<PAGE> 1
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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 June 30, 2000
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period ____________ to __________
COMMISSION FILE NUMBER 000-29809
OTG SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 7372 52-1769077
(state or other jurisdiction of (Primary Standard Industrial (IRS Employer
incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
6701 DEMOCRACY BOULEVARD, SUITE 800
BETHESDA, MARYLAND 20817
(301) 897-1400
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
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 July 31, 2000, there were outstanding 25,766,444 shares of OTG
Software, Inc. common stock, $0.01 par value per share.
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<PAGE> 2
OTG SOFTWARE, INC.
Form 10-Q
Quarterly Period Ended June 30, 2000
Table of Contents
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements 1
Condensed Consolidated Balance Sheets as of June 30, 2000 and
December 31, 1999 1
Condensed Consolidated Statements of Operations for the three months
and six months ended June 30, 2000 and 1999 2
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2000 and 1999 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits 27
(b) Reports on Form 8-K 28
SIGNATURES 28
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
OTG SOFTWARE, INC.
Condensed Consolidated Balance Sheets
(in thousands, except share and per share amounts)
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents $ 68,218 $ 2,494
Accounts receivable, net of allowance of
$947 and $803, respectively 10,270 7,596
Deferred income taxes 880 -
Prepaid royalties and other current assets 1,553 693
--------- ---------
Total current assets 80,921 10,783
Other assets
Property and equipment, net 2,249 1,444
Goodwill, net 2,799 -
Other intangibles, net 762 -
Other assets, net 304 362
--------- ---------
Total other assets 6,114 1,806
--------- ---------
Total assets $ 87,035 $ 12,589
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities
Accounts payable $ 1,857 $ 1,509
Accrued expenses 5,105 3,708
Accrued interest - 1,327
Notes payable to banks - 5,000
Current portion of long-term debt 51 13,803
Subordinated notes payable-stockholders - 1,969
Deferred revenues 4,281 3,450
--------- ---------
Total current liabilities 11,294 30,766
Other liabilities
Long-term debt, net of current portion 57 3,529
Deferred income taxes 415 -
--------- ---------
Total other liabilities 472 3,529
--------- ---------
Total liabilities 11,766 34,295
Commitments and contingencies
Shareholders' equity (deficit)
Preferred stock, $0.01 par value; 5,000,000 shares
authorized, none issued - -
Common stock, $0.01 par value; 65,000,000 shares
authorized, 25,731,774 and 16,314,682 shares
issued and outstanding, respectively 257 163
Additional paid-in capital 101,659 4,081
Deferred compensation, net (2,187) (2,557)
Accumulated deficit (23,459) (22,416)
--------- ---------
Total shareholders' equity (deficit) before stock
subscriptions receivable 76,270 (20,729)
--------- ---------
Less: stock subscriptions receivable (1,001) (977)
--------- ---------
Total stockholders' equity (deficit) 75,269 (21,706)
--------- ---------
Total liabilities and shareholders' equity (deficit) $ 87,035 $ 12,589
========= =========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
1
<PAGE> 4
OTG SOFTWARE, INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three months Six months
ended June 30, ended June 30,
2000 1999 2000 1999
---- ---- ---- ----
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues
Software licenses $ 7,000 $ 3,648 $ 13,437 $ 7,490
Services 2,603 1,913 4,466 3,505
-------- -------- -------- --------
Total revenues 9,603 5,561 17,903 10,995
Cost of revenues
Software licenses 495 230 736 479
Services 1,123 678 2,128 1,407
-------- -------- -------- --------
Total cost of revenues 1,618 908 2,864 1,886
-------- -------- -------- --------
Gross profit 7,985 4,653 15,039 9,109
Operating expenses
Sales and marketing 4,364 2,979 8,122 5,168
Research and development 2,009 1,177 3,837 2,483
General and administrative 1,455 919 2,869 1,774
Amortization of acquired intangible assets 139 - 139 -
Write-off of acquired in-process research
and development 620 - 620 -
-------- -------- -------- --------
Total operating expenses 8,587 5,075 15,587 9,425
-------- -------- -------- --------
Loss from operations (602) (422) (548) (316)
Other income (expense)
Interest income 1,054 7 1,255 17
Interest expense (2) (519) (614) (1,009)
-------- -------- -------- --------
Total other income (expense) 1,052 (512) 641 (992)
-------- -------- -------- --------
Income (loss) before income taxes 450 (934) 93 (1,308)
Provision for income taxes - - - -
-------- -------- -------- --------
Net income (loss) $ 450 $ (934) $ 93 $ (1,308)
======== ======== ======== ========
Net income (loss) per common share
Basic $ 0.02 $ (0.06) $ - $ (0.08)
Diluted $ 0.02 $ (0.06) $ - $ (0.08)
Shares used for computation
Basic 25,635 16,315 22,082 16,315
Diluted 28,783 16,315 25,162 16,315
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
2
<PAGE> 5
OTG SOFTWARE, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
Six months
ended June 30,
2000 1999
---- ----
(unaudited)
<S> <C> <C>
Cash and cash equivalents at beginning of period $ 2,494 $ 437
-------- --------
Cash flows from operating activities:
Net income (loss) 93 (1,308)
Adjustments to reconcile net income (loss) to cash (used for)
provided by operating activities
Write-off of acquired in-process research and
development 620 -
Amortization of acquired intangible assets 139 -
Depreciation and amortization 471 240
Stock compensation expense 370 77
Provision for bad debts and returns 585 (13)
Deferred income taxes (465) -
Changes in certain assets and liabilities
Accounts receivables, net (3,259) 642
Prepaid royalties and other current assets (1,045) (48)
Accounts payable and accrued liabilities 389 1,270
Deferred revenues 831 (17)
-------- --------
Net cash (used for) provided by operating activities (1,271) 843
Cash flows from investing activities:
Purchases of property and equipment (1,150) (605)
Acquisition of xVault, net of cash acquired (1,731) -
-------- --------
Net cash used for investing activities (2,881) (605)
Cash flows from financing activities:
Net proceeds from initial public offering 87,373 -
Proceeds from issuance of common stock 220 12
Repayments on note payable to bank (5,000) -
Borrowings under long-term debt 31 10
Repayments on long-term debt (1,790) (250)
Repayments of stockholders' notes (9,798) (91)
Distributions to stockholders (1,160) -
-------- --------
Net cash provided by (used for) financing activities 69,876 (319)
-------- --------
Net increase (decrease) in cash and cash equivalents 65,724 (81)
-------- --------
Cash and cash equivalents at end of period $ 68,218 $ 356
======== ========
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements.
3
<PAGE> 6
OTG SOFTWARE, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. Basis of Presentation and Nature of Operations
The accompanying condensed consolidated financial statements include the
accounts of OTG Software, Inc. (OTG Software), OTG Sales, Inc. (OTG Sales) and
OTG E-Mail Corp. (OTG E-Mail). OTG Software, OTG Sales and OTG E-Mail are
collectively referred to as "the Company." The statements have been prepared in
accordance with generally accepted accounting principles (GAAP) and the
applicable rules and regulations of the United States Securities and Exchange
Commission (SEC). These interim financial statements should be read in
conjunction with the audited consolidated financial statements and accompanying
notes thereto contained in the Company's Registration Statement on Form S-1, as
amended, filed with the SEC on December 23, 1999 (SEC File No. 333-93581). The
interim financial statements contained in this report are unaudited and, as
permitted by GAAP as well as SEC rules and regulations, do not include certain
information and disclosures normally included in audited financial statements
filed annually with the SEC.
In the opinion of management, the accompanying condensed consolidated
financial statements reflect all adjustments, consisting of only normal
recurring accruals, necessary for a fair presentation of the Company's financial
position, results of operations and cash flows for the periods presented. All
significant intercompany balances and transactions have been eliminated in
consolidation. The preparation of financial statements in conformity with GAAP
requires management to make certain assumptions and estimates that affect the
reported amounts of assets and liabilities as of the date of the financial
statements and the reported amount of revenues and expenses during the reporting
period. Actual results could differ from those estimates. In addition, the
Company's operating results for interim periods may not be indicative of the
results of operations for a full fiscal year.
Headquartered in Bethesda, Maryland, OTG Software is a provider of
comprehensive on-line data storage management and data access solutions,
including complete e-mail storage and retrieval. OTG Software's products enable
enterprises to store, track and retrieve data over a variety of network
architectures, including the Web and storage area networks. OTG Software's
products support over 500 storage devices on almost any media type, are easy to
install and use, and can manage storage systems ranging in size from a single
storage device to an enterprise-wide network storage system. OTG Software's
products are used by over 7,000 organizations worldwide and are available
through a network of over 300 value-added resellers, distributors and original
equipment manufacturers (OEMs). The Company's primary product line is sold under
the name "XtenderSolutions."
Prior to December 30, 1999, OTG Sales was under common control and
majority stock ownership with OTG Software. On December 30, 1999, in connection
with the Company's planned IPO (as defined below), the stock of OTG Sales was
contributed to OTG Software for no consideration. The combination was accounted
for at historical cost. The accompanying financial statements have been
retroactively restated to give effect to the combination of the two companies as
if the combination occurred prior to January 1, 1997.
OTG E-Mail reflects the activity of the former xVault, Inc. (xVault), a
company that OTG Software acquired on April 25, 2000. Because the acquisition
was accounted for using the "purchase method," the assets acquired and
liabilities assumed from xVault were adjusted to fair value as of April 25, 2000
and consolidated with the Company's balance sheet as of that date. Activity
related to the former xVault entity is recognized in the Company's financial
results beginning April 26, 2000. See Note 3 for additional information.
4
<PAGE> 7
2. Initial Public Offering
On March 10, 2000, the Company issued 5,000,000 shares of common stock,
$0.01 par value (Common Stock), in an initial public offering. The transaction
generated net proceeds to the Company of $86.4 million after direct costs of the
offering (the "IPO"). A portion of the net proceeds of the IPO was used to repay
all outstanding balances under the Company's commercial credit facility ($5.0
million), its senior subordinated notes ($4.5 million) and certain obligations
to stockholders and other related parties ($8.7 million), as discussed in Note
10. See also Note 5(a).
3. Acquisition of xVault
On April 25, 2000, OTG Software acquired xVault by means of a reverse
triangular merger for consideration consisting of a cash payment of $1.75
million and 160,000 shares of the Company's common stock. xVault is a provider
of e-mail solutions to government, business and industry. xVault's products
provide organizations with tools to enforce e-mail policies, increase employee
productivity, comply with statutory and regulatory mandates and secure
electronic data against loss or espionage. xVault has since been renamed "OTG
E-Mail Corp."
The cash component of the acquisition price was available to OTG Software
from cash on hand. The value of the common stock component of the consideration
was determined to be $2.2 million based on an analysis prepared by a third-party
appraiser. The common stock component of the consideration includes certain
restrictions on sale of these shares. The acquisition was accounted for using
the "purchase method" and, accordingly, activity related to the former xVault
entity is included in the Company's financial statements beginning April 26,
2000.
The Company acquired net liabilities from xVault of $72,000 and incurred
direct costs associated with the acquisition of approximately $325,000,
including the elimination of a deposit related to an OEM agreement entered into
with xVault in early 2000. The Company recorded goodwill of $2.9 million and
other intangibles totaling $0.8 million resulting from the acquisition. The
other intangibles include developed technology, assembled workforce and acquired
customer base. The goodwill is being amortized over 5 years and the other
intangibles are being amortized over lives ranging from 3 - 4 years. In
addition, the Company recognized a one-time write-off of $620,000 related to
in-process research and development resulting from the acquisition. In-process
research and development reflects the portion of the cost of acquisition
representing technology that did not meet the accounting definition of
"completed technology." As such, under generally accepted accounting principles,
the amount allocated to in-process research and development is required to be
immediately charged against earnings. The assessment of in-process research and
development involved analyzing the discounted cash flows associated with each of
the technologies that were under development at the time of the acquisition,
including estimated cash flows from successful completion and cash flows
necessary to complete each project. The resulting cash flows are adjusted for
certain risks before being discounted to present value. Risks taken into
consideration include estimates of market size, timing of completion, product
pricing and competitive factors for each of the acquired technologies. The
discount rate used reflects xVault's estimated weighted average cost of capital.
The acquired technologies were in various stages of completion ranging from 13%
to 43% of completion, with estimated completion dates no later than 2001. A
third-party appraiser was used to determine the fair value of the assets
(including goodwill and other intangible assets) and liabilities acquired from
xVault as well as the amount of acquired in-process research and development.
The amounts recorded by OTG Software in its financial statements related to the
acquisition of xVault, including the write-off of in-process research and
development, are subject to further study and analysis.
5
<PAGE> 8
The following unaudited pro forma financial information was prepared as
if the acquisition occurred on January 12, 1999 (the date of xVault's
inception). This information excludes the one-time write-off of in-process
research and development discussed above. In the opinion of OTG Software's
management, all adjustments necessary to present fairly such information have
been made based on the terms and structure of the transaction. The following
information is presented for illustrative purposes only and does not necessarily
represent the financial results that would have resulted had the acquisition
actually occurred on the date indicated nor are the results indicative of the
future results of operations or financial condition of OTG Software on a
consolidated basis. In addition, this information is based upon information and
assumptions available at the time of the filing of this report, including fair
values of the assets acquired and the liabilities assumed from xVault as part of
the acquisition which are subject to further study and analysis. This
information should be read in conjunction with OTG Software's Form 8-K and
related Form 8-K/A filed with the SEC on May 9, 2000 and July 10, 2000,
respectively.
<TABLE>
<CAPTION>
Three months Six months
ended June 30, ended June 30,
2000 1999 2000 1999
---- ---- ---- ----
(unaudited)
<S> <C> <C> <C> <C>
Revenues $ 9,603 $ 5,561 $ 18,009 $ 10,995
Operating income (loss) $ (389) $ (883) $ (873) $ (1,065)
Net income (loss) $ 664 $ (1,395) $ (131) $ (2,057)
EPS-Basic $ 0.03 $ (0.08) $ (0.01) $ (0.12)
EPS-Diluted $ 0.02 $ (0.08) $ (0.01) $ (0.12)
</TABLE>
4. Cash Equivalents
The Company accounts for its investments in accordance with Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Management determines the
appropriate classification at the time of purchase and reevaluates such
designations as of each balance sheet date.
All highly liquid investments purchased within three months of maturity
are classified as cash equivalents. These investments are primarily composed of
obligations issued by various federal and state governmental agencies and
certain domestic corporations. Cash equivalents are stated at amortized cost,
which approximates fair value due to the highly liquid nature and short
maturities of the underlying securities.
5. Stockholders' Equity (Deficit)
(a) Common Stock
On January 18, 2000, the Company's Board of Directors declared a
two-for-one split of the Company's Common Stock in the form of a stock dividend
and recommended to the Company's stockholders the adoption of an Amended and
Restated Certificate of Incorporation, which increased the authorized number of
shares of Common Stock to 65,000,000. By written consent dated February 17,
2000, the Company's stockholders holding a majority of the shares entitled to
vote thereon approved the adoption of the Company's Amended and Restated
Certificate of Incorporation. The Company's Amended and Restated Certificate of
Incorporation became effective upon filing with the Secretary of the State of
Delaware on March 9, 2000. All common share, per common share and conversion
amounts related to Common Stock, stock
6
<PAGE> 9
options and stock purchase warrants included in the Financial Statements and
accompanying Notes to Condensed Consolidated Financial Statements have been
retroactively adjusted to reflect the stock split.
As discussed in Note 2, on March 10, 2000, the Company issued 5,000,000
shares of Common Stock in the IPO. In addition, in conjunction with the IPO, all
of the Company's outstanding convertible subordinated notes were converted into
4,161,506 shares of Common Stock. Prior to conversion the principal amount of
these notes was $7.6 million and the related accrued interest was $1.2 million;
the Company was not obligated to pay any accrued but unpaid interest on the
notes at the time of conversion.
During the three months ended June 30, 2000, employee exercises of stock
options resulted in proceeds to the Company of $175,049 and the issuance of
92,749 shares of Common Stock. The first offering period (May 22, 2000 - June
30, 2000) under the Company's 2000 Employee Stock Purchase Plan (2000 ESPP)
ended in June 2000, resulting in proceeds to the Company of $45,534 and the
issuance of 2,837 shares of Common Stock.
(b) Preferred Stock
The Company's Amended and Restated Certificate of Incorporation
authorizes the Company to issue up to 5,000,000 shares of preferred stock with a
par value of $0.01 per share. The preferred stock may be issued at the
discretion of the Company's Board of Directors in one or more series and on one
or more occasions. Each series of preferred stock will have such number of
shares, designations, preferences, voting powers, qualifications and special or
relative rights or privileges as the Company's Board of Directors may determine.
6. Lease Commitment
In June 2000, the Company entered into a lease commitment for a portion
of an office building currently being constructed in Rockville, Maryland. The
payments due under the ten-year arrangement total approximately $39 million,
based on current cost estimates and excluding renewal options. The lease
provides for payments of approximately $271,000 per month during the first year
of the agreement escalating to approximately $362,000 per month in the last year
of the agreement. The Company expects to occupy the space, which will serve as
the Company's new headquarters, in 2001.
7. Software Revenue Recognition
Software license revenues consist of fees for licenses of the Company's
software products. The Company sells its software products primarily through
value-added resellers, distributors and OEMs. In some cases, the Company
provides extended payment terms to certain distributors and resellers. For
arrangements in which payment terms are within six months, the Company
recognizes the revenue when the agreement is signed, the arrangement fee is
fixed and determinable, delivery of the software has occurred, and
collectibility of the fee is considered probable. For arrangements in which
payment terms extend beyond six months, the Company recognizes revenue when
payment by the customer is made or becomes due, if all other revenue recognition
criteria have been met.
Services revenues consist of maintenance and technical support, training
and consulting. Revenues from maintenance and technical support, which consist
of unspecified when-and-if-available product updates and customer telephone
support services, are recognized ratably over the term of the service period,
typically one year. Other services revenues are recognized as the related
services are provided.
7
<PAGE> 10
8. Net Income (Loss) Per Common Share
Net income or loss per common share (EPS) is presented on both a basic
and diluted basis in accordance with SFAS No. 128, "Earnings per Share." Basic
EPS is computed by dividing net income or loss by the weighted average number of
shares of common stock outstanding during the period. Diluted EPS reflects the
maximum dilution that would result after giving effect to dilutive securities.
The table below presents the computation of basic and diluted EPS (the
amounts presented in table are in thousands, except per share amounts). Because
the Company recognized net losses for the three months and six months ended June
30, 1999, the inclusion of incremental shares from the assumed conversion of
stock options and warrants into common stock would be anti-dilutive. Therefore,
such amounts have not been included in the EPS calculations.
<TABLE>
<CAPTION>
Three months Six months
ended June 30, ended June 30,
2000 1999 2000 1999
---- ---- ---- ----
(unaudited)
<S> <C> <C> <C> <C>
Net income (loss):
Net income (loss) (Basic and Diluted) $ 450 $ (934) $ 93 $ (1,308)
======== ======== ======== ========
Shares of common stock:
Weighted average shares of common
stock outstanding (Basic) 25,635 16,315 22,082 16,315
======== ======== ======== ========
Incremental shares related to:
Outstanding stock options 3,119 - 3,051 -
Outstanding warrants 28 - 28 -
Shares purchased by employees under
Employee Stock Purchase Plan 1 - 1 -
-------- -------- -------- --------
Weighted average equivalent shares of
common stock outstanding (Diluted) 28,783 16,315 25,162 16,315
======== ======== ======== ========
EPS-Basic $ 0.02 $ (0.06) $ - $ (0.08)
======== ======== ======== ========
EPS-Diluted $ 0.02 $ (0.06) $ - $ (0.08)
======== ======== ======== ========
</TABLE>
9. Stock-Based Compensation
On January 18, 2000, the Company's Board of Directors adopted, and on
February 17, 2000 the Company's stockholders approved, the 2000 Stock Incentive
Plan (2000 SIP) and the 2000 Employee Stock Purchase Plan (2000 ESPP). Under the
2000 SIP, 1,000,000 shares of the Company's Common Stock were reserved for
issuance as incentive stock options, nonstatutory stock options, awards of
unvested common stock and other stock-based awards. The Board of Directors
determined that, subsequent to February 17, 2000, no additional awards of
stock-based compensation will be granted under the Company's Stock Plan, a
stock-based award plan authorized in 1998.
The 2000 ESPP authorizes the issuance of up to 600,000 shares of the
Common Stock to participating employees. Eligible employees are permitted to
purchase Common Stock up to 10% of the employee's base pay at a purchase price
equal to 85% of the lesser of the closing price of the Common Stock on the first
and last days of the offering period, as defined in the 2000 ESPP. See also Note
5(a).
8
<PAGE> 11
10. Related Party Transactions
In March 2000, subsequent to the IPO, the Company made payments totaling
$1.2 million to certain current and former stockholders representing
reimbursement of income taxes paid by these stockholders when the Company was
treated as a Subchapter S entity for income tax purposes. In addition, also in
March 2000 and subsequent to the IPO, the Company retired all of its outstanding
senior subordinated notes held by certain stockholders. At retirement, the
principal amount of these notes was $4.4 million and the related accrued
interest was $0.1 million. See also Note 5(a) related to the conversion of all
of the Company's outstanding convertible notes held by certain stockholders into
shares of the Company's Common Stock.
Pursuant to an agreement with the Company's principal stockholder, the
Company retired promissory notes with an aggregate principal amount of $3.0
million in March 2000. These notes had similar terms, including retirement
within 60 days after the closing of the IPO. As mentioned previously, the
Company completed an IPO on March 10, 2000.
On June 9, 1998, the Company purchased from a former stockholder all of
his shares for $11.5 million. The Company recorded this transaction as the
re-purchase and retirement of treasury stock. The Company paid $6.0 million in
cash and issued a note to the former stockholder with a face value of $5.5
million and a 10% rate of interest. The Company recorded the note at its face
value, which approximated the fair value of the note at the date of issuance. In
January 2000, a principal payment of $1.0 million was made on the note. In late
March 2000, the Company retired the note with a final payment of $4.2 million.
In March 2000, the Company made a bonus compensation payment to a former
employee of $0.3 million. The payment was contingent on the Company consummating
the IPO.
11. Segment Information and Related Disclosures
The Company operates under one business segment providing data storage
management and data access solutions products and services. For the three months
and six months ended June 30, 2000 and 1999, the Company's revenues from foreign
countries represented 19% and 6%, respectively, and 13% and 6%, respectively, of
total revenues. One sale (software licenses) recognized in the second quarter of
2000 represented 64% of the international revenues for that period.
12. Supplemental Information - Condensed Consolidated Statements of Cash
Flows
<TABLE>
<CAPTION>
Three months Six months
ended June 30, ended June 30,
2000 1999 2000 1999
---- ---- ---- ----
(unaudited)
<S> <C> <C> <C> <C>
Cash paid during the period for (in thousands):
Income taxes $ - $ - $ - $ -
Interest $ 2 $ 406 $ 679 $ 673
Material non-cash transactions (in thousands):
Issuance of Common Stock related to the
April 2000 acquisition of xVault $ 2,173 $ - $ 2,173 $ -
Conversion of all outstanding convertible
subordinated notes payable (including
related accrued interest) into 4,161,506
shares of Common Stock in March 2000 $ - $ - $ 8,833 $ -
</TABLE>
9
<PAGE> 12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of the Company's financial condition and results
of operations should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" contained in the
prospectus included in the Company's Registration Statement on Form S-1, as
amended, filed with the SEC on December 23, 1999 (SEC File No. 333-93581) (the
"Form S-1"). The information contained herein is not a comprehensive discussion
and analysis of the financial condition and results of operations, but rather
updates disclosures made in the Company's Form S-1 filing.
Certain information contained herein should be considered
"forward-looking information" within the meaning of the Federal Private
Securities Litigation Reform Act of 1995. Forward-looking information is subject
to a number of substantial risks and uncertainties that can cause actual results
to differ materially. These risks and uncertainties include the timely
development and market acceptance of our products and our ability to manage our
growth. Statements contained herein that are not statements of historical fact
may be deemed to be forward-looking information. Without limiting the foregoing,
words such as "anticipates," "believes," "could," "estimate," "expect,"
"intend," "may," "might," "should," "will," and "would" and other forms of these
words or similar words are intended to identify forward-looking information. For
example, the Company's forward-looking statements include statements regarding:
- revenue growth;
- development, deployment and acceptance of new products;
- technological changes;
- use of the proceeds from the Company's initial public offering;
- variations in gross margin;
- expansion plans;
- spending on research and development;
- levels of expenditures generally, including investments in property
and equipment; and
- sufficiency of the Company's liquidity and capital resources.
Such forward-looking statements are made only as of the date of this
report. Important factors known to the Company that could cause such material
differences are discussed under the caption "Risk Factors" below. In light of
these risks, uncertainties and assumptions, the future events, developments, or
results described by the forward-looking statements in this report could turn
out to be materially different from those discussed or implied. The Company
undertakes no obligation to update or revise any forward-looking information,
whether as a result of new information, future events or otherwise.
Overview
Headquartered in Bethesda, Maryland, OTG Software is a provider of
comprehensive on-line data storage management and data access solutions,
including complete e-mail storage and retrieval. OTG Software's products enable
enterprises to store, track and retrieve data over a variety of network
architectures, including the Web and storage area networks. OTG Software's
products support over 500 storage devices on almost any media type, are easy to
install and use, and can manage storage systems ranging in size from a single
storage device to an enterprise-wide network storage system. OTG Software's
products are used by over 7,000 organizations worldwide and are available
through a network of over 300 value-added resellers, distributors and OEMs. The
Company's primary product line is sold under the name "XtenderSolutions."
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The Company reaches its customer base and target market through a
multi-channel sales and marketing strategy that includes a network of
value-added resellers (VARs), distributors and OEMs (collectively referred to as
the indirect sales channel). The Company's products and services are also sold
through a growing in-house sales force (referred to as the direct sales
channel). OEMs either bundle the Company's products with the products they offer
or resell the Company's products under their own label. Under a typical OEM
arrangement, the Company recognizes revenue each time an OEM licenses a copy of
its products that incorporates one or more copies of the Company's products. The
Company's license agreements with OEMs generally contain no minimum sales
requirements and no assurance can be given that any OEMs will either commence or
continue licensing the Company's products in the future. Additionally, following
the execution of a new license agreement, a significant period of time may lapse
before any revenues are generated due to the development work typically
associated with such agreements and the time needed for the sales and marketing
groups within these OEMs, customers and resellers to become familiar with our
products.
Software license revenues consist of fees for licenses of the Company's
software products. In some cases, the Company provides extended payment terms to
certain customers. For arrangements in which payment terms are within six
months, the Company recognizes the revenue when the agreement is signed, the
arrangement fee is fixed and determinable, delivery of the software has occurred
and collectibility of the fee is considered probable. As of June 30, 2000,
amounts due from such arrangements were $4.7 million. For arrangements in which
payment terms extend beyond six months, the Company recognizes revenue when
payment by the customer is made or becomes due, if all other revenue recognition
criteria have been met.
The Company's services revenues consist of fees derived from annual
maintenance agreements, consulting and training and other services. Maintenance
agreements provide for technical support and minor unspecified product updates
for fees based on the number of software licenses purchased and the level of
service chosen by the customer. The Company also provides training and
consulting services. Consulting services are priced based upon the amount of
time worked and the cost of the materials used in providing the services. The
Company also offers training and provides classrooms as well as on-site training
on a daily fee basis. Training and consulting services revenue typically have
lower gross margins than revenues from sales of software licenses and
maintenance and support agreements.
Services revenues consist of maintenance and technical support, training
and consulting. Revenues from maintenance and technical support, which consists
of unspecified when-and-if-available product updates and customer telephone
support services, are recognized ratably over the term of the service period.
These agreements are typically for one year. Other services revenues are
recognized as the related services are provided.
Growth and New Products
For the six months ended June 30, 2000, the Company's revenues increased
63% compared with the same period of 1999. The Company's revenues for all of
1999 represented a 47% increase compared with the revenues recognized in 1998
and were more than double revenues recognized in 1997. The Company expects to
continue to increase its employee base in support of its expanding operations,
particularly in sales and marketing, research and development and infrastructure
areas. As of June 30, 2000, the Company had 233 employees compared with 171 and
136 employees as of December 31, 1999 and 1998, respectively. Related to its
rapid expansion, the Company has announced plans to move to a new corporate
headquarters in 2001.
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<PAGE> 14
In June 2000, the Company launched "EmailXtender." EmailXtender is the
Company's solution to the efficient storage and management of e-mail.
EmailXtender can automatically capture e-mail messages and their attachments,
freeing up message file servers and increasing server reliability and up-time.
The product's intelligent search engine capability allows users fast and
efficient access to all of their historical e-mail. EmailXtender also allows
up-to-the-minute recovery from virus attacks and, in the next phase of the
product, will enable system administrators to centrally restore message systems
from the file server.
In April 2000, the Company acquired xVault, a provider of e-mail
solutions to government, business and industry. xVault's products provide
organizations with tools to enforce e-mail policies, increase employee
productivity, comply with statutory and regulatory mandates and secure
electronic data against loss or espionage. The Company believes that the
technology and workforce acquired as part of this acquisition will result in
additional enhancements to the Company's product offerings, particularly
EmailXtender. See Note 3 to Notes to Consolidated Condensed Financial Statements
contained in Part I, Item 1 of this report for additional information related to
the Company's acquisition of xVault. xVault has subsequently been renamed "OTG
E-mail Corp."
Also in June 2000, the Company introduced "OnlineStor.com," a new
Application Service Provider offering to sell and distribute the Company's
storage and content management products. This offering, a Web-hosted version of
OTG Software's storage and content management products, provides customers with
information storage and management needs an outsourcing alternative to investing
in software, staff and related infrastructure. Pricing is based on a customer
needs analysis of storage space, Web and network connection, rate of growth and
number of users.
During the first quarter of 2000, the Company introduced a new version of
"DiskXtender," the backbone of XtenderSolutions, which enables comprehensive
data storage management throughout an enterprise's network. The new product
"DiskXtender 2000," allows the Company's existing technology to operate on the
Windows 2000 platform. Also during this quarter, the Company announced that
Tivoli Systems, Inc. (Tivoli), an IBM subsidiary, had selected DiskXtender 2000
as its Windows NT/2000 solution for Tivoli Space Manager, Tivoli's storage
management and data migration product. Under the terms of an OEM agreement,
Tivoli will sell DiskXtender worldwide, integrated with Tivoli Space Manager.
The Company believes that this relationship will help increase the exposure of
the Company's products, particularly to larger, multi-national organizations.
The Company continues to increase its international presence. The
Company's international sales are primarily generated through indirect sales
channels, although the Company currently has employees in England, Germany and
the Netherlands. In March 2000, OTG Software entered into a strategic alliance
with Mitsui & Company, a Japanese company and one of the largest conglomerates
in the world. One of the key goals of this relationship is to develop a Japanese
version of "DiskXtender." Revenues derived from customers located outside of the
United States and Canada, most of which are denominated in U.S. dollars,
accounted for approximately 6% of the Company total revenues in each of 1999 and
1998. For 1999, the Company's international revenues increased 32% compared with
1998. For the first three months and six months of 2000, the Company's revenues
from international sales increased to 19% and 13% of sales, respectively, from
6% and 6% of sales, respectively, for the comparable periods in 1999. One sale
(software licenses) recognized in the second quarter of 2000 represented 64% of
the international revenues for that period.
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<PAGE> 15
IPO and Related Transactions
On March 10, 2000, the Company issued 5,000,000 shares of common stock,
$0.1 par value per share (Common Stock), in an initial public offering,
generating net proceeds to the Company of approximately $86.4 million after
considering the direct costs of the offering (the "IPO"). A portion of the net
proceeds of the IPO was used to repay all outstanding balances under the
Company's commercial credit facility ($5.0 million), its senior subordinated
notes ($4.5 million) and certain obligations to stockholders and other related
parties ($8.7 million).
In conjunction with the IPO, all of the Company's outstanding convertible
subordinated notes were converted into 4,161,506 shares of Common Stock. Prior
to conversion, the principal amount of these notes was $7.6 million and the
related accrued interest was $1.2 million; the Company was not obligated to pay
any accrued but unpaid interest on the converted notes at the time of
conversion.
The Company intends to use the remaining net proceeds of the IPO for
working capital and general corporate purposes as well as in support of
advancing strategic objectives, including the acquisition of other businesses,
products or technologies that are complementary to our business. See related
information under Part II, Item 2 of this report.
(this space intentionally left blank)
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RESULTS OF OPERATIONS
The following section pertains to activity included in the Company's
Condensed Consolidated Statements of Operations (which are contained in Part I,
Item 1 of this report), comparing results of operations for the three months and
six months ended June 30, 2000 with the comparable periods in 1999.
The table below presents the line items included in the Company's
Condensed Consolidated Statements of Operations as a percentage of total
revenues. This table excludes the write-off of in-process research and
development of $620,000 and amortization of acquired intangible assets of
$139,000 associated with the Company's acquisition of xVault in April 2000. The
write-off of in-process research and development is a one-time charge. Both
items are discussed in detail in Note 3 to Notes to Consolidated Condensed
Financial Statements.
<TABLE>
<CAPTION>
Three months Six months
ended June 30, ended June 30,
2000 1999 2000 1999
---- ---- ---- ----
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Revenues
Software licenses 73 % 66 % 75 % 68 %
Services 27 34 25 32
---- ---- ---- ----
Total revenues 100 100 100 100
Cost of revenues
Software licenses 5 4 4 4
Services 12 12 12 13
---- --- --- ----
Total cost of revenues 17 16 16 17
---- --- --- ----
Gross profit 83 84 84 83
Operating expenses
Sales and marketing 45 54 45 47
Research and development 21 21 21 23
General and administrative 15 17 17 16
Amortization of acquired intangible assets - - - -
Write-off of acquired in-process research
and development - - - -
---- ---- ---- ----
Total operating expenses 81 92 83 86
Income (loss) from operations 2 (8) 1 (3)
Other income (expense)
Interest income 11 - 7 -
Interest expense - (9) (3) (9)
----- ---- --- ----
Total other income (expense) 11 (9) 4 (9)
---- ---- --- ----
Income (loss) before income taxes 13 (17) 5 (12)
Provision for income taxes - - - -
----- ---- --- ----
Net income (loss) 13 % (17)% 5 % (12)%
==== === === ===
</TABLE>
Software licenses revenues-For the second quarter of 2000 compared with the
second quarter of 1999, software licenses revenues increased $3.4 million (92%)
due primarily to an increase in overall demand for data storage management
products, increased market acceptance of the Company's products, the
introduction of new products and continued expansion of sales through the
Company's indirect distribution channel. International sales increased 350%. One
sale
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<PAGE> 17
(software licenses) recognized in the second quarter of 2000 represented 64% of
the international revenues for that period. The increase for the first six
months of 2000 versus the first six months of 1999 (79%) is primarily due to the
same factors mentioned for the quarter-over-quarter increase, including a 243%
increase in international sales. The increase in license revenues as a
percentage of total revenues for both comparative periods reflects sales of
software licenses increasing at a rate higher than the rate at which the
Company's professional services function is growing.
Services revenues-For the second quarter of 2000, services revenues increased
$0.7 million (36%) due primarily to increased sales of services and support
contracts on sales of software licenses to new customers, an increase in the
number of renewals of maintenance contracts by existing customers and, to a
lesser extent, increased demand for consulting and training services. The
increase for the first six months of 2000 versus the first six months of 1999
(27%) is primarily due to the same factors mentioned for the
quarter-over-quarter increase. See also "Software licenses revenues" above
related to changes in services fees revenues as a percentage of total revenues.
Cost of software licenses revenues-Cost of software licenses revenues consists
primarily of royalties, media, product manuals and distribution expenses. These
costs more than doubled for the second quarter of 2000 compared with the second
quarter of 1999 due primarily to an increase in royalties expenses. The increase
for the first six months of 2000 versus the first six months of 1999 (54%) is
primarily due to the same factors mentioned for the quarter-over-quarter
increase. The gross margins on software license revenues may vary from period to
period based on the software license mix as certain of the Company's products
have higher royalty rates than others. The gross margin on software license
revenues is substantially higher than gross margin on services revenues,
reflecting the low materials, packaging and other costs associated with software
licenses compared with the relatively high personnel costs associated with
providing maintenance and technical support, consulting and training services.
The Company does not anticipate significant improvements in gross margin on
software license revenues.
Cost of services revenues-Cost of services revenues consist primarily of
personnel-related costs in providing maintenance and technical support,
consulting and training to customers. Cost of services revenues varies based
upon the mix of the services performed during a period. These costs increased
66% for the second quarter of 2000 compared with the second quarter of 1999 due
primarily to an increase in personnel in the Company's customer support,
training and consulting organizations, particularly in support of implementation
and related services, and an increase in subcontracted services. For the first
six months of 2000, cost of services revenues increased $0.7 million (51%) due
to the same factors that are attributed to the quarter-over-quarter increase.
The gross margins on services revenues may vary from period to period based on
the mix of maintenance and technical support, consulting and training services,
and can also be affected by the gross margins achieved on specific services
engagements. See also "Cost of software licenses revenues" above.
Sales and marketing expenses-These expenses consist primarily of the costs of
the Company's sales and marketing personnel as well as the costs of direct mail,
advertising, and other sales and marketing efforts. For the second quarter of
2000 compared with the second quarter of 1999, these expenses increased $1.4
million (47%) attributable primarily to an increase in the number of sales and
marketing employees and an overall increase in marketing efforts. In addition,
expenses related to the Company's stock-based compensation program increased to
approximately $75,000 for the second quarter of 2000 from approximately $15,000
for the second quarter of 1999. For the first six months of 2000 compared with
the first six months of 1999, sales and marketing expenses increased $3.0
million (57%) for reasons similar to the quarter-over-quarter increase,
including a $249,000 increase in expenses related to the Company's stock-based
compensation program. The Company continues to expand its global
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<PAGE> 18
sales and marketing infrastructure, including its direct sale force, and,
accordingly, expects sales and marketing expenses to continue to increase in
future periods.
Research and development expenses-These expenses consist primarily of personnel
costs and other engineering-related costs associated with the Company's efforts
to research, develop, maintain and enhance the Company's existing software
product lines and with the development of new products. For the second quarter
of 2000 compared with the second quarter of 1999, these expenses increased $0.8
million (71%) due primarily to higher staffing levels in the Company's research
and development areas. The Company believes that a significant level of research
and development investment is required to remain competitive. The increase in
expenses on a year-to-date basis is also primarily attributable to an increase
in staffing. The Company expects research and development expenses to increase
in future periods; the Company continues to be committed to targeting over 20%
of revenues as an appropriate level for spending on research and development
activities.
General and administrative expenses-These expenses include the costs of
corporate operations, accounting and finance, legal, human resources and similar
functions. For the second quarter of 2000 compared with the second quarter of
1999, general and administrative expenses increased $0.5 million (58%) related
to increased staffing and expenses associated with enhancing the Company's
infrastructure in order to manage and support the Company's rapid growth and its
status as a publicly-held company. On a year-to-date basis, these expenses
increased $1.1 million (62%) for reasons similar to the quarter-over-quarter
increase. General and administrative expenses for the second quarter of 2000
were relatively unchanged when compared to the first quarter of 2000.
Interest income-The increase for both comparative periods is related to an
increase in cash and cash equivalents, which increased substantially as a result
of the Company's IPO.
Interest expense-In March 2000, following its IPO, the Company repaid all
outstanding balances under its revolving line of credit facility, retired all
notes payable to certain stockholders and retired its senior subordinated notes.
In addition, in conjunction with the IPO, the Company's convertible subordinated
notes were converted into shares of the Company's Common Stock.
Provision (credit) for income taxes-The Company recognized no tax expense or
benefit for the three months ended June 30, 2000. As a result of the Company's
history of losses, a full valuation allowance was established against net
deferred tax assets when the Company converted from a Subchapter S-corporation
to an entity subject to tax as a regular corporation. As of June 30, 2000, the
Company's management reduced the valuation allowance against gross deferred tax
assets to equal the amount in excess of gross deferred tax liabilities and the
current tax liability generated while the Company has been subject to tax as a
regular corporation. The Company's management believes it is more likely than
not that the portion of the deferred tax assets will be realized equal to the
current tax liability through the future reversal of temporary differences and
recovery of taxes paid through carrybacks. The Company reevaluates the
appropriateness of this valuation allowance at each balance sheet date.
The Company was treated as a Subchapter S corporation for federal and
state income tax purposes prior to the IPO. Under Subchapter S, the Company's
income was allocated and taxable to the Company's stockholders. Accordingly, the
Company did not recognize any federal or state income taxes prior to
consummation of the IPO. Immediately preceding the consummation of the IPO, the
Company elected to terminate its Subchapter S status. Accordingly the Company is
currently subject to federal and state income taxes as a Subchapter C
corporation. As a result, the Company has adopted SFAS No. 109, "Accounting for
Income Taxes." Had the Company been a corporation subject to federal and state
income tax on its income for the entire six months ended June 30, 2000 and the
three months and six months ended June 30, 1999, it would not have
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<PAGE> 19
recognized a tax expense or benefit for any of these periods due to establishing
a full valuation allowance against its net operating losses and other net
deferred tax assets generated in those periods.
Recently issued accounting standards-In December 1999, the SEC issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements." This SAB expresses the SEC's views in applying generally accepted
accounting principles to revenue recognition in financial statements.
Registrants can apply the accounting and disclosure requirements of this SAB
retrospectively, or, for entities with a calendar year end, such as OTG
Software, adopt the provisions for the fourth quarter of 2000. The Company does
not believe that the application of this SAB in its existing format will have a
material impact on the Company's financial statements.
In October 1997, The American Institute of Certified Public Accountants
(AICPA) issued Statement of Position No. 97-2, "Software Revenue Recognition"
(SOP 97-2). Subsequently, in March 1998 and December 1998, the AICPA issued SOP
No. 98-4, "Deferral of the Effective Date of a Provision of SOP 97-2" (SOP 98-4)
and SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition with
Respect to Certain Transactions" (SOP 98-9), respectively. SOP 98-4 and SOP 98-9
deferred the effective date for application of certain provisions of SOP 97-2
until January 1, 2000, including guidance in 97-2 that limited the definition of
vendor specific objective evidence for determining the fair value of various
elements in a multiple element arrangement. The Company adopted the provisions
of SOP 97-2 not deferred by SOP 98-4 and SOP 98-9 on January 1, 1998 and the
remaining provisions of SOP 97-2 on January 1, 2000. The adoption of these
accounting policies did not have a material impact on the Company's financial
condition or results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). The new standard establishes
accounting and reporting standards for derivative instruments embedded in other
contracts and for hedging activities. This statement, as amended, is effective
for all fiscal quarters beginning after June 15, 2000. The Company does not
expect SFAS 133 to have a material affect on its financial position or results
of operations.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2000 and December 31, 1999, the Company's cash and cash
equivalents totaled $68.2 million (representing 78% of total assets) and $2.5
million, respectively. The substantial increase reflects the net proceeds from
the Company's March 2000 IPO. The Company received interest on its cash and cash
equivalents of $1.1 million during the three months ended June 30, 2000. As of
June 30, 2000, the Company had no interest-bearing debt outstanding, with the
exception of approximately $108,000 related to certain equipment acquired under
a capital lease. See "IPO and Related Transactions" above related to the
Company's retirement of certain debt obligations in the first quarter of 2000.
As of December 31, 1999, the Company had outstanding notes and similar
obligations totaling $24.3 million. In 1999, the Company recognized interest
expenses totaling $2.1 million related to interest-bearing debt obligations.
As discussed above, the Company realized net proceeds of $86.4 million
(after direct costs of the offering, including $1.0 million of direct costs that
were accrued for as of June 30, 2000) from the IPO completed on March 10, 2000.
As of June 30, 2000, the Company had stockholders' equity of $75.3 million
compared with a stockholders' deficit of $21.7 million as of December 31, 1999.
The increase in stockholders' equity reflects the Company's sale of Common Stock
in the IPO and the conversion of the Company's subordinated convertible notes to
Common Stock completed in conjunction with the IPO.
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<PAGE> 20
For the six months ended June 30, 2000, net cash used for operating
activities was $1.3 million. For the corresponding period in 1999, operating
activities provided net cash of $0.8 million. The decrease in cash provided by
operating activities is primarily related to an increase in accounts receivable.
The Company's operating activities provided net cash of $0.4 million for the
three months ended June 30, 2000, primarily related to the Company's operating
results for the period. As mentioned above, the Company continues to be
committed to targeting 20% of revenues as an appropriate level for spending on
research and development activities, most of which are considered operating
activities for the purposes of reporting cash flows.
For the six months ended June 30, 2000 and 1999, net cash used for
investing activities was $2.9 million and $0.6 million, respectively. The
increase in cash used in investing activities reflects the Company's acquisition
of xVault in April 2000 for $1.7 million and an increase in the Company's
investment in property and equipment in support of its rapidly expanding
operations. The Company expects to continue to invest in property and equipment
in the ordinary course of its business as required, particularly in support of
the Company's expanding operations and infrastructure needs. In July 2000, the
Company signed an agreement with a software provider to acquire software related
to management of the sales and marketing, research and development, professional
services and technical support functions. The total investment in this program,
which is expected to be substantially complete before the end of 2000, is
expected to exceed $1 million, excluding training and other periodic costs. The
capitalized costs associated with this program will be amortized over a
three-year period.
For the six months ended June 30, of 2000, cash provided by financing
activities was $69.6 million, which reflects net proceeds from the Company's IPO
offset by repayments of certain debt obligations (see discussion above under
"IPO and Related Transactions"). Financing activity in the second quarter of
2000 included the payment of certain direct costs of the IPO that were accrued
as of March 31, 2000. For the first six months of 1999, cash used for financing
activities was $0.3 million.
The Company believes that its current liquidity, defined as cash and cash
equivalents and both short-term and long-term investments, combined with
anticipated cash flows from operating activities, will satisfy the Company's
anticipated working capital and capital expenditures requirements for at least
the next twelve months.
RISK FACTORS
There are a number of important factors that could affect our business
and future operating results, including, without limitation, the factors set
forth below, and the information contained in this Quarterly Report on Form 10-Q
should be read in light of such factors. Any of the following factors could harm
our business and our future operating results. References to "we", "us", or
"our" below mean OTG Software, Inc. and its wholly-owned subsidiaries.
We may not be able to sustain our current revenue growth rates
Although our revenues have grown rapidly in recent years, we may not be
able to maintain this rate of revenue growth because of the difficulty of
maintaining high percentage increases as our base of revenue increases. In
addition, growing competition, lower-than-expected market acceptance of
Windows NT and Windows 2000, or the failure of the market for storage area
networks to develop, could also affect our revenue growth.
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<PAGE> 21
Our operating results may fluctuate significantly
Our revenues in any quarter will depend substantially on orders we
receive, ship and determined to be collectable in that quarter. In addition, we
typically receive a significant portion of orders during the last month of each
quarter, and we cannot predict whether those orders will be placed, fulfilled
and shipped in that period. If we have lower revenues than we expect, we
probably will not be able to reduce our operating expenses in time to compensate
for any revenue shortfall. Therefore, any significant shortfall in revenues or
delay of customer orders could have an immediate adverse effect on our operating
results in that quarter.
Our operating results have fluctuated in the past, and they are likely to
fluctuate significantly in the future. Quarterly comparisons of our financial
results are not necessarily meaningful and you should not rely on them as an
indication of our future performance.
Factors that could affect our operating results include:
- the unpredictability of the timing and level of sales through our
indirect sales channels;
- the timing, payment terms and magnitude of large orders;
- changes in the mix of our sales, including the mix between higher
margin software licenses and lower margin services;
- the timing and amount of our marketing, sales and product development
expenses;
- the cost and time required to develop new software products;
- the introduction, timing and market acceptance of new products
introduced by us or our competitors;
- changes in data storage and networking technology or the introduction
of new operating system upgrades, which could require us to modify our
products or develop new products;
- the growth rate of Windows NT;
- the rate of adoption of Windows 2000;
- the rate of adoption of storage area networks;
- pricing policies, payment terms and distribution terms; and
- the timing and size of acquisitions, if any.
In addition, our efforts to expand our software product suite, sales and
marketing activities, direct and indirect distribution channels and maintenance
and technical 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 operating results may vary significantly from quarter to
quarter.
Fluctuations in our operating results are likely to affect our stock
price in a manner that may be unrelated to our long-term operating performance.
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<PAGE> 22
Our business depends on the acceptance of Windows NT and Windows 2000 to run
computer networks, and a decrease in their rates of acceptance could cause our
revenues to decline
For the foreseeable future, we expect a substantial majority of our
revenues to continue to come from sales of our Windows NT-based data storage
software products. As a result, we depend on the growing use of Windows NT for
computer networks. If the deployment of Windows NT does not increase as we
anticipate, or if it decreases, our revenues could decline. In addition, if
users do not accept Windows 2000, or if there is a wide acceptance of other
existing or new operating systems, our business would suffer.
Windows 2000 may not gain market acceptance. In addition, users of
previous versions of Windows NT may decide to migrate to another operating
system due to these delays or improved functionality of another operating
system. We have expended significant resources on the development of Windows
2000-compatible versions of our product suite and our future success depends
upon sales of this product suite. If users of Windows 2000 networks do not
widely adopt and purchase our products, our revenue and business will suffer.
Furthermore, if we fail to introduce Windows 2000-compatible versions of all
products in our XtenderSolutions product suite within a short time after the
commercial release of Windows 2000, the delay may cause customers to forego
purchases of our products and instead purchase those of our competitors.
In the future, our business may depend upon the development of the emerging
market for storage area networks, and if this market fails to develop, or
develops more slowly than we anticipate, or if our products are not widely
accepted in this market, our business will suffer
Our future growth and profitability will depend upon the widespread
acceptance of storage area networks as one of several enterprise-wide data
storage methods and the acceptance of our products for use in such networks.
Accordingly, widespread adoption of storage area networks is critical to our
future success. The market for storage area networks has only recently begun to
develop and evolve. Because this market is new, it is difficult to predict its
potential size or growth rate. Potential customers that have invested
substantial resources in their existing data storage management systems may be
reluctant or slow to adopt a new approach like storage area networks. Our
success in generating revenues in this emerging market will depend, among other
things, on our ability to educate potential original equipment manufacturers and
system integrators, as well as potential end-users, about the benefits of
storage area networks and our data storage management solutions when deployed in
the storage area network environment. Furthermore, although we are attempting to
position our products as a standard for data storage management on storage area
networks, if we are unsuccessful in doing so, competing standards may emerge
that will be preferred by original equipment manufacturers, systems integrators
or end-users.
We have experienced significant growth in our business and our failure to manage
this growth or any future growth could harm our business
We continue to increase the scope of our operations and have grown our
headcount substantially. As of June 30, 1998, we had a total of 104 employees,
as of December 31, 1998 we had a total of 144 employees, as of December 31, 1999
we had a total of 172 employees and as of June 30, 2000 we had a total of 233
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
rate sufficient to absorb the costs associated with a larger overall headcount.
Our future success and our ability to sustain our revenue growth also
depend upon the continued service of our executive officers and other key sales
and research and development personnel. The loss of any of our executive
officers or key employees, especially Richard A.
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Kay, F. William Caple and Ronald W. Kaiser, could adversely affect our business
and slow our product development processes. Although we have employment
agreements with these executives, these agreements do not obligate them to
remain employed by us. We do not have key person life insurance policies
covering any of our employees. Furthermore, we must continue to hire large
numbers of highly qualified individuals. Competition for these individuals is
intense, and we may not be able to attract, assimilate or retain additional
highly qualified personnel in the future.
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 compromise our ability to attract necessary qualified personnel. This may
have a negative effect on our business and future operating results.
Our revenues depend primarily on sales of licenses for one product line, our
XtenderSolutions product suite, and a decline in sales of licenses for this
product suite could cause our revenues to fall
We have derived the substantial majority of our revenue from the sale of
our XtenderSolutions product suite. During 1999, 1998 and 1997, sales of our
XtenderSolutions products accounted for approximately 72%, 70% and 72% of our
total revenues, respectively. We expect that these products will continue to
account for a large portion of our revenues for the foreseeable future.
Accordingly, our business and future operating results depend on the continued
market acceptance of our XtenderSolutions products and future enhancements to
these products. Any factors adversely affecting the pricing of, demand for or
market acceptance of our XtenderSolutions products, including competition or
technological change, could cause our revenues to decline and our business and
future operating results to suffer.
Our multiple distribution channels are subject to many risks that could
adversely affect our sales
Direct sales: We have a growing direct sales force to sell our products,
especially to large customers. Direct sales involve a number of risks,
including:
- longer sales cycles, typically three to six months;
- our need to hire, train, retain and motivate our sales force; and
- the length of time it takes our new sales representatives to begin
generating sales.
Indirect sales: We expect that a significant portion of our revenues will
continue to come from indirect sales. These include sales to original equipment
manufacturers that incorporate our data storage management software into systems
they sell. We also expect future revenues from distributors and value-added
resellers that sell our software, often bundled with their own software or
services. We have no control over the shipping dates or volumes of systems our
original equipment manufacturers, value-added resellers or distributors ship,
and they have no obligation to ship systems incorporating our software. They
generally have no minimum sales requirements and can terminate their
relationship with us on short notice. We develop customized versions of our
products for some of our original equipment manufacturers to be included in
their systems software and other products. Developing products for these
original equipment manufacturers causes us to divert resources from other
activities that are also important to our business. If these versions do not
result in substantial revenues, our business and financial results could be
adversely affected.
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Our original equipment manufacturers could choose to compete with us or with
each other, which could harm our business
Our original equipment manufacturers, value-added resellers and
distributors could choose to develop their own data storage management products
and incorporate those products into their systems or product offerings in lieu
of our products. In addition, the original equipment manufacturers that we do
business with may compete with one another. To the extent that one of our
original equipment manufacturer customers views the products we have developed
for another original equipment manufacturer as competitive, it may decide to
stop doing business with us, which could harm our business.
Overlapping sales efforts may lead to inefficiencies and may adversely affect
our relationships with those who sell our products
Our original equipment manufacturers, value-added resellers, distributors
and direct sales force might target the same sales opportunities, which could
lead to an inefficient allocation of sales resources. This would result in us
marketing similar products to the same end-users. These overlapping sales
efforts could also adversely affect our relationships with our original
equipment manufacturers, value-added resellers, distributors and other sales
channels and result in them being less willing to market our products
aggressively, or impact margins on products sold directly.
The market for outsourced data storage software over the Web is new and
evolving, and if this market fails to develop, or if our products are not widely
accepted in this market, our business could suffer
Part of our strategy is to offer outsourced data storage software to
customers over the Web. In this business model, customers who wish to reduce
their in-house hardware and maintenance costs would pay us or a third party
using our products to provide metered or leased data storage capacity and
management. If this business model does not gain acceptance among potential
customers, we will not be able to implement this strategy successfully. The
market for electronic outsourced data storage software has only recently begun
to emerge and we cannot be sure that it will develop or grow. Among other
things, the development of this market could be limited by:
- concerns over the reliability and security of the Web, especially as a
means of moving data that is critical to the customer's business; and
- customer reluctance to cede control over the hardware and network
infrastructure used to store important data and to rely on systems
provided by a third party.
We have expended significant resources to develop products for this
market and have introduced our OnlineStor.com products to compete in this
market. We do not have significant experience in the market for these services.
We expect to continue to spend significant resources to develop products for
this market, and if this market fails to develop, or our products are not
accepted in the market, we will not realize any return on this investment, and
our business may suffer.
If we encounter system failures or other difficulties in providing outsourced
data storage services, we could be exposed to liability and our reputation could
suffer
We depend upon a hardware and networking infrastructure to deliver
outsourced data storage capacity to our customers. If this infrastructure fails,
or customers otherwise experience difficulties or delays in retrieving data, we
could face liability claims from them and our reputation could be damaged. We
currently expect that we will not develop any related hardware
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and networking infrastructure ourselves, but rather will contract with third
parties, such as Internet service providers and application service providers,
to supply these components on our behalf. For this reason, we will be dependent
on the performance of the systems deployed and maintained by these parties, whom
we will not control. In some cases, we might contract directly with the customer
to provide the outsourced services; in other cases, we might act as a reseller
for application service providers, internet service providers or others. In
either case, we would expect to include contractual provisions limiting our
liability to the customer for system failures and delays, but we cannot be sure
that these limits will be enforceable or will be sufficient to shield us from
liability. We also expect that we would carry liability insurance to cover
problems of this nature, but we cannot guarantee that insurance will be
available or that the amounts of our coverage will be sufficient to cover all
potential claims.
Other companies have developed or may choose to develop competing products and
potential customers for our products may choose to develop internal data storage
management capabilities or satisfy their needs with a traditional data back-up
solution, any of which could cause our revenues and our business to suffer
We face a variety of competitors that offer products with some of our
products' features. Some potential customers may elect to internally develop
capabilities similar to those provided by our products rather than buying them
from us or another outside vendor. Although our products generally enhance
traditional data back-up capabilities offered by companies such as Veritas,
Legato Systems, Computer Associates and IBM, our products may compete against
traditional back-up solutions when a potential customer seeks to address its
storage needs with only a data back-up solution. Furthermore, Veritas has
recently begun to offer a Windows NT-based product that competes with
DiskXtender. If potential customers choose to develop their own capabilities,
choose a traditional data back-up solution or purchase a competing product, our
revenues and business will suffer.
In addition, Microsoft could develop competing products. Windows 2000
includes basic data storage management capabilities. Microsoft could compete
with us by enhancing and expanding these capabilities to offer an integrated
storage management capability within their basic operating system. This would
reduce or eliminate the need to purchase our products, which would cause our
revenues and business to suffer.
Our products must remain compatible with operating system software, network
hardware and software configurations, which are currently undergoing, and will
likely continue to undergo, significant change that could render our products
obsolete
The market for our data storage management software 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. We have expended
significant resources to allow our products to take advantage of the release of
Windows 2000 and to prepare our products for the emergence of storage area
networks, and we expect to continue to do so. If Windows 2000 and storage area
networks are not widely adopted, our business and future operating results will
suffer.
As the emergence of storage area networks demonstrates, the computing
environments in which our products must operate are complex and change rapidly.
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, and depend significantly on our ability to hire and retain
increasingly scarce technically competent personnel. Significant delays in new
product releases or significant problems in installing or implementing new
product releases could result in lost revenues and significant additional
expense.
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Our future success also depends, in part, on the compatibility of our
products with other vendors' software and hardware products, particularly those
provided by Microsoft and SAN manufacturers. While we have expended efforts to
certify compatibility of our products with such SAN component manufacturers as
Gadzoox Networks, Crossroads Systems and Chaparral Network Storage, these
developers, Microsoft or other vendors may change their products so that they
will no longer be compatible with our products. These vendors may also decide to
bundle their products with other competing products for promotional purposes. If
that were to happen, our business and future operating results might suffer as
we might be priced out of the market or no longer be able to offer commercially
viable products.
We have experienced errors in our products in the past, and any such errors in
the future could harm our reputation and could cause customers to demand refunds
from us or assert claims for damages against us, which could harm our business
and future operating results
Because our software products are complex, they have in the past, and
could in the future, contain errors or bugs. Bugs can be detected at any point
in a product's life cycle. In the past, we have devoted significant resources to
the detection and correction of errors and we expect to do so in the future.
While we continually test our products for errors and work with customers
through our customer support services and engineering personnel to identify and
correct bugs in our software, we expect that errors in our products, especially
new releases of our current products and new product offerings, will continue to
be found in the future. Any of these errors could be significant and could harm
our business and future operating results. Detection of any significant errors
may result in:
- the loss of or delay in market acceptance and sales of our products;
- diversion of development resources;
- injury to our reputation; or
- increased maintenance and warranty costs.
Because customers use our products to store and retrieve critical
information, we may be subject to 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 pay significant damages.
Claims of this nature, whether or not successful, could seriously damage our
reputation and our business.
Our software products rely on our intellectual property, and any failure by us
to protect, or any misappropriation of, our intellectual property could enable
our competitors to market products with similar features that may reduce demand
for our products
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 we are seeking to expand
our operations and where the laws may not protect our proprietary rights as
fully as those in the United States. Our success and ability to compete depend
substantially upon our internally developed technology, which is incorporated in
the source code for our products. We protect our intellectual property through a
combination of copyright, trade secret and trademark law. We have registered, or
are in the process of registering, all of our trademarks under applicable law.
We generally enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and control access to our source
code and other intellectual property and
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the distribution of our software, documentation and other proprietary
information. These measures afford only limited protection and may be
inadequate, especially because employees such as ours are highly sought after
and may leave our employ with significant knowledge of our proprietary
information. Others may develop technologies that are similar or superior to our
technology or design around the copyrights and trade secrets we own.
Our products employ technology that may infringe the proprietary rights of
others, and we may be liable for significant damages as a result
We expect that our 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 do not conduct comprehensive patent searches to determine whether
technologies used in our products infringe upon patents or patent applications
held by others. In addition, we hire employees who may be privy to the
proprietary information of their prior employers. Although we believe that our
products do not employ technology that infringes any proprietary rights of third
parties, third parties nevertheless may claim that we infringe their
intellectual property rights. Regardless of whether these claims have any merit,
they 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, which 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 damage our
business because we would not be able to sell our products without redeveloping
them or incurring significant additional expenses.
The expansion of our international operations subjects our business to
additional economic risks that could have an adverse impact on our revenue and
business
In both 1998 and 1999, products we sold to customers outside the United
States accounted for approximately 6% of our total sales. For the first six
months of 2000, international sales accounted for approximately 13% of our sales
activity (one sale of software licenses recognized in the second quarter of 2000
represented 64% of the international revenues for that period). We plan to
increase our international sales activities, but these activities are subject to
a number of risks, including:
- greater difficulty in accounts receivable collection and longer
collection periods;
- political and economic instability;
- greater difficulty in attracting distributors that market and support
our products effectively;
- the need to comply with varying employment policies and regulations
which could make it more difficult and expensive to manage our
headcount if we need to establish more direct sales staff outside the
United States;
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- weaker operating results from our international operations in our
quarters ending each September 30 due to the summer slowdown in Europe;
and
- the effects of currency fluctuations.
As we seek to expand our international operations, if any of these risks
materialize, our revenues and our business could be adversely affected.
If we undertake acquisitions, they may be expensive and disruptive to our
business and could have an adverse effect on our business, future operations and
market price of our stock
In April 2000, we acquired a complementary business by means of a merger.
We may continue to make investments in complementary companies, products or
technologies. We could have difficulty in assimilating an acquired 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 and the market
price of our stock may decline. As of the date of this report, we have no
agreements or understandings regarding any future acquisitions.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company does not currently have any derivative financial instruments
and does not invest in derivative financial instruments. The Company invests
excess cash in short-term, highly-liquid investments. In addition, the Company
currently has no long-term indebtedness, except for $108,000 related to certain
equipment acquired under a capital lease. As a result, the Company believes that
its exposure to interest rate risk is not material to its financial condition
and results of operations.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
No new material legal proceedings have commenced during the time period
covered by this interim report.
Item 2. Changes in Securities and Use of Proceeds
The Company sold 5,000,000 shares of its Common Stock on March 10, 2000
pursuant to a Registration Statement on Form S-1 (Registration No. 333-93581),
which was declared effective by the SEC on March 9, 2000. A stockholder of the
Company sold an aggregate of 750,000 shares of the Company's Common Stock
pursuant to this registration statement. The managing underwriters of the
initial public offering were Credit Suisse First Boston Corporation, Deutsche
Bank Securities Inc., SG Cowen Securities Corporation and Friedman, Billings,
Ramsey & Co., Inc. The aggregate, gross proceeds raised in the initial public
offering from the sale of the stock by the Company and the selling shareholder
were $95.0 million and $14.25 million, respectively. The Company's total
expenses in connection with the initial public offering were approximately $8.6
million, of which $6.7 million was for underwriting discounts and commissions
and approximately $1.9 million was for other direct expenses of the offering.
The Company's net proceeds from the initial public offering were approximately
$86.4 million. From the effective
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date of the registration statement through June 30, 2000, the Company used $18.2
million of such net proceeds to retire its revolving line of credit facility,
subordinated senior notes, notes to its principal stockholder, notes to certain
other related parties and distributions to certain stockholders to cover their
aggregate federal and state income tax liabilities for 1998, 1999 and the
portion of 2000 prior to the Company terminating its S Corporation status and
approximately $2.4 million for operating and investing activities in the normal
course of business. Approximately $8.7 million of the $13.2 million distribution
to related parties was paid to certain officers, directors and 10% stockholders
of the Company. In addition, the Company acquired xVault in April 2000 for
consideration consisting of cash of $1.75 million and 160,000 shares of the
Company's common stock. xVault was a provider of e-mail software. See Note 3 to
Notes to Condensed Consolidated Financial Statements for additional information
related to the Company's purchase of xVault.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters To a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Amended Restated Certificate of Incorporation of the Company
(incorporated herein by reference to Exhibit 3.1 to the
Company's Registration Statement on Form S-1; SEC file No.
333-93581).
3.2 Restated By Laws of the Company (incorporated herein by
reference to Exhibit 3.4 to the Company's Registration Statement
on Form S-1; SEC file No. 333-93581).
4.1 Refer to Exhibits 3.1 and 3.2.
10.1 1998 Stock Incentive Plan, as amended (incorporated herein by
reference to Exhibit 10.1 to the Company's Registration
Statement on Form S-1; SEC file No. 333-93581).
10.2 2000 Stock Incentive Plan (incorporated herein by reference to
Exhibit 10.2 to the Company's Registration Statement on Form
S-1; SEC file No. 333-93581).
10.3 2000 Employee Stock Purchase Plan, as amended (incorporated
herein by reference to Exhibit 10.3 to the Company's Quarterly
Report on Form 10-Q for the Three Month Period Ended March 31,
2000).
10.4 Form of Indemnification Agreement to be executed with directors
and executive officers (incorporated herein by reference to
Exhibit 10.6 to the Company's Registration Statement on Form
S-1; SEC file No. 333-93581).
10.5 Form of Subchapter S Tax Indemnification Agreement to be
executed with certain stockholders (incorporated herein by
reference to Exhibit 10.10 to the Company's Registration
Statement on Form S-1; SEC file No. 333-93581).
10.6 Lease for facilities at 2600 Tower Oaks Boulevard in Rockville,
Maryland.
27.1 Financial Data Schedule as of June 30, 2000
27.2 Financial Data Schedule as of June 30, 1999
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(b) Reports on Form 8-K
May 9, 2000 Item 2; Related to OTG Software's acquisition
of xVault.
July 10, 2000 Item 2; Related to OTG Software's acquisition
of xVault.
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.
<TABLE>
<S> <C>
By: /s/ Richard A. Kay Date: August 8, 2000
---------------------------
Richard A. Kay
President, Chairman and Chief Executive Officer
By: /s/ Ronald W. Kaiser Date: August 8, 2000
--------------------------
Ronald W. Kaiser
Chief Financial Officer and Treasurer
(Principal Financial Officer)
</TABLE>
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