UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD OF FROM__________________TO________________
Commission file number 0-21077
INTERLINK COMPUTER SCIENCES, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2990567
(State of incorporation) (IRS Employer Identification Number)
47370 Fremont Boulevard
Fremont, California 94538
(510) 657-9800
(Address and telephone number of principal executive offices)
-----------------
Indicate by check mark whether 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, and (2) has been subject to such filing requirements
for the past 90 days.
YES _X_ NO___
7,638,423 shares of the registrant's Common stock, $0.001 par value, were
outstanding as of November 1, 1997.
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INTERLINK COMPUTER SCIENCES, INC.
AND SUBSIDIARIES
CONTENTS
<CAPTION>
Page
----
PART I: FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets:
September 30, 1997 and June 30, 1997................................................................4
Condensed Consolidated Statements of Operations:
Three months ended September 30, 1997 and 1996......................................................5
Condensed Consolidated Statements of Cash Flows:
Three months ended September 30, 1997 and 1996......................................................6
Notes to Condensed Consolidated Financial Statements....................................................7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................................................................11
PART II: OTHER INFORMATION
Item 1 Legal Proceedings..........................................................................................26
Item 6 Exhibits and Reports on Form 8-K...........................................................................26
Signatures ...........................................................................................................27
</TABLE>
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PART I: FINANCIAL INFORMATION
3
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<TABLE>
INTERLINK COMPUTER SCIENCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
<CAPTION>
September 30, June 30,
------------- --------
1997 1997
---- ----
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ....................................................... $ 23,422 $ 28,106
Accounts receivable, net ........................................................ 6,645 9,752
Inventories ..................................................................... 667 674
Other current assets ............................................................ 3,222 3,332
-------- --------
Total current assets ........................................................ 33,956 41,864
Property and equipment, net .......................................................... 2,697 1,676
Long-term deferred tax asset ......................................................... 2,549 1,541
Purchased software products and other non-current assets ............................. 3,052 3,282
-------- --------
Total assets ................................................................ $ 42,254 $ 48,363
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ............................................... $ 251 $ 314
Accounts payable ................................................................ 954 1,421
Accrued liabilities ............................................................. 4,227 7,286
Deferred maintenance and product revenue ........................................ 6,625 7,488
-------- --------
Total current liabilities ................................................... 12,057 16,509
Long-term debt, less current portion ................................................. 868 802
Deferred maintenance revenue ......................................................... 1,277 1,403
Other liabilities .................................................................... 3,112 975
-------- --------
Total liabilities ............................................................... 17,314 19,689
-------- --------
Commitments and contingencies (Note 6)
Common stock ......................................................................... 7 7
Additional paid-in capital ........................................................... 50,839 50,814
Cumulative translation adjustment .................................................... (609) (591)
Accumulated deficit .................................................................. (25,297) (21,556)
-------- --------
Total stockholders' equity ...................................................... 24,940 28,674
-------- --------
Total liabilities and stockholders' equity .................................. $ 42,254 $ 48,363
======== ========
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
</TABLE>
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INTERLINK COMPUTER SCIENCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Three months ended
September 30,
-------------
1997 1996
---- ----
(unaudited)
Revenues:
Product ......................................... $ 2,833 $ 4,832
Maintenance and consulting ...................... 3,482 3,893
-------- --------
Total revenues ........................... 6,315 8,725
-------- --------
Cost of revenues:
Product ......................................... 280 685
Maintenance and consulting ...................... 1,329 1,237
-------- --------
Total cost of revenues ................... 1,609 1,922
-------- --------
Gross profit ........................................... 4,706 6,803
-------- --------
Operating expenses:
Product development ............................. 2,318 1,901
Sales and marketing ............................. 2,778 3,064
General and administrative ...................... 1,324 912
Purchased research and development and other .... 3,599 --
Purchased software amortization ................. 147 162
-------- --------
Total operating expenses ................. 10,166 6,039
-------- --------
Operating income (loss) ................................ (5,460) 764
Interest and other income (expense), net ............... 265 (56)
-------- --------
Income (loss) before provision income taxes ............ (5,195) 708
Benefit from (provision for) income taxes .............. 1,454 (269)
-------- --------
Net income (loss) ...................................... ($ 3,741) $ 439
======== ========
Net income (loss) per share ............................ ($ 0.50) $ .07
======== ========
Shares used in per share calculation ................... 7,557 6,147
======== ========
See accompanying notes to condensed consolidated financial statements.
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INTERLINK COMPUTER SCIENCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<CAPTION>
Three months ended September 30,
1997 1996
---- ----
(unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) ......................................................................... ($ 3,741) $ 439
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Purchased research and development and other ..................................... 3,599 --
Depreciation and amortization .................................................... 503 457
Provision for excess and obsolete inventory ...................................... 101 --
Provision for (reduction in) doubtful accounts .................................. (7) 50
Exchange loss (gain) ............................................................. 65 (51)
Deferred income taxes ............................................................ (1,080) --
Changes in operating assets and liabilities:
Accounts receivable .......................................................... 2,916 1,433
Inventories .................................................................. (100) 77
Other assets ................................................................. 343 959
Accounts payable ............................................................. (464) (865)
Accrued liabilities .......................................................... (3,170) (1,195)
Deferred maintenance and product revenue ..................................... (944) (1,171)
Other liabilities ............................................................ (65) (88)
-------- --------
Net cash provided by (used in) operating activities ...................... (2,044) 45
-------- --------
Cash flows from investing activities:
Acquisition of NetLOCK network security technology ........................................ (1,175) --
Acquisition of property and equipment ..................................................... (1,269) (168)
Capitalization of software development costs .............................................. -- (25)
-------- --------
Net cash used in investing activities .................................... (2,444) (193)
-------- --------
Cash flows from financing activities:
Payments on capital lease obligations ..................................................... (68) (65)
Payments on notes payable and other ....................................................... (105) (497)
Payments on bank line of credit ........................................................... -- (5,000)
Proceeds from issuance of common stock, net ............................................... 26 22,133
-------- --------
Net cash provided by (used in) financing activities ...................... (147) 16,571
-------- --------
Net increase (decrease) in cash and cash equivalents ................ (4,635) 16,423
Effect of exchange rate changes on cash ........................................................ (49) 5
Cash and cash equivalents, beginning of period ................................................. 28,106 6,121
-------- --------
Cash and cash equivalents, end of period ....................................................... $ 23,422 $ 22,549
======== ========
<FN>
See accompanying notes to condensed consolidated financial statements.
</FN>
</TABLE>
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INTERLINK COMPUTER SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation:
The unaudited condensed consolidated financial statements included herein have
been prepared by Interlink Computer Sciences, Inc. and its subsidiaries
(collectively, the "Company") in accordance with generally accepted accounting
principles and reflect all adjustments, consisting only of normal recurring
adjustments, which in the opinion of management are necessary to fairly present
the Company's consolidated financial position, results of operations, and cash
flows for the periods presented. The financial statements include the accounts
of the Company and its wholly owned subsidiaries after all material intercompany
balances and transactions have been eliminated. The Notes to the Consolidated
Financial Statements contained in the fiscal year 1997 report on Form 10-K
should be read in conjunction with these Condensed Consolidated Financial
Statements. The consolidated results of operations for the three months ended
September 30, 1997 are not necessarily indicative of the results to be expected
for any subsequent period or for the entire fiscal year ending June 30, 1998.
The June 30, 1997 balance sheet was derived from audited financial statements,
but does not include all disclosures required by generally accepted accounting
principles.
2. Inventories:
Inventories are stated at the lower of cost (determined on a first-in, first-out
basis) or market. Inventories are principally comprised of finished goods at
September 30, 1997 and June 30, 1997.
3. NetLOCK Network Security Technology Acquisition:
On September 18, 1997, the Company acquired NetLOCK technology, an end-to-end
network security technology that encrypts data and helps prevent security
break-ins and certain assets from Hughes Aircraft Company for approximately
$2,144,000 in cash and incurred related acquisition costs of $300,000. The
Company also licensed certain core technology that is incorporated into the
NetLOCK technology from a third party licensor. Under the terms of the license
agreement, the Company paid an up front fee of $175,000 and is obligated to pay
royalties ranging from 3% to 9% of future NetLOCK revenues on an ongoing basis,
with guaranteed future minimum royalties of $2,300,000 through 2002. As of the
date of the acquisition, the NetLOCK technology had not reached technological
feasibility nor did it have any future alternative use. Accordingly, $3.1
million has been recorded as purchased research and development, which consists
of the amount of the purchase price allocated to purchased research and
development and the guaranteed minimum royalty payments, net of discount of
$724,000, and the $175,000 paid to the third party licensor. The remaining
portion of the purchase price of $1,144,000 has been recorded as property and
equipment. In conjunction with the NetLOCK technology purchase, the Company
employed approximately 25 people and entered into an operating lease for
facilities with a third party. The related employee and facility costs have been
included in the Company's results of operations from the date of the acquisition
of the technology.
Under the terms of the NetLOCK operating lease, the Company is obligated to make
future minimum lease payments of $364,000 through fiscal 2001.
4. Write-Down of Purchased Software Products Related to the Acquisition of New
Era Systems Services LTD.:
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On December 29, 1995, the Company acquired all of the outstanding stock of New
Era Systems Services Ltd. ("New Era"), a Canadian company that develops, markets
and supports storage management and software distribution products and recorded
$3.2 million as purchased software products. During the quarter ended September
30, 1997 revenue expectations for the storage management and software
distribution products declined due to the sales force focusing on NetLOCK as the
primary application product of the future and IBM gaining market share through
its ADSM product. As a result, the Company determined that the recorded amount
for purchased software had been impaired and recorded a loss of approximately
$550,000, the amount by which the recorded intangible at September 30, 1997
exceeded the present value of the estimated future net cash flows.
5. Computation of Net Income (Loss) Per Share:
Net income (loss) per share is computed using the weighted average number of
common and common equivalent shares outstanding during the period. Common
equivalent shares are included in the per share calculations where the effect of
their inclusion would be dilutive. Dilutive equivalent shares consist of the
incremental common shares issuable upon conversion of stock options and
warrants, using the treasury stock method in all periods.
6. Contingencies:
The Company and the Company's subsidiary in France are involved in a commercial
dispute with a former Italian distributor ("Claimant") of the Company's
TCPaccess products. The former distributor alleged in a letter sent to the
Company that the Company had breached and unlawfully terminated the agreement
pursuant to which the former distributor was appointed a distributor of the
Company's products in Italy and asserted other related claims against the
Company. The letter demanded the former distributor's reinstatement as a
distributor, the execution of a written distribution agreement setting forth the
distribution arrangements between the parties, and compensation in an
unspecified amount to be paid to the former distributor for the harm that it has
suffered. The Company's Canadian subsidiary, New Era Systems Services Ltd., has
also previously used the former distributor as a distributor of the HARBOR
products in Italy pursuant to a separate agreement which was entered into
between the claimant and New Era Systems Services Ltd's Irish subsidiary, Era
Nua Teoranta.
On January 27, 1997 the former distributor initiated a lawsuit in the Court of
Milan in Milan, Italy against New Era Systems Services Ltd., a Canadian company
and wholly owned subsidiary of the Company, the Company, Interlink France
S.A.R.L., a French company and wholly owned subsidiary of the Company and the
Company's current distributor in Italy. The litigation is based on the
Claimant's distribution of Company's HARBOR products pursuant to a distributor
agreement with Era Nua Teoranta, which pre-dates the Company's acquisition of
New Era Systems Services, Ltd. The Company's distributor relationship with
Claimant for the distribution of the Company's HARBOR products in Italy and
Spain has terminated. This litigation does not involve the Cisco IOS/390
products or the TCPaccess products. Pursuant to Claimant's court documents,
Claimant alleges damages for breach of contract and related tort claims in the
amount of 2,500,000,000 Italian Lira (approximately $1,500,000) and requests
that the defendants pay all expenses resulting from the litigation. Era Nua
Teoranta has filed a lawsuit against the claimant in Ireland for recovery of
amounts due on outstanding invoices and a declaration that the distributor
relationship has terminated.
On March 12, 1997 the former distributor initiated a separate lawsuit in Alameda
County, California against the Company, certain employees of the Company and the
Company's current Italian distributor. The litigation is based upon alleged
actions taken by the Company and certain employees of the Company. Pursuant to
Claimant's complaint, Claimant alleged various tort claims, including fraud,
deceit, and unfair competition, in
8
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addition to statutory trade secret misappropriation, and breach of confidential
relationship. Claimant is requesting that the defendants pay compensatory
damages in excess of $2,000,000, unspecified punitive damages, interest,
attorneys' fees, and costs of the litigation. The Company and the individual
defendants moved to stay the lawsuit on the grounds that all claims are subject
to arbitration under the terms of the distributor agreement. The lawsuit was
stayed by the Alameda County Superior Court pending arbitration of the claims.
No arbitration has to date been initiated.
On August 28, 1997, a Danish distributor has made a claim against the Company
asking for approximately $300,000 in monetary damages caused by the Company's
failure to deliver workable products on three software orders in Denmark. The
claim is in the discovery stage and the Company believes it has meritorious
defenses to the asserted claim.
No provision for any liability that may result upon resolution of these matters
has been made in the financial statements nor can an estimate be made of the
range of loss. Should the Company be unsuccessful in defending any of these
claims, the Company's business, financial condition and results of operations
would be materially adversely affected.
<TABLE>
7. Supplemental Cash Flow Disclosures (in thousands):
<CAPTION>
Three months ended September 30,
1997 1996
---- ----
<S> <C> <C>
Interest paid........................................................... $5 $158
Income taxes paid....................................................... $1,205 $909
Non cash transactions from financing activities:
Conversion of preferred stock to common
stock in connection with initial public offering............... -- $6,310
Liabilities assumed in connection with the purchase of the
NetLOCK network security technology............................ $1,876 --
</TABLE>
8. Concentrations of Revenues:
During the quarter ended September 30, 1997, 13% of the Company's total revenues
were derived from sales to and through Cisco Systems, Inc. ("Cisco"). During the
quarter ended September 30, 1996, no one customer accounted for more than 10% of
total revenues.
9. Recent Pronouncements:
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 (SFAS 128), Earning Per Share, which
specifies the computation, presentation and disclosure requirements for earnings
per share. SFAS 128 supersedes Accounting Principles Board Opinion No. 15,
Earnings Per Share, and is effective for financial statements issued for periods
ending after December 15, 1997. SFAS 128 requires restatement of all
prior-period earnings per share data presented after the effective date. SFAS
128 is not expected to have a material impact on the Company's financial
position, results of operations or cash flows.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive
Income. This statement establishes requirements for disclosure of comprehensive
income and becomes effective for the Company for fiscal years beginning after
December 15,
9
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1997, with reclassification of earlier financial statements for comparative
purposes. Comprehensive income generally represents all changes in stockholders'
equity except those resulting from investments or contributions by stockholders.
The Company is evaluating alternative formats for presenting this information,
but does not expect this pronouncement to materially impact the Company's
results of operations.
In June 1997, The Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of
an Enterprise and Related Information. This statement establishes standards for
disclosure about operating segments in annual financial statements and selected
information in interim financial reports. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. This statement supersedes Statement of Financial Accounting Standards
No. 14, Financial Reporting for Segments of a Business Enterprise. The new
standard becomes effective for fiscal years beginning after December 15, 1997,
and requires that comparative information from earlier years be restated to
conform to the requirements of this standard. The Company is evaluating the
requirements of SFAS 131 and the effects, if any, on the Company's current
reporting and disclosures.
In October 1997, the Accounting Standards Executive Committee issued Statement
of Position 97-2 (SOP 97-2), Software Revenue Recognition, which delineates the
accounting for software product and maintenance revenues. SOP 97-2 supersedes
the Accounting Standards Executive Committee Statement of Position 91-1,
Software Revenue Recognition, and is effective for transactions entered into in
fiscal years beginning after December 15, 1997. The Company is evaluating the
requirements of SOP 97-2 and the effects, if any on the Company's current
revenue recognition policies.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed in the section below entitled
"Risk Factors That May Affect Future Results," as well as those risks discussed
in this section and elsewhere in this Report.
Overview
The Company offers a suite of high-performance, network transport products and
systems management applications which efficiently transport, store and protect
the integrity of mission-critical data and applications. The Company was
incorporated in December 1985 and initially focused its products and development
on providing interoperability between IBM mainframes and DECnet network
environments. In 1990, the Company acquired the core technology of its TCPaccess
suite of products. In December 1995 the Company acquired New Era Systems
Services Ltd. ("New Era"), the developer of the HARBOR products, a software
product line providing enterprise systems management applications for
client/server networks. This transaction was accounted for as a purchase. Prior
to the acquisition, the Company distributed the HARBOR products in certain
countries in Europe for more than one year. New Era is a wholly-owned subsidiary
headquartered in Calgary, Alberta.
In January 1997 the Company entered into a strategic alliance with Cisco
pursuant to which Cisco and the Company agreed to cooperate to develop certain
TCP/IP software known as IOS/390. Although Interlink is an authorized reseller
of the IOS/390 product, which has been available since May 13, 1997, the Company
continues to independently market and sell IOS/390 and TCPaccess. Support for
the IOS/390 sold through Cisco and Cisco's reseller channels is provided by
Cisco. In August 1997 the Company signed a reseller agreement with Cisco for the
Cisco IOS for S/390 software and the Cisco 7505 and 7513 router products. In
October 1997 the Company modified the definitive agreement with Cisco which
clarified the research and development investment and modified the sales and
marketing processes.
The alliance with Cisco is subject to all the risks inherent in such strategic
relationships including the failure of the parties to meet their respective
obligations under the terms of the alliance, the risk of loss of rights to
important intellectual property either jointly developed in connection with the
alliance or otherwise, and the risk of a dispute over key provisions of the
alliance. There can be no assurance that the parties will meet their objectives
under the terms of the alliance. The failure of either the Company or Cisco to
meet their obligations under the terms of the alliance would have a material
adverse effect on the Company's business, financial condition, and results of
operations. In addition, either Cisco or the Company may terminate the
relationship upon 90 days written notice.
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Results of Operations
The following table sets forth, as a percentage of total revenues, certain
condensed consolidated statement of operations data for the periods indicated:
Three months
ended September 30,
-------------------
1997 1996
---- ----
Revenues:
Product ............................................. 44.9% 55.4%
Maintenance and consulting .......................... 55.1 44.6
----- -----
Total revenues .................................. 100.0 100.0
----- -----
Cost of revenues:
Product ............................................. 4.4 7.9
Maintenance and consulting .......................... 21.1 14.2
----- -----
Total cost of revenues .......................... 25.5 22.1
----- -----
Gross profit ............................................. 74.5 77.9
Operating expenses:
Product development ................................. 36.7 21.8
Sales and marketing ................................. 44.0 35.1
General and administrative .......................... 21.0 10.5
Purchased research and development and other ........ 57.0
Purchased software amortization ..................... 2.3 1.8
----- -----
Total operating expenses ........................ 161.0 69.2
----- -----
Operating income (loss) .................................. (86.5) 8.7
Interest and other income (expense), net ................. 4.2 (.6)
----- -----
Income (loss) before income taxes ................... (82.3) 8.1
Provision for (benefit from) income taxes ................ (23.0) 3.1
----- -----
Net income (loss) ................................... (59.2)% 5.0%
===== =====
Cost of sales as a percentage of the related revenues:
Product ............................................. 9.9% 14.2%
Maintenance and consulting .......................... 38.2% 31.8%
Revenues:
Total revenues were $6.3 million and $8.7 million for the three months ended
September 30, 1997 and 1996, respectively, representing a decrease of 28%.
Product sales were $2.8 million and $4.8 million for the three months ended
September 30, 1997 and 1996, respectively, representing a decrease of 41%. This
decrease was primarily due to slower development in the selling relationship
with Cisco and that international sales were 78% lower than in the first quarter
of fiscal year 1997. Additionally, there was a decrease in HARBOR product
revenue of $500,000 in the three months ended September 30, 1997 versus the
three months ended September 30, 1996. Maintenance and consulting revenues were
$3.5 million and $3.9 million for the three months ended September 30, 1997 and
1996, respectively, representing an decrease of 11%. This decrease resulted
principally from a decrease in maintenance revenues from the DECnet product
line.
Cost of Revenues:
Product. Cost of revenues from product sales consists primarily of hardware,
product media, documentation and packaging costs. Cost of revenues for product
sales was $280,000 and $685,000, representing 10% and
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14% of total product revenues for the three months ended September 30, 1997 and
1996, respectively. This percentage decrease was due to a reduction in
third-party revenue and a decline in hardware revenue, which carry higher
product costs as a percentage of their respective revenues.
Maintenance and Consulting. Cost of revenues from maintenance and consulting
consists primarily of personnel related costs incurred in providing telephone
support and software updates. Cost of revenues from maintenance and consulting
was $1.3 million and $1.2 million, representing 38% and 32% of total maintenance
and consulting revenues for the three months ended September 30, 1997 and 1996,
respectively. This increase in maintenance and consulting costs as a percentage
of the related revenue is due to lower revenues with costs remaining consistent
as the majority of costs is headcount driven.
Operating Expenses:
Total operating expenses were $10.2 million and $6.0 million, representing 161%
and 69% of total revenues for the three months ended September 30, 1997 and
1996, respectively. The increase in total operating expenses is primarily due to
the purchased research and development expense relating to the acquisition of
the NetLOCK network security technology. See further discussion below.
Product Development. Product development expenses consist primarily of personnel
related costs. Product development expenses were $2.3 million and $1.9 million,
representing 37% and 22% of total revenues for the three months ended September
30, 1997 and 1996, respectively. This increase in product development expenses
resulted from the expansion of the Company's product line as a result of the
acquisition of NetLOCK network security technology and ongoing product
development efforts. The Company believes that research and development expenses
will increase in absolute dollars in the future primarily due to expansion of
the Company's product line as a result of the acquisition of the NetLOCK network
security technology, alliance with Cisco to further develop IOS/390 and other
anticipated product development efforts.
Sales and Marketing. Sales and marketing expenses consist primarily of salaries
and commissions for sales and marketing personnel, the fixed costs of worldwide
sales offices, and promotional costs. The Company sells through its direct sales
force, resellers and distributors. The direct channel produced 86% and 80% of
product revenues for the three months ended September 30, 1997 and 1996,
respectively. Sales and marketing expenses were $2.8 million and $3.1 million,
representing 44% and 35% of total revenues for the three months ending September
30, 1997 and 1996, respectively. The decrease in absolute dollars was a result
of lower commission expense on lower revenues.
General and Administrative. General and administrative expenses include
personnel and other costs of the finance, human resources and administrative
departments of the Company. General and administrative expenses were $1.3
million and $900,000, representing 21% and 11% of total revenues for the three
months ended September 30, 1997 and 1996, respectively. The increase in absolute
dollars was a result of higher legal costs, recruiting costs, and allowances for
doubtful accounts.
Purchased Research and Development and Other. Purchased research and development
and other was $3.6 million, representing 57% of total revenues for the three
months ended September 30, 1997. There were no purchased research and
development and other expense for the three months ended September 30, 1996. The
increase relates to a one-time write-off of $3.1 million of purchased research
and development related to the NetLOCK network security technology acquisition
in September 1997 and a write-down of $550,000 of purchased software products
relating to the acquisition of New Era. (See Notes 3 and 4 to Condensed
Consolidated Financial Statements)
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Interest and Other Income (Expense) Net. Net interest and other income (expense)
was $265,000 and ($56,000) for the three months ended September 30, 1997 and
1996, respectively. The increase in interest income and decrease in interest
expense was due primarily to a reduction of bank borrowings related to the New
Era Acquisition and interest earned on cash during the quarter.
Benefit from (Provision for) Income Taxes. The income tax provision was $1.5
million and ($269,000) for the three months ended September 30, 1997 and 1996,
respectively. The effective tax rate was approximately 28% and 39% for the three
months ended September 30, 1997 and 1996, respectively. Decrease in the
effective tax rate is due to an operating loss experienced during the quarter.
Recent Pronouncements
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 (SFAS 128), Earning Per Share, which
specifies the computation, presentation and disclosure requirements for earnings
per share. SFAS 128 supersedes Accounting Principles Board Opinion No. 15,
Earnings Per Share, and is effective for financial statements issued for periods
ending after December 15, 1997. SFAS 128 requires restatement of all
prior-period earnings per share data presented after the effective date. SFAS
128 is not expected to have a material impact on the Company's financial
position, results of operations or cash flows.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), Reporting Comprehensive
Income. This statement establishes requirements for disclosure of comprehensive
income and becomes effective for the Company for fiscal years beginning after
December 15, 1997, with reclassification of earlier financial statements for
comparative purposes. Comprehensive income generally represents all changes in
stockholders' equity except those resulting from investments or contributions by
stockholders. The Company is evaluating alternative formats for presenting this
information, but does not expect this pronouncement to materially impact the
Company's results of operations.
In June 1997, The Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of
an Enterprise and Related Information. This statement establishes standards for
disclosure about operating segments in annual financial statements and selected
information in interim financial reports. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. This statement supersedes Statement of Financial Accounting Standards
No. 14, Financial Reporting for Segments of a Business Enterprise. The new
standard becomes effective for fiscal years beginning after December 15, 1997,
and requires that comparative information from earlier years be restated to
conform to the requirements of this standard. The Company is evaluating the
requirements of SFAS 131 and the effects, if any, on the Company's current
reporting and disclosures.
In October 1997, the Accounting Standards Executive Committee issued Statement
of Position 97-2 (SOP 97-2), Software Revenue Recognition, which delineates the
accounting for software product and maintenance revenues. SOP 97-2 supersedes
the Accounting Standards Executive Committee Statement of Position 91-1,
Software Revenue Recognition, and is effective for transactions entered into in
fiscal years beginning after December 15, 1997. The Company is evaluating the
requirements of SOP 97-2 and the effects, if any on the Company's current
revenue recognition policies.
Liquidity and Capital Resources
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Working capital was $21.9 million and $25.4 million at September 30, 1997 and
June 30, 1997, respectively. Decrease in working capital was primarily due to
$2.6 million relating to the acquisition of NetLOCK network security technology
and certain assets and a net loss for the quarter.
For the three months ended September 30, 1997, net cash used in operating
activities resulted primarily from a net loss, decrease in accrued liabilities,
decrease in deferred maintenance and product revenue, and an increase in the
deferred tax asset, partially offset by a decrease in accounts receivable and a
write-off of purchased research and development. For the three months ended
September 30, 1996, net cash provided by operations resulted primarily from net
income, depreciation and amortization, decrease in accounts receivable and other
assets, partially offset by a decrease in accounts payable, decrease in accrued
liabilities and a decrease in deferred maintenance and product revenue.
For the three months ended September 30, 1997, the Company's investing
activities have consisted primarily of the acquisition of NetLOCK network
security technology and purchases of property and equipment. For the three
months ended September 30, 1996, the Company's investing activities consisted
primarily of purchases of property and equipment.
For the three months ended September 30, 1997, the Company's financing
activities have consisted primarily of payments on capital lease obligations and
payments on notes payable. For the three months ended September 30, 1996, the
Company's financing activities consisted of proceeds from the initial public
offering partially offset by payments on the Company's bank line of credit.
At September 30, 1997, the Company had $23.4 million in cash and cash
equivalents. The Company had $6.6 million in accounts receivable, net of
allowance for doubtful accounts, and $7.9 million of unearned revenues, majority
of which are expected to be earned over the 12 month period following September
30, 1997.
The Company believes that its current cash and cash equivalents balance and its
cash flow from operations, if any, will be sufficient to meet its anticipated
working capital and capital expenditure requirements for at least the next 12
months.
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RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company operates in a rapidly changing environment that involves a number of
risks, some of which are beyond the Company's control, and include the
following:
Dependence on Strategic Relationships
Alliance with Cisco. In January 1997 the Company entered into a strategic
alliance with Cisco pursuant to which Cisco and the Company agreed to cooperate
to develop the IOS/390 product, which has been available since May 13, 1997. In
August 1997 the Company signed a reseller agreement with Cisco for the Cisco IOS
for S/390 software and the Cisco 7505 and 7513 router products. In October 1997
the Company modified the definitive agreement with Cisco which clarified the
research and development investment and modified the sales and marketing
processes. Cisco has not guaranteed the Company any minimum sales revenues in
connection with its sales of the IOS/390 product, and there can be no assurance
that the Company will receive any revenues therefrom. Based on the amended
agreement, marketing for the IOS/390 product is performed independently by each
Company. The Company does not know at this time what effect this sales and
marketing relationship will have on the sales cycle and on obtaining current
sales information for planning purposes. In addition, customer price quotes are
managed by Cisco.
The alliance with Cisco is subject to all the risks inherent in such strategic
relationships including the failure of the parties to meet their respective
obligations under the terms of the alliance, the risk of loss of rights to
important intellectual property either jointly developed in connection with the
alliance or otherwise, and the risk of a dispute over key provisions of the
alliance. There can be no assurance that the parties will meet their objectives
under the terms of the alliance. The failure of either the Company or Cisco to
meet their obligations under the terms of the alliance would have a material
adverse effect on the Company's business, financial condition, and results of
operations. In addition, either Cisco or the Company may terminate the
relationship upon 90 days written notice.
The Company is currently investing, and plans to continue to invest, significant
resources to develop additional strategic relationships, and such investments
could adversely affect the Company's operating margins. The Company believes
that its success in penetrating markets for its products depends in large part
on its ability to maintain these relationships, to cultivate additional
relationships and to cultivate alternative relationships if distribution
channels change. There can be no assurance that any distributor, system
integrator or strategic partner will not discontinue its relationship with the
Company, form competing arrangements with the Company's competitors, or disrupt
the Company's other strategic relationships.
Dependence on Distributors
The Company's sales are primarily made through the Company's direct sales force
and the Company's distributors in some international markets. The Company is
currently investing, and plans to continue to invest, significant resources to
develop new strategic marketing relationships, which investments could adversely
affect the Company's operating margins. The Company believes that its success in
penetrating markets for its products depends in large part on its ability to
maintain its existing marketing and distribution relationships, to cultivate
additional relationships and to cultivate alternative relationships if
distribution channels change. There can be no assurance that any distributor,
systems integrator or strategic partner will not discontinue its relationship
with the Company, for competing arrangements with the Company's competitors, or
dispute the Company's other strategic relationships.
The loss of, or a significant reduction in revenues from, the Company's
international distributors through which
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the Company sells certain of its products could have a material adverse effect
on the Company's business, financial condition and results of operations. In
addition, if one of the Company's distributors declares bankruptcy, becomes
insolvent, or is declared bankrupt before the distributor remits to the Company
the payments for the Company's products, the Company may not be able to obtain
the revenues to which it would be entitled for sales made by such distributor
prior to the bankruptcy or insolvency proceeding. In addition, the Company's
distributors generally offer other products and these distributors may give
higher priority to sales of such other products.
The Company is involved in a commercial dispute and litigation with a former
distributor. Should the distributor prevail on its claims, the Company's
business, financial condition and results of operations would be materially
adversely affected.
In addition, the Company has received notice of a claim from its distributor in
Denmark which if successful could result in money damages of up to $300,000.
(See Note 6 to the Condensed Consolidated Financial Statements)
Dependence on Current Products
During the three months ended September 30, 1997 and 1996, sales of the network
transport products, excluding maintenance and hardware, accounted for
approximately 31% and 34%, and, including related maintenance and hardware,
accounted for approximately 88% and 85%, respectively, of the Company's total
revenues. The Company's operating results have historically been significantly
dependent upon sales of the network transport products. A portion of the
maintenance revenues are from historical customers of the Company's DECnet
product. The Company no longer actively markets the DECnet product, and
maintenance revenues from DECnet customers have declined each year since the
fiscal year ended June 30, 1993, and are expected to continue to decline.
Since its availability on May 13, 1997, the Company has experienced difficulty
in deriving significant revenues from sales by Cisco or the Company of the
IOS/390 product. In addition, the Company has experienced difficulty in deriving
significant revenues from sales of the HARBOR products since the acquisition of
New Era and the HARBOR product line in December 1995. The Company's operating
results are currently dependent upon continued IOS/390 product sales by both
Cisco and the Company and upon continued sales of HARBOR and other third-party
products. The failure by either Cisco or the Company to increase sales levels of
the IOS/390 product or the failure by the Company to maintain sales levels of
the HARBOR products could adversely affect the Company's results of operations.
Reliance on IBM and Emergence of the Mainframe as an Enterprise Server
The Company's current software products are designed for use with IBM and
IBM-compatible mainframe computers. Specifically, these software products target
users of the MVS operating system, the Customer Information Control System
communications subsystem and the IMS and DB2 database management systems. As a
result, future sales of the Company's existing products and associated recurring
maintenance revenues are dependent upon continued use of mainframes and their
related systems software. In addition, because the Company's products operate in
conjunction with IBM systems software, changes to IBM systems software may
require the Company to adapt its products to these changes, and any inability to
do so, or delays in doing so, may adversely affect the Company's business,
financial condition and results of operations. Currently, TCP/IP is the
communications protocol for the Internet and is being adopted by some
organizations as the communications protocol for their client/server local area
networks and wide area networks. This adoption has allowed IBM MVS mainframe
computers to act as enterprise servers on such networks. The use of mainframes
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as enterprise servers is relatively new and still emerging. The Company's future
financial performance will depend in large part on the acceptance and growth in
the market for centralized network management. Adoption of another
communications protocol on client/server networks could make TCP/IP
communication not viable, which would undermine the demand for the Company's
IOS/390 and TCPaccess product, and have a material adverse effect on the
Company's business, financial condition and results of operations.
Competition
General. The market in which the Company operates is intensely competitive and
is characterized by extreme price competition and rapid technological change.
The competitive factors influencing the markets for the Company's products
include product performance, price, reliability, features, scalability,
interoperability across multiple platforms, adherence to industry standards, and
the provision of support and maintenance services. The Company competes with a
number of companies, principally IBM, that specialize in one or more of the
Company's product lines, and such competitors may have greater financial,
technical sales and marketing resources to devote to the development, promotion
and sale of their products, and may have longer operating histories, greater
name recognition, and greater market acceptance for their products and services
compared to those of the Company. There can be no assurance that the Company's
current competitors or any new market entrants will not develop networked
systems management products or other technologies that offer significant
performance, price or other advantages over the Company's technologies, the
occurrence of which would have a material adverse effect on the Company's
business, financial condition and results of operations.
Network Transport Products. The Company historically sold its TCPaccess suite of
products principally to customers who had installed IBM mainframes using the MVS
operating system. The Company and Cisco have begun jointly marketing with
IOS/390 product. The Company's main competition for its IOS/390 and TCPaccess
products is IBM. IBM sells TCP/IP and associated products for its MVS mainframe
systems that compete directly with the IOS/390 product. IBM has continued to
enhance the functionality and performance of its TCP/IP product. In addition,
IBM's OS/390 operating system, which includes TCP/IP communications software in
a bundle of software provided to purchasers of OS/390, has been and is
aggressively marketed by IBM, and the Company believes it has lost and may
continue to lose sales of the Company's IOS/390 and TCPaccess products as a
result. IBM has in some cases included and may continue to include its TCP/IP
product in the bundle of software provided to purchasers of its OS/390 operating
system without charge. The Company believes that any general reduction in price
of the IBM TCP/IP products, or the widespread bundling of those products without
charge in its OS/390 operating system, would make marketing of the Company's
IOS/390 and TCPaccess products difficult, which would have a material adverse
effect on the Company's business, financial condition and results of operations.
System Management Applications.
The primary competitors for the expected NetLOCK products based on the Company's
recently acquired end-to-end network security product, is McAfee Associates,
Inc., Security Dynamics Technologies, Inc., Cylink, Time Step, Red Creek
Communications Inc., Pretty Good Privacy, Inc., V-One Technologies, Inc. and
Security First Technologies, Inc. In addition, security products comparable to
NetLOCK are currently available and are already incorporated into some operating
systems, thereby significantly diminishing the market for NetLOCK.
The primary competitors for the Company's HARBOR Backup and HARBOR Distributed
Storage Server products are IBM, Innovation Data Processing, Inc., Panorama
Software and Storage Technology. The Company's competition for the HARBOR
Distribution product includes IBM and Novadigm, Inc. ("Novadigm"). IBM is
aggressively marketing its ADSM backup product, which is included in the System
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View package on IBM's UNIX system, AIX. There can be no assurance that IBM will
not include the ADSM backup products in a software "bundle" with the sale of its
mainframe hardware systems. The bundling of competing software products with
mainframe hardware systems could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company also
competes with a number of software vendors who develop and market products for
UNIX and Windows NT operating systems, such as Microsoft, Computer Associates
International, Inc., EMC Corporation, Hewlett-Packard Company, Legato, Novadigm,
PLATINUM Technology, Inc., Seagate, Sterling Software Inc., Sun Microsystems,
Inc. and Veritas Software. Although the Company has signed a strategic marketing
agreement with Legato, the Company is still a competitor of Legato in the
storage management market. Competition from these companies could increase due
to an expansion of their product lines or a change in their approaches to
enterprise systems management or networking products. The bundling of network
transport software with a network controller by these competitors could prevent
the Company from selling the IOS/390 product to the customers of these
competitors, which would have a material adverse effect on the Company's
business, financial condition and results of operations.
Other Factors. The Company's ability to compete successfully depends on many
factors, including the Company's success in developing new products that
implement new technologies, performance, price, product quality, reliability,
success of competitors' products, general economic conditions, and protection of
Interlink products by effective utilization of intellectual property laws. In
particular, competitive pressures from existing or new competitors who offer
lower prices or other incentives or introduce new products could result in price
reductions which would adversely affect the Company's profitability. There can
be no assurance that the Company's current or other new competitors will not
develop enhancements to, or future generations of, competitive products that
offer superior price or performance features, that the Company will be able to
compete successfully in the future, or that the Company will not be required to
incur substantial additional investment costs in connection with its
engineering, research, development, marketing and customer service efforts in
order to meet any competitive threat. The Company expects competition to
intensify, and increased competitive pressure could cause the Company to lower
prices for its products, or result in reduced profit margins or loss of market
share, any of which could have a material adverse effect on the Company's
business, financial condition and results of operations.
Dependence on Key Personnel
The Company is highly dependent on the continued service of, and on its ability
to attract and retain, qualified technical, sales, marketing and managerial
personnel. The Company's Vice President and Chief Financial Officer, Gloria
Purdy, tendered her resignation on October 17, 1997 and agreed to remain with
the Company until December 31, 1997. Barbara Booth, Vice President of Research
and Development and Customer Support has relocated from the Company's
headquarters to Brea, California to manage the Company's NetLOCK acquisition.
The Company's Vice President of Sales and Marketing, Augustus Berkeley, was
promoted to President and Chief Executive Officer in September 1997. While the
Company intends to fill these positions, experienced executive-level sales,
marketing, finance, customer support and research and development professionals
in the Company's industry are in high demand and may not be attracted and
retained on terms advantageous to the Company. The competition for qualified
personnel in the software industry (including engineers skilled in MVS operating
systems) is intense, and the loss of any such persons, as well as the failure to
recruit additional key personnel in a timely manner, could have a material
adverse effect on the Company's business, financial condition and results of
operations. There can be no assurance that the Company will be able to continue
to attract and retain the qualified personnel necessary for the development of
its business. The Company has employment agreements with certain executive
officers, but such agreements do not ensure their continued service to the
Company or prevent their competition with the Company following a termination of
employment. The Company does not maintain key man life insurance on the lives of
its key employees.
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New TCP/IP Products and Rapid Technological Change
The markets for the Company's network transport products and systems management
applications are characterized by rapidly changing technologies, evolving
industry standards, frequent new product introductions and rapid changes in
customer requirements. The Company believes that its future success will depend
upon its ability to develop, manufacture and market products which meet changing
user needs, to continue to enhance its products and to develop and introduce in
a timely manner new products that take advantage of technological advances, keep
pace with emerging industry standards, and address the increasingly
sophisticated needs of its customers. There can be no assurance whether TCP/IP
will continue to be accepted as a communications protocol on client/server
networks. Furthermore, there can be no assurance that the Company will be
successful in acquiring, developing or marketing, on a timely basis, product
enhancements or new products (including the IOS/390 product and the NetLOCK
technology), either independently or with strategic partners, that respond to
technological change or evolving industry standards, that the Company will not
experience difficulties that could delay or prevent the successful development,
introduction and sale of these products, or that any such new products or
product enhancements will adequately meet the requirements of the marketplace
and achieve market acceptance. The Company's failure or inability to adapt its
products to technological changes or to acquire or develop new products
successfully would have a material adverse effect on the Company's business,
financial condition and results of operations.
The introduction or announcement of products by the Company or one or more of
its competitors, including, but not limited to IBM, embodying new technologies,
or changes in customer requirements or the emergence of new industry standards
and practices could render the Company's existing products obsolete and
unmarketable. There can be no assurance that the introduction or announcement of
new product offerings by the Company or one or more of its competitors will not
cause customers to defer purchasing the existing products of the Company or that
the Company will successfully manage the transition from older products. Such
deferment of purchases or inability to manage the transition of products could
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, there can be no assurance that the
Company will successfully identify new product opportunities, develop and bring
to market in a timely manner such new products, or that products or technologies
developed by others will not render the Company's products or technologies
noncompetitive or obsolete.
Product Errors; Product Liability
Software products as complex as those offered and being developed by the Company
often contain undetected errors or failures when first introduced or as new
versions are released. Testing of the Company's products is particularly
challenging because it is difficult to simulate the wide variety of computing
environments in which the Company's customers may deploy its products.
Accordingly, there can be no assurance that, despite testing by the Company and
by current and potential customers, errors will not be found after commencement
of commercial shipments, resulting in lost revenues, loss of or delay in market
acceptance and negative publicity about the Company and its products, any of
which could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, in the process of
commercializing NetLOCK the Company may detect errors or failures that delay or
prevent commercialization, any of which could have a material adverse effect on
the Company's business, financial condition and results of operations.
The Company's license agreements with customers typically contain provisions
designed to limit the Company's exposure to potential product liability claims.
The limitation of liability provisions contained in such license agreements may
not be effective under the laws of some jurisdictions, particularly if the
Company in the future relies on "shrink wrap" licenses that are not signed by
licensees. The Company's products are generally used to
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manage data critical to organizations, and as a result, the sale and support of
products by the Company may entail the risk of product liability claims. A
successful liability claim brought against the Company could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Fluctuations in Operating Results; Absence of Backlog; Seasonality
The Company's operating results have historically been subject to quarterly
fluctuations due to a variety of factors. The Company has typically sold its
products through a trial process to allow customers to evaluate the
effectiveness of the Company's products before determining whether to proceed
with broader deployment of such products. The Company's sales cycle, from the
date the sales agent first contacts a prospective customer to the date a
customer ultimately purchases the Company's product, has typically been three to
six months for the IOS/390 and TCPaccess products and six to nine months for the
HARBOR products. The sales cycle for the IOS/390 product has not been
established due to limited selling and revenue experience with the IOS/390
product, nor has the sales cycle for NetLOCK been established due to its lack of
commercialization. There can be no assurance that customers will purchase the
Company's products after a trial period or that the Company's sales cycle will
not lengthen, exposing it to the possibility of shortfalls in quarterly
revenues, which could have a material adverse effect on the Company's business,
financial condition or results of operations and cause results to vary from
period to period. The Company's operating results may also be affected by the
seasonality on fluctuations of Cisco sales, if any, of the IOS/390 product. The
Company's maintenance revenue is subject to fluctuations depending on the
customers choice in installing IOS/390 systems, which will be supported by
Cisco, rather than TCPaccess which is supported by the Company. The Company's
operating results will also be affected by general economic and other conditions
affecting the timing of customer orders and capital spending, and order
cancellations or rescheduling.
The Company operates with very little backlog and most of its product revenues
in each quarter result from orders closed in that quarter, and a substantial
majority of those orders are completed at the end of that quarter. The Company
establishes its expenditure levels for sales, marketing, product development and
other operating expenses based in large part on its expectations as to future
revenues, and revenue levels below expectations could cause expenses to be
disproportionately high. If revenues fall below expectations in a particular
quarter, operating results and net income are likely to be materially adversely
affected. Any inability of the Company to adjust spending to compensate for
failure to meet sales forecasts or to collect accounts receivable, or any
unexpected increase in product returns or other costs, could magnify the adverse
impact of such events on the Company's operating results.
The Company's business has historically experienced and is expected to continue
to experience significant seasonality. The Company has had higher sales of its
software products in the quarters ending in December and June and weaker sales
in the quarters ending in September and March. The decrease in product revenues
in the quarters ending in September is due to the international customer
seasonal buying patterns. The quarters ending in March are historically weak due
to government and large organization annual budgeting cycles. The impact of
IOS/390 revenues, if any, on this pattern is not certain. Due to the foregoing
factors, quarterly revenue and operating results are likely to vary
significantly in the future and period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
indications of future performance. Further, it is likely that in some future
quarters the Company's revenue or operating results will be below the
expectations of public market analysts and investors. In such event, the price
of the Company's Common Stock would likely be materially adversely affected.
Integration of Acquisitions; Customer Acceptance and Scalability of New
Products; History of Acquired Technologies
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There can be no assurance that the Company will be successful in integrating the
operations and personnel associated with its recent acquisition of the NetLOCK
technology, incorporating the NetLOCK technology into its product lines,
successfully commercializing the NetLOCK technology by the summer of 1998 or at
all, deriving significant future sales therefrom, establishing and maintaining
uniform standards, controls, procedures and policies, or overcoming other
problems that may be encountered in connection with the acquisition and
commercialization of such technology. To the extent that the Company is unable
to accomplish the foregoing, the Company's business, financial condition and
results of operations may be materially adversely affected. Further development
of the NetLOCK technology is required, and there can be no assurance that the
Company can successfully develop the NetLOCK technology. In addition, even if
successfully developed there can be no assurance of customer acceptance of the
products.
To date, the Company's core technologies for its principal network transport
products and systems management applications have been acquired and have not
been developed internally. There can be no assurance that the Company will have
the opportunity to successfully acquire or develop new technologies in the
future or that such technology, if acquired, can be successfully integrated and
commercialized by the Company. Specifically, there can be no assurance that the
Company can successfully commercialize NetLOCK by the summer of 1998 or at all.
An inability to acquire, develop or commercialize new technologies would have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company may also seek to acquire or invest in
businesses, products or technologies that expand, complement or otherwise relate
to the Company's current business or product line. There can be no assurance
that such acquisitions will be successfully or cost-effectively integrated into
the Company's current operations, or that the acquired technologies will provide
the necessary complement to the Company's current products. If the Company
consummates additional acquisitions in the future that must be accounted for
under the purchase method of accounting, such acquisitions would likely increase
the Company's amortization expenses. In addition, any such acquisitions would be
subject to the risks of integration mentioned above. The Company does not
currently have any understandings, commitments or agreements with respect to any
potential acquisition or corporate partnering arrangements, nor is it currently
engaged in any discussions or negotiations with respect to any such transaction.
Reliance on and Risks Associated with International Sales
During the three months ended September 30, 1997 and 1996, 28% and 51%,
respectively, of the Company's total revenues were derived from sales to
international customers. Such a decrease in sales is indicative of the risks
associated with international sales and there can be no assurance that such a
decrease will not occur again in the future. The Company's international sales
have been primarily to European markets, and sales are generally denominated in
local currencies. Some of the Company's international subsidiaries have been
restructured to act as resellers of the IOS/390 product. To the extent this
restructuring is unsuccessful, the Company's results of operations could be
adversely affected. Although the Company plans to focus its initial NetLOCK
sales efforts on the U.S. market, the regulatory environment with respect to
sales of NetLOCK to international customers is complex and uncertain. Should the
Company wish to sell NetLOCK internationally it may be unable to do so or may be
required to incur considerable regulatory costs to do so. Sales to international
customers are subject to additional risks including longer receivables
collection periods, greater difficulty in accounts receivable collection,
failure of distributors to report sales of the Company's products, political and
economic instability, nationalization, trade restrictions, the impact of
possible recessionary environments in economies outside the United States,
reduced protection for intellectual property rights in some countries, currency
fluctuations and tariff regulations and requirements for export licenses. There
can be no assurance that foreign intellectual property laws will adequately
protect the Company's intellectual property rights. In addition, effective
copyright and trade secret protection may be unavailable or limited in certain
foreign
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countries. Substantially all of the Company's distribution and other agreements
with international distributors require any dispute between the Company and any
distributor to be settled by arbitration. Under these agreements, the party
bringing the action, suit or claim is required to conduct the arbitration in the
domicile of the defendant. The result is that, if the Company has a cause of
action against a party, it may not be feasible for the Company to pursue such
action, as arbitration in a foreign country could prove to be excessively costly
and have a less certain outcome depending on the laws and customs in the foreign
country. These international factors could have a material adverse effect on
future sales of the Company's products to international end users and,
consequently, the Company's business, financial condition and results of
operations.
Most of the Company's international sales are denominated in local currencies.
The Company hasn't historically attempted to reduce the risk of currency
fluctuations by hedging except in certain limited circumstances where the
Company has held an account receivable expected to be outstanding for a period
of at least 6 months. The Company may be disadvantaged with respect to its
competitors operating in foreign countries by foreign currency exchange rate
fluctuations that make the Company's products more expensive relative to those
of local competitors. The Company may attempt to reduce these risks by
continuing to hedge in certain limited transactions in the future. Accordingly,
changes in the exchange rates or exchange controls may adversely affect the
Company's results of operations. There can be no assurance that the Company's
current or any future currency exchange strategy will be successful in avoiding
exchange related losses or that any of the factors listed above will not have a
material adverse effect on the Company's future international sales and,
consequently, on the Company's business, financial condition and results of
operations.
Dependence Upon Proprietary Technology; Risk of Third-Party Claims of
Infringement
The Company's success and ability to compete is dependent in part upon its
proprietary information. The Company relies primarily on a combination of
copyright and trademark laws, trade secrets, software security measures, license
agreements and nondisclosure agreements to protect its proprietary technology
and software products. There can be no assurance, however, that such protection
will be adequate to deter misappropriation, deter unauthorized third parties
from copying aspects of, or otherwise obtaining and using, the Company's
software products and technology without authorization, or that the rights
secured thereby will provide competitive advantages to the Company.
There can be no assurance that others will not independently develop similar
products or duplicate the Company's products. There can be no assurance that the
steps taken by the Company to protect its proprietary technology will prevent
misappropriation of such technology, and such protections may not preclude
competitors from developing products with functionality or features similar to
or superior to the Company's products. A substantial amount of the Company's
sales are in international markets, and the laws of other countries may afford
the Company little or no effective protection of its intellectual property.
While the Company believes that its products and trademarks do not infringe upon
the proprietary rights of third parties, there can be no assurance that the
Company will not receive future communications from third parties asserting that
the Company's products infringe, or may infringe, on the proprietary rights of
third parties. The Company was denied a trademark registration of the name
"Interlink" based on the use of similar names by other companies in the computer
industry. The Company expects that software product developers will be
increasingly subject to infringement claims as the number of products and
competitors in the Company's industry segments grow and the functionality's of
products in different industry segments overlap. Any such claims, with or
without merit, could be time consuming, result in costly litigation and
diversion of technical and management personnel, cause product shipment delays
or require the Company to develop non-infringing technology or enter into
royalty or licensing agreements, any of which could have a material adverse
effect on the Company's business, financial condition and results of operations.
Moreover, an adverse outcome in
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litigation or similar adversarial proceedings could subject the Company to
significant liabilities to third parties, require expenditure of significant
resources to develop non-infringing technology, require disputed rights to be
licensed from others or require the Company to cease the marketing or use of
certain products, any of which could have a material adverse effect on the
Company's business, financial condition and results of operations.
Possible Volatility of Share Price
There can be no assurance that the market price of the Company's Common Stock
will not decline or remain below the initial public offering price. The trading
prices of the Company's Common Stock may be subject to wide fluctuations in
response to a number of factors, including variations in operating results,
alliances, changes in earnings estimates by securities analysts, announcements
of extraordinary events such as litigation, alliances, or acquisitions,
announcements of technological innovations or new products or new contracts by
the Company or its competitors, announcements and reports about the declining
number of mainframe computers shipped, press releases or reports of IBM or other
competitors introducing competitive or substitute products, as well as general
economic, political and market conditions. In addition, the stock market has
from time-to-time experienced significant price and volume fluctuations that
have particularly affected the market prices for the common stocks of technology
companies and that have often been unrelated to the operating performance of
particular companies. These broad market fluctuations may also adversely affect
the market price of the Company's Common Stock. In the past, following periods
of volatility in the market price of a company's securities, securities class
action litigation has occurred against the issuing company. There can be no
assurance that such litigation will not occur in the future with respect to the
Company. Such litigation could result in substantial costs and a diversion of
management's attention and resources, which would have a material adverse effect
on the Company's business, financial condition and results of operations. Any
adverse determination in such litigation could also subject the Company to
significant liabilities.
24
<PAGE>
PART II: OTHER INFORMATION
25
<PAGE>
<TABLE>
<CAPTION>
ITEM 1. Legal Proceedings
<S> <C> <C>
Incorporated by reference from the Notes to Condensed Consolidated Financial
Statements provided in Part I hereto.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibit 11.1 Statement Regarding Computation of Net Income
(Loss) Per Share
(b) Exhibit 27 Financial Data Schedule
(EDGAR version only)
(c) Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended
September 30, 1997.
</TABLE>
26
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 7, 1997 INTERLINK COMPUTER SCIENCES INC.
AND SUBSIDIARIES
(Registrant)
By: /s/ Gloria M. Purdy
-------------------
Gloria M. Purdy
Chief Financial Officer and Secretary
By: /s/ Augustus J. Berkeley
------------------------
Augustus J. Berkeley
President and Chief Executive Officer
<TABLE>
EXHIBIT 11.1
INTERLINK COMPUTER SCIENCES, INC. AND SUBSIDIARIES
COMPUTATION OF NET INCOME (LOSS) PER SHARE (1)
(in thousands, except per share data)
<CAPTION>
Three months ended
------------------
September 30, 1997 September 30, 1996
------------------ ------------------
(unaudited)
<S> <C> <C>
Primary and fully diluted:
Weighted average shares......................... 7,557 4,998
Common equivalent shares from stock options
and warrants................................ -- 1,159
------- ------
Shares used in per share calculation................. 7,557 6,147
======= ======
Net income (loss).................................... $(3,741) $ 439
======= ======
Net income (loss) per share.......................... $ (.50) $ 0.07
======= ======
<FN>
(1) There is no difference between primary and fully diluted net income (loss) per share for
all periods presented.
</FN>
</TABLE>
28
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 23,422
<SECURITIES> 0
<RECEIVABLES> 7,261
<ALLOWANCES> (616)
<INVENTORY> 667
<CURRENT-ASSETS> 33,956
<PP&E> 2,697
<DEPRECIATION> 268
<TOTAL-ASSETS> 42,254
<CURRENT-LIABILITIES> 12,057
<BONDS> 0
0
0
<COMMON> 7
<OTHER-SE> 24,933
<TOTAL-LIABILITY-AND-EQUITY> 42,254
<SALES> 2,833
<TOTAL-REVENUES> 6,315
<CGS> 280
<TOTAL-COSTS> 1,609
<OTHER-EXPENSES> 10,166
<LOSS-PROVISION> (7)
<INTEREST-EXPENSE> 42
<INCOME-PRETAX> (5,195)
<INCOME-TAX> (1,454)
<INCOME-CONTINUING> (3,741)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,741)
<EPS-PRIMARY> (.50)
<EPS-DILUTED> (.50)
</TABLE>
