINST
OUR COMPANY, OUR OFFICERS OR DIRECTORS OR IF WE ENTER INTO A SETTLEMENT.
We received correspondence from Commerce Funding Corporation, one of our
stockholders, alleging that we failed to give it proper notice of its right of
first refusal with respect to the proposed resale of 250,000 shares of our stock
by two of our stockholders. We filed a petition seeking a declaratory judgment
that Mission Critical has no liability with respect to Commerce Funding
Corporation's claims on July 1, 1999. On August 2, 1999, Mission Critical, our
Chief Executive Officer and Chief Financial Officer were named as defendants in
a complaint filed by Commerce Funding Corporation. The parties to these actions
are now conducting discovery. We believe that Commerce Funding Corporation's
claims are without merit and intend to vigorously defend the complaint. If
Commerce Funding Corporation were to be awarded a judgment
38
<PAGE>
in its complaint or we were unable to obtain the relief we have requested, we
would be required to indemnify our officers with respect to legal fees, pay our
legal expenses and possibly those of Commerce Funding Corporation. In addition,
even if Commerce Funding Corporation's claims are denied, this litigation could
distract our officers and directors from the day to day management of our
business and cause us to incur substantial legal expenses.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
Mission Critical Software did not file any reports on Form 8-K during the
quarter ended September 30, 1999.
39
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: November 15, 1999.
MISSION CRITICAL SOFTWARE, INC.
(Registrant)
/s/ MICHAEL S. BENNETT
---------------------------------------
Michael S. Bennett
President and Chief Executive Officer
(Principal Executive Officer)
/s/ STEPHEN E. ODOM
---------------------------------------
Stephen E. Odom
Chief Operating Officer, Chief Financial Officer,
and Secretary
(Principal Financial and Accounting Officer)
40
<PAGE>
INDEX TO EXHIBITS
EXHIBITS
27.1 Financial Data Schedule
41
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extraced from Mission
Critical Software, Inc. September 30, 1999 Financial Statements 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-30-1999
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 62,187
<SECURITIES> 0
<RECEIVABLES> 3,320
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 65,818
<PP&E> 3,322
<DEPRECIATION> 0
<TOTAL-ASSETS> 69,700
<CURRENT-LIABILITIES> 13,576
<BONDS> 0
0
0
<COMMON> 14
<OTHER-SE> 55,627
<TOTAL-LIABILITY-AND-EQUITY> 69,700
<SALES> 9,020
<TOTAL-REVENUES> 9,441
<CGS> 346
<TOTAL-COSTS> 8,234
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9
<INCOME-PRETAX> 1,198
<INCOME-TAX> 180
<INCOME-CONTINUING> 1,018
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,018
<EPS-BASIC> 0.10
<EPS-DILUTED> 0.06
</TABLE>
