<PAGE> 1
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, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ to ______________
COMMISSION FILE NUMBER 0-23067
CONCORD COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MASSACHUSETTS 04-2710876
(State of incorporation) (IRS Employer Identification Number)
33 BOSTON POST ROAD, WEST
MARLBORO, MASSACHUSETTS 01752
(508) 460-4646
(ADDRESS AND TELEPHONE 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 [ ]
12,958,472 SHARES OF THE REGISTRANT'S COMMON STOCK, $0.01 PAR VALUE, WERE
OUTSTANDING AS OF OCTOBER 31, 1998.
THIS DOCUMENT CONTAINS 21 PAGES.
THE EXHIBIT INDEX IS ON PAGE 22.
<PAGE> 2
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 1998
CONTENTS
Item Number Page
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Balance sheets:
September 30, 1998 and December 31, 1997 3
Statements of operations:
Three and nine months ended September 30, 1998 and
September 30, 1997 4
Statements of cash flows:
Nine months ended September 30, 1998 and September 30, 1997 5
Notes to financial statements 6-7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-18
Item 3. Quantitative and Qualitative Disclosures about Market Risk 18
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities and Use of Proceeds 19
Item 3. Defaults Upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURE 21
EXHIBIT INDEX 22
2
<PAGE> 3
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONCORD COMMUNICATIONS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
(UNAUDITED)
------------ ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents .................................... $ 7,075,005 $ 7,858,186
Marketable securities ........................................ 37,490,663 28,681,117
Accounts receivable, net of allowance of approximately
$397,000 and $240,000, respectively ....................... 4,405,793 3,040,850
Prepaid expenses and other current assets .................... 696,643 282,311
------------ ------------
Total current assets .................................. 49,668,104 39,862,464
------------ ------------
Equipment and Improvements, at cost:
Equipment .................................................... 3,068,094 6,473,305
Leasehold improvements ....................................... 323,167 85,957
------------ ------------
3,391,261 6,559,262
Less -- Accumulated depreciation and amortization ............ 1,111,200 4,507,737
------------ ------------
2,280,061 2,051,525
------------ ------------
$ 51,948,165 $ 41,913,989
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable ............................................. $ 3,562,068 $ 1,764,580
Accrued expenses ............................................. 3,131,967 3,368,585
Deferred revenue ............................................. 4,240,692 2,298,092
------------ ------------
Total current liabilities ............................. 10,934,727 7,431,257
------------ ------------
Stockholders' Equity
Preferred stock, $.01 par value --
Authorized -- 1,000,000 shares
no shares issued and outstanding
Common stock, $.01 par value -- .............................. -- --
Authorized -- 50,000,000 shares
Issued and outstanding -- 12,856,052 and 12,019,188
shares, respectively .................................... 128,561 120,193
Additional paid-in capital ................................... 68,676,194 67,942,708
Deferred compensation ........................................ (113,181) (149,157)
Unrealized gains on marketable securities .................... 345,067 19,750
Accumulated deficit .......................................... (28,023,203) (33,450,762)
------------ ------------
Total stockholders' equity ............................ 41,013,438 34,482,732
------------ ------------
$ 51,948,165 $ 41,913,989
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements
3
<PAGE> 4
CONCORD COMMUNICATIONS, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------- ----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
License revenues ....................... $ 8,871,444 $ 4,635,012 $22,076,035 $11,524,994
Service revenues ....................... 1,724,165 628,488 4,120,085 1,439,891
----------- ----------- ----------- -----------
Total revenues .................... 10,595,609 5,263,500 26,196,120 12,964,885
Cost of Revenues ............................ 1,199,744 771,049 3,052,002 2,050,544
----------- ----------- ----------- -----------
Gross profit ...................... 9,395,865 4,492,451 23,144,118 10,914,341
----------- ----------- ----------- -----------
Operating Expenses:
Research and development ............... 1,871,055 1,145,998 5,086,423 3,272,662
Sales and marketing .................... 4,647,777 2,597,858 12,093,884 6,917,675
General and administrative ............. 778,287 520,893 1,945,105 1,420,825
----------- ----------- ----------- -----------
Total operating expenses ............... 7,297,119 4,264,749 19,125,412 11,611,162
----------- ----------- ----------- -----------
Operating income (loss) ........... 2,098,746 227,702 4,018,705 (696,821)
----------- ----------- ----------- -----------
Other Income (Expense):
Interest income ........................ 572,814 4,334 1,677,628 13,657
Interest expense ....................... -- (31,144) (514) (83,353)
Other .................................. (14,919) 1,120 (54,460) 2,112
----------- ----------- ----------- -----------
Total other income (expense) ...... 557,895 (25,690) 1,622,654 (67,584)
----------- ----------- ----------- -----------
Net income (loss) before taxes .... 2,656,641 202,012 5,641,359 (764,405)
Provision for taxes .............. 213,800 -- 213,800 --
Net income (loss) after taxes ..... $ 2,442,841 $ 202,012 $ 5,427,559 $ (764,405)
=========== =========== =========== ===========
Net income (loss) per common and
potential common share:
Basic .................................... $ 0.19 $ 0.19 $ 0.43 $ (0.81)
=========== =========== =========== ===========
Diluted .................................. $ 0.17 $ 0.02 $ 0.39 $ (0.81)
=========== =========== =========== ===========
Pro forma diluted ........................ $ 0.17 $ 0.02 $ 0.39 $ (0.08)
=========== =========== =========== ===========
Weighted average common and
potential common shares
outstanding:
Basic .................................... 12,790,004 1,047,538 12,526,567 944,365
=========== =========== =========== ===========
Diluted .................................. 14,135,361 10,951,825 14,018,940 944,365
=========== =========== =========== ===========
Pro forma diluted ........................ 14,135,361 10,951,825 14,018,940 9,052,623
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements
4
<PAGE> 5
CONCORD COMMUNICATIONS, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
--------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
------------ ------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income (loss) $ 5,427,559 $ (764,405)
Adjustments to reconcile net income (loss) to net
cash provided by operations
Depreciation and amortization 757,354 405,114
Changes in current assets and liabilities
Accounts receivable (1,364,943) (667,681)
Prepaid expenses and other current assets (414,332) 26,241
Accounts payable 1,797,488 543,820
Accrued expenses (236,618) (313,862)
Deferred revenue 1,942,600 1,424,579
----------- ----------
Net cash provided by operating activities 7,909,108 653,806
----------- ----------
Cash Flows from Investing Activities:
Investments in marketable securities (8,484,229) --
Purchases of equipment and improvements (949,914) (883,744)
----------- ----------
Net cash used in investing activities (9,434,143) (884,744)
----------- ----------
Cash Flows from Financing Activities:
Proceeds from bank borrowings -- 571,483
Repayments of bank borrowings -- (83,223)
Proceeds from exercise of stock options 741,854 132,838
Deferred financing costs -- (454,365)
----------- ----------
Net cash provided by financing activities 741,854 166,733
----------- ----------
Net (Decrease) in Cash and Cash Equivalents (783,181) (63,205)
Cash and Cash Equivalents, beginning of period 7,858,186 1,663,896
----------- ----------
Cash and Cash Equivalents, end of period $ 7,075,005 $1,600,691
----------- ----------
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ -- $ 83,353
=========== ==========
Supplemental Disclosure of Noncash Transactions:
Accretion of dividends on preferred stock $ -- $ 662,334
=========== ==========
Deferred compensation related to grants of stock options $ -- $ 191,875
=========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements
5
<PAGE> 6
CONCORD COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
FORM 10-Q, SEPTEMBER 30, 1998
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNT)
(UNAUDITED)
1. INTERIM FINANCIAL STATEMENTS
The accompanying financial statements have been presented by Concord
Communications, Inc., (the "Company") without audit (except that the balance
sheet information as of December 31, 1997 has been derived from audited
financial statements) in accordance with generally accepted accounting
principles for interim financial statements and with the instructions to Form
10-Q and Regulation S-X pertaining to interim financial statements. Accordingly,
these interim financial statements do not include all information and footnotes
required by generally accepted accounting principles for complete financial
statements. The financial statements reflect all adjustments and accruals which
management considers necessary for a fair presentation of financial position as
of September 30, 1998 and December 31, 1997, and results of operations for the
three and nine months ended September 30, 1998 and 1997. The results for the
interim periods presented are not necessarily indicative of results to be
expected for any future period. The financial statements should be read in
conjunction with the audited financial statements and the notes thereto included
in the Company's 1997 Annual Report on Form 10-K filed with the Securities and
Exchange Commission in March 1998, as amended.
2. NET INCOME (LOSS) PER SHARE
In 1997, the Company adopted SFAS No. 128, Earnings Per Share, effective
December 15, 1997. SFAS No. 128 establishes standards for computing and
presenting earnings per share and applies to entities with publicly held common
stock or potential common stock. The Company has applied the provisions of SFAS
No. 128 retroactively to all periods presented. In accordance with Staff
Accounting Bulletin (SAB) No. 98, the Company has determined that there were no
nominal issuances of common stock or potential common stock in the period prior
to the Company's initial public offering (IPO). The dilutive effect of potential
common shares for the three and nine months ended September 30, 1998, consisting
of outstanding stock options is determined using the treasury method. Pro forma
diluted net income (loss) per common and potential common share assumes that all
series of redeemable convertible preferred stock had been converted to common
stock as of the original issuance dates. Calculations of basic, diluted and pro
forma diluted net income (loss) per common share and potential common share are
as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net income (loss) ..................................... $ 2,442,841 $ 202,012 $ 5,427,559 $ (764,405)
=========== =========== =========== ===========
Weighted average common shares outstanding ............ 12,790,004 1,047,538 12,677,534 944,365
Potential common shares pursuant to stock options ..... 1,345,357 1,796,029 1,341,406 --
Potential common shares pursuant to conversion of
redeemable convertible preferred stock.............. -- 8,108,258 -- --
----------- ----------- ----------- -----------
Diluted weighted average shares ....................... 14,135,361 10,951,825 14, 018,940 944,365
Pro forma conversion of redeemable
convertible preferred stock ........................ -- -- -- 8,108,258
----------- ----------- ----------- -----------
Pro forma diluted weighted average
shares outstanding ................................. 14,135,361 10,951,825 14,018,940 9,052,623
----------- ----------- ----------- -----------
Basic net income (loss) per common share .............. $ 0.19 $ 0.19 $ 0.43 $ (0.81)
=========== =========== =========== ===========
Diluted net income (loss) per common
and potential common share ......................... $ 0.17 $ 0.02 $ 0.39 $ (0.81)
=========== =========== =========== ===========
Pro forma diluted net income (loss) per
common and potential common share . ................ $ 0.17 $ 0.02 $ 0.39 $ (0.08)
=========== =========== =========== ===========
</TABLE>
6
<PAGE> 7
3. COMPREHENSIVE INCOME
Statement of Financial Accounting Standards (SFAS) No. 130, Reporting
Comprehensive Income, establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. The statement is effective for fiscal years beginning
after December 15, 1997 and the Company has adopted the statement in its quarter
ended March 31, 1998. Comprehensive income for the three and nine months ended
September 30, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- -----------------------
1998 1997 1998 1997
---------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Net income (loss) $2,442,841 $202,012 $5,641,359 $(764,405)
Unrealized gains on
marketable securities 298,924 -- 325,317 --
---------- -------- ---------- ---------
Comprehensive income (loss) $1,832,774 $202,012 $2,958,325 $(764,405)
========== ======== ========== =========
</TABLE>
4. INITIAL PUBLIC OFFERING
On October 24, 1997, the Company completed its initial public offering of
3,335,000 shares of common stock at a price of $14.00 per share. Of these
shares, 2,735,000 were issued by the Company and 600,000 were sold by existing
shareholders. The Company received net proceeds of approximately $34.7 million.
The Company's redeemable convertible preferred stock automatically converted
into 8,108,258 shares of common stock upon the closing of the public offering.
Effective upon the closing of the offering, the Company amended and restated its
articles of organization to increase its authorized common stock to 50,000,000
shares and to authorize 1,000,000 shares of preferred stock, $.01 par value.
5. TAX PROVISION
The Company has recorded a tax provision of $213,800 in the three months
and nine months ended September 30, 1998, based on its revised estimates of its
tax obligations for 1998. The Company's effective tax rate for 1998 will be
significantly lower than the statutory rate due to the use of its remaining
unrestricted net operating loss and credit carryforwards.
7
<PAGE> 8
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 1998
(UNAUDITED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company develops, markets and supports a family of turnkey, automated,
scaleable, software-based performance analysis and reporting solutions for the
management of computer networks. Substantially all of the Company's revenues are
derived from the Network Health product family which began shipping in the first
quarter of 1995.
The Company does not provide forecasts of the future financial performance
of the Company. From time to time, however, the information provided by the
Company or statements made by its employees may contain forward-looking
statements. In particular, statements contained in this Form 10-Q that are not
historical statements (including, but not limited to, statements concerning the
plans and objectives of management; increases in sales and marketing, research
and development and general and administrative expenses; expenses associated
with Year 2000 and the Company's expected liquidity and capital resources) may
constitute forward-looking statements. These statements, like all
forward-looking statements, are subject to risks and uncertainties that may
cause future results to differ materially from those expected. Factors that may
cause such differences include, but are not limited to, the factors discussed
beginning on page 12 under the heading "Certain Factors That May Affect Future
Results".
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
financial data as percentages of the Company's total revenue:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
License revenues 83.7% 88.0% 84.3% 88.9%
Service revenues 16.3% 12.0% 15.7% 11.1%
---------------------------------------------------------
Total revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 11.3% 14.7% 11.7% 15.8%
---------------------------------------------------------
Gross profit 88.7% 85.3% 88.3% 84.2%
Operating expenses:
Research and development 17.7% 21.8% 19.4% 25.2%
Sales and marketing 43.9% 49.4% 46.2% 53.4%
General and administrative 7.3% 9.9% 7.4% 11.0%
---------------------------------------------------------
Income (loss) from operations 19.8% 4.2% 15.3% (5.4%)
---------------------------------------------------------
Other income (expense), net 5.3% (0.4%) 6.2% (0.5%)
---------------------------------------------------------
Net income (loss) before taxes 25.1% 3.8% 21.5% (5.9%)
---------------------------------------------------------
Provision for taxes (2.0%) -- (0.8%) --
---------------------------------------------------------
Net income (loss) after taxes 23.1% 3.8% 20.7% (5.9%)
---------------------------------------------------------
</TABLE>
TOTAL REVENUES. The Company's total revenues increased 101.3% to $10.6
million in the three months ended September 30, 1998 from $5.3 million in the
three months ended September 30, 1997. The Company's total revenues increased
102.1% to $26.2 million in the nine months ended September 30, 1998 from $13.0
million in the nine months ended September 30, 1997.
LICENSE REVENUES. The Company's license revenues are derived from the
licensing of software products. License revenues increased 91.5% to $8.9
million, or 83.7% of total revenues, in the three months ended September 30,
1998 from $4.6 million, or 88.0% of total revenues, in the three months ended
September 30, 1997. License revenues increased 91.5% to $22.1 million, or 84.3%
of total revenues, in the nine months ended September 30, 1998 from $11.5
million, or 88.9% of total revenues, in the nine months ended September 30,
1997. The increase in license revenues resulted from increased sales to new
customers and additional sales to existing customers for new products and
upgrades of existing licenses.
8
<PAGE> 9
SERVICE REVENUES. The Company's service revenues consist of fees for
maintenance, training and professional services. Service revenues increased
174.1% to $1.7 million or 16.3% of total revenues, in the three months ended
September 30, 1998 from $628,000, or 12.0% of total revenues, in the three
months ended September 30, 1997. Service revenues increased 186.1% to $4.1
million or 15.7% of total revenues, in the nine months ended September 30, 1998
from $1.4 million, or 11.1% of total revenues, in the nine months ended
September 30, 1997. The increase in service revenues was attributed to an
increase in revenue from maintenance contracts for new and existing customers
and also from an increase in revenue from training and professional services.
COST OF REVENUES. Cost of revenues include expenses associated with royalty
costs, production, fulfillment and product documentation, along with personnel
costs associated with providing customer support in connection with maintenance
and professional service contracts. Royalty costs are comprised of third party
software costs. Cost of revenues increased 55.4% to $1.2 million, or 11.3% of
total revenues, in the three months ended September 30, 1998 from $771,000, or
14.7% of total revenues, in the three months ended September 30, 1997, resulting
in gross margins of 88.7% and 85.3% in each respective period. Cost of revenues
increased 48.9% to $3.1 million or 11.7% of total revenues, in the nine months
ended September 30, 1998 from $2.1 million or 15.8% of total revenues, in the
nine months ended September 30, 1997, resulting in gross margins of 88.3% and
84.2% in each respective period. The increase in cost of revenues in absolute
dollars was primarily the result of increased spending in customer support to be
more responsive to a growing customer base. The improvement in the gross margin
percentages were attributable to lower royalty unit costs associated with the
higher sales volumes during the 1998 period.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist primarily of personnel costs associated with software development.
Research and development expenses increased 63.3% to $1.9 million, or 17.7% of
total revenues, in the three months ended September 30, 1998 from $1.1 million,
or 21.8% of total revenues, in the three months ended September 30, 1997.
Research and development expenses increased 55.4% to $5.1 million, or 19.4% of
total revenues, in the nine months ended September 30, 1998 from $3.3 million,
or 25.2% of total revenues, in the nine months ended September 30, 1997. The
increase in absolute dollars was primarily due to the use of outside contractors
for consulting and recruiting along with increased headcount in research and
development from 42 to 48 for the period from September 30, 1997 to September
30, 1998. The Company's product architecture and higher revenue base have
allowed the Company to introduce new products at lower incremental costs thereby
reducing research and development expenses as a percentage of revenues. The
Company anticipates that it will continue to commit substantial resources to
research and development in the future and that product development expenses may
increase in absolute dollars in future periods.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of salaries, commissions to sales personnel and agents, travel,
tradeshow participation, public relations and other promotional expenses. Sales
and marketing expenses increased 80.0% to $4.6 million, or 43.9 % of total
revenues, in the three months ended September 30, 1998 from $2.6 million, or
49.4% of total revenues, in the three months ended September 30, 1997. Sales and
marketing expenses increased 74.8% to $12.1 million, or 46.2% of total revenues,
in the nine months ended September 30, 1998 from $6.9 million, or 53.4% of total
revenues, in the nine months ended September 30, 1997. The increase in absolute
dollars was primarily the result of increased headcount to continue to build the
direct sales force along with additional marketing and promotional activities to
penetrate the market. The decline in sales and marketing expenses as a
percentage of total revenues is due to sales productivity improvements resulting
from the expansion of the Network Health product family, increased revenues from
existing customers, improved lead generation and reduced sales cycles. Headcount
in sales and marketing increased from 39 to 62 people from September 30, 1997 to
September 30, 1998.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of salaries for financial, administrative and management
personnel and related travel expenses, as well as legal and accounting expenses.
General and administrative expenses increased 49.3% to $778,000, or 7.3% of
total revenues, in the three months ended September 30, 1998 from $521,000, or
9.9% of total revenues, in the three months ended September 30, 1997. General
and administrative expenses increased 36.9% to $1.9 million or 7.4% of total
revenues, in the nine months ended September 30, 1998 from $1.4 million, or
11.0% of total revenues, in the nine months ended September 30, 1997. The
increase in absolute dollars is associated to an increase of costs in general
support areas. Headcount in general and administrative remained at 13 people
from September 30, 1997 to September 30, 1998. General and administrative
expenses declined as a percentage of total revenues during the 1998 period due
to a significant increase in revenues during that period.
OTHER INCOME(EXPENSE). Other income consists of interest earned on funds
available for investment net of interest paid in connection with the financing
of capital equipment. The Company had net other income of $558,000 for the three
months ended September 30, 1998 and net other expense of ($26,000) for the three
months ended September 30, 1997. The Company had net other income of $1.6
million for the nine months ended September 30, 1998 and net other expense of
($68,000) for the nine months ended
9
<PAGE> 10
September 30, 1997. The increase in net other income for the nine months ended
September 30, 1998 is attributed to the investment of proceeds from the
Company's IPO and also the repayment of all outstanding capital equipment
financing.
LIQUIDITY AND CAPITAL RESOURCES
Prior to its initial public offering, the Company financed its operations
primarily through the private sale of equity securities and a credit line for
equipment purchases. On October 24, 1997, the Company completed its initial
public offering of 3,335,000 shares of Common Stock at a price of $14.00 per
share. Of these shares, 2,735,000 were issued by the Company and 600,000 were
sold by existing shareholders. The Company received net proceeds of
approximately $34.7 million. The Company had working capital of $38.8 million at
September 30, 1998.
Net cash provided by operating activities was $7.9 million and $655,000 for
the nine months ended September 30, 1998 and 1997, respectively. Cash, cash
equivalents and marketable securities were $44.6 million at September 30, 1998,
and $1.6 million at September 30, 1997. Deferred revenues increased for the nine
months ended September 30, 1998 by $1.9 million due to an increase in overall
sales activity; the increase consisted of $1.5 million from deferred maintenance
contracts and $355,000 from service and software license sales with remaining
contingencies such as completion of services, product acceptance and credit
worthiness.
Investing activities have consisted of the acquisition of property and
equipment, most notably computer and networking equipment to support the growing
employee base and corporate infrastructure as well as investments in marketable
securities. The Company manages its market risk on its investment securities by
selecting investment grade securities with the highest credit ratings of
relatively short duration that trade in highly liquid markets. Financing
activities consisted of the proceeds from bank borrowings in connection with
equipment purchases and costs associated with the initial public offering during
the nine months ended September 30, 1997 and the issuance of common stock from
the exercise of stock options during the nine months ended September 30, 1998
and 1997.
The Company had available net operating loss carryforwards of approximately
$23.0 million and federal research and development tax credit carryforwards of
approximately $1.5 million as of December 31, 1997 to reduce future income tax
liabilities. These carryforwards expire from 1999 through 2011 and are subject
to review and possible adjustment by the appropriate taxing authorities.
Approximately $11.1 million of the Company's net operating loss and research and
development tax credit carryforwards expire between 1999 and 2001. Pursuant to
the Tax Reform Act of 1986, the utilization of net operating loss carryforwards
for tax purposes may be subject to an annual limitation if a cumulative change
of ownership of more than 50% occurs over a three-year period. As a result of
the Company's 1995 preferred stock financings, such a change in ownership has
occurred. As a result of this ownership change, the use of the net operating
loss carryforwards will be limited. The Company has determined that its initial
public offering did not cause another ownership change. The Company has deferred
tax assets of approximately $13.6 million comprised primarily of net operating
loss carryforwards and research and development credits. The Company has fully
reserved for these deferred tax assets by recording a valuation allowance of
$13.6 million, as the Company believes that it is more likely than not that it
will not be able to realize this asset.
Pursuant to paragraphs 20 to 25 of Statement of Financial Accounting
Standards No. 109, the Company considered both positive and negative evidence in
assessing the need for a valuation allowance at December 31, 1997 and through
the first nine months of 1998. The factors that weighed most heavily on the
Company's decision to record a full valuation allowance were (i) the Company's
history of losses (ii) the substantial restrictions on the use of its existing
net operation loss (NOL) carryforwards and (iii) the uncertainty of future
profitability.
As a result of the ownership change described above, the future use of
approximately $16.3 million of the Company's NOL carryforwards are limited to
only $330,000 per year; the substantial majority of such NOL carryforwards will
expire before they can be used. While the balance of the Company's NOL's are not
limited, the Company is subject to rapid technological change, competition from
substantially larger competitors, a limited family of products and other related
risks, as more thoroughly described in the Company's filing on Form 10-K, as
amended. The Company's limited operating success in late 1997 and through the
first nine months of 1998 and its dependence on a single product family in an
emerging market makes the prediction of future results difficult, if not
impossible, especially in the highly competitive software industry. As a result,
the Company found the evidence described above to be the most reliable objective
evidence available in determining that a full valuation allowance against its
tax assets would be necessary.
In light of the Company's strong performance to date in 1998, the Company
expects to use all its remaining unrestricted NOL and credit carryforwards in
1998. Accordingly, the Company recorded a tax provision of $213,800 in the third
quarter and expects to
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record an additional provision in the last quarter of 1998. However, the
continuing restrictions on the future use on its NOL carryforwards will severely
limit the benefit, if any, the Company will attribute to this asset.
The Company's current export sales are denominated in United States
dollars. To the extent that international sales continue to be denominated in
United States dollars, an increase in the value of the United States dollar
relative to other currencies could make the Company's products and services more
expensive and, therefore, potentially less competitive in international markets.
As of September 30, 1998, the Company's principal sources of liquidity
included cash. The Company believes that the net proceeds from its initial
public offering, together with its current cash balances and cash provided by
future operations, will be sufficient to meet its working capital and
anticipated capital expenditure requirements for at least the next 12 months.
Although operating activities may provide cash in certain periods, to the extent
the Company experiences growth in the future, its operating and investing
activities may require significant cash. Consequently, any such future growth
may require the Company to obtain additional equity or debt financing.
YEAR 2000 COMPLIANCE/YEAR 2000 READINESS DISCLOSURE STATEMENT
The company is aware of the issues associated with the programming code in
existing computer systems and software products as the millennium (Year 2000)
approaches. The Company has set up a task force which consists of the Director
of IT and Operations, the Manager of System Applications and representative
personnel from each functional area. This task force is addressing the Year 2000
issue in the following categories: the Network Health product; internal business
computer systems and software applications; internal systems other than computer
hardware and software; and systems of the Company's external suppliers and
service providers. The Company is also assessing its Year 2000 associated costs,
risks and potential contingency plans. Despite the Company's efforts with
respect to the Year 2000 issue, there can be no assurance that the Company's
business, results of operations or financial condition would not be materially
adversely affected by the failure of the Company's products, its internal
systems and applications or the systems of its third party suppliers and service
providers to properly operate or manage data beyond 1999.
NETWORK HEALTH PRODUCT. In 1997, the Company initiated the necessary development
to ensure Year 2000 compliance in the Network Health family of applications and
believes it has achieved Year 2000 compliance in Network Health 4.1 which was
released in August 1998. The Company's existing customers can receive this
release, at no charge, through their annual software maintenance contract. The
Company requires its customers to purchase software maintenance in order to
receive product support. Specifically, the Company defines Year 2000 Compliance
as the following: no value for current date will cause any interruption in
operation; date-based functionality must behave consistently for dates prior to,
during, and after Year 2000; in all interfaces and data storage, the century in
any date must be specified either explicitly or by unambiguous algorithms or
inferencing rules; Year 2000 must be recognized as a leap year. The Company's
definition of Year 2000 Compliance is adopted from the British Standard
Institute's Definition of Year 2000 Conformity Requirements (PD2000-1). A copy
of the standard is available for review on the Company's website. The Company
makes no guarantee of, claims no responsibility for, and disclaims any liability
to its customers, with respect to Year 2000 compliance of operating platforms,
hardware, software, or other products not developed by the Company, including
equipment monitored by the Network Health product.
INTERNAL BUSINESS COMPUTER SYSTEMS AND SOFTWARE APPLICATIONS. In 1998, the
Company commenced a Year 2000 date conversion project to address all internal
existing computer systems, software applications, and related computer equipment
(e.g. printers) used in conjunction with its internal operations. The Company
plans to identify, modify, upgrade, and/or replace any systems that have been
identified as non-Year 2000 compliant to minimize the possibility of a material
disruption to it business. The Company expects to finish assessing all existing
internal systems by the end of 1998 and also expects to complete the compliance
process on these systems before the end of 1999.
INTERNAL SYSTEMS OTHER THAN COMPUTER HARDWARE AND SOFTWARE. The operation of
office and facilities equipment such as fax machines, photocopiers, telephone
switches, security systems, elevators, and other common devices may also be
affected by the Year 2000 issue. The Company has identified, and is currently
assessing its options to remediate, the Year 2000 issue on its office and
facilities equipment.
SYSTEMS OF EXTERNAL SUPPLIERS AND SERVICE PROVIDERS. The Company has initiated
communications with third party suppliers of the computers, software, and other
equipment used, operated, or maintained by the Company to identify and, to the
extent possible, to resolve any issues regarding the Year 2000 issue. The
Company has also initiated communications with facilities service providers upon
which the Company relies for daily operations. All external suppliers and
service providers will be asked to provide a written assurance that they are
also preparing to be Year 2000 compliant in a timely manner, and that their
products/services
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will be available to the Company up to and beyond the Year 2000, without
interruption. However, there can be no assurance that the systems operated by
other companies upon which the Company relies will be Year 2000 compliant on a
timely basis.
ASSOCIATED COSTS. To date, the Company has not incurred any material costs
related to the assessment of, and preliminary efforts to upgrade or replace
existing systems identified as non-Year 2000 compliant. Management has not yet
assessed the total Year 2000 compliance expense, but based on a preliminary
review to date, does not expect the amounts required to be expensed over the
next two years to have an adverse material effect on its business, results of
operations or financial condition. There can be no assurance, however, that
further assessment of the Company's internal systems and applications will not
indicate that additional Company efforts to assure Year 2000 compliance are
necessary, and that such efforts may be costly.
ASSOCIATED RISKS. The Company expects to identify and resolve all Year 2000
issues that could materially adversely affect its business, financial condition
or results of operations. However, management realizes it may not be possible to
determine with complete certainty that all Year 2000 problems affecting the
Company will be identified or corrected in a timely manner. As a result, the
Company could be at risk of experiencing a significant number of operational
inconveniences and inefficiencies that may divert management's time and
attention from its ordinary business activities and at risk of experiencing a
lesser number of serious system or product failures that may require significant
efforts by the Company to prevent or alleviate material business disruptions.
CONTINGENCY PLANS. The Company recognizes the importance of readiness for
potential worst case scenarios. As a result, the Company is working to identify
scenarios with significant risks, which would require contingency plans. The
Company expects to develop and complete any needed contingency plans no later
than the summer of 1999.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
Information provided by the Company from time to time including statements
in this Form 10-Q which are not historical facts, are so-called "forward-looking
statements" that involve risks and uncertainties, made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. In
particular, statements contained in Management's Discussion and Analysis of
Financial Condition and Results of Operations which are not historical facts
(including, but not limited to, statements concerning the plans and objectives
of management; increases in sales and marketing, research and development and
general and administrative expenses; expenses associated with Year 2000 and the
Company's expected liquidity and capital resources) may constitute
forward-looking statements. The Company's actual future results may differ
significantly from those stated in any forward-looking statements. Factors that
may cause such differences include, but are not limited to, the factors
discussed below, and the other risks discussed in the Company's 1997 Annual
Report on Form 10-K filed with the Securities and Exchange Commission in March
1998, as amended.
LIMITED OPERATING HISTORY; UNCERTAINTY OF FUTURE OPERATING RESULTS
The Company changed its focus to network management software in 1991 and
commercially introduced its first Network Health product in 1995. Accordingly,
the Company has only a limited operating history in the network performance
analysis and reporting market upon which an evaluation of its business and
prospects can be based. The Company has incurred significant net losses in each
of the last five fiscal years preceding fiscal year 1997. As of September 30,
1998, the Company had accumulated net losses of $26.0 million. The limited
operating history of the Company and its dependence on a single product family
in an emerging market makes the prediction of future results of operations
difficult or impossible, and the Company and its prospects must be considered in
light of the risks, costs and difficulties frequently encountered by emerging
companies, particularly companies in the competitive software industry. Although
the Company has achieved recent revenue growth, and profitability for the fiscal
year ended 1997, there can be no assurance that the Company can generate
substantial additional revenue growth on a quarterly or annual basis, or that
any revenue growth that is achieved can be sustained. Revenue growth that the
Company has achieved or may achieve may not be indicative of future operating
results. In addition, the Company has increased, and plans to increase further,
its operating expenses in order to fund higher levels of research and
development, increase its sales and marketing efforts, develop new distribution
channels, broaden its customer support capabilities and expand its
administrative resources in anticipation of future growth. To the extent that
increases in such expenses precede or are not subsequently followed by increased
revenues, the Company's business, results of operations and financial condition
would be materially adversely affected. There can be no assurance that the
Company will sustain profitability on a quarterly or annual basis. The Company
must achieve substantial revenue growth in order to sustain profitability. In
addition, in view of recent revenue growth, the rapidly evolving nature of its
business and markets and its limited operating history in its current market,
the Company believes that period-to-period comparisons of financial results are
not necessarily meaningful and should not be relied upon as an indication of
future performance. In light of the Company's strong performance to date in
1998, the Company expects to use all its remaining unrestricted NOL and credit
carryforwards in 1998. Accordingly, the Company recorded a tax provision of
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$213,800 in the third quarter and expects to record an additional provision in
the last quarter of 1998. However, the continuing restrictions on the future use
on its NOL carryforwards will severely limit the benefit, if any, the Company
will attribute to this asset.
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company is likely to experience significant fluctuations in quarterly
operating results caused by many factors, including, but not limited to: (i)
changes in the demand for the Company's products; (ii) the timing, composition
and size of orders from the Company's customers, including the tendency for
significant bookings to occur in the last month of each fiscal quarter; (iii)
spending patterns and budgetary resources of its customers on network management
software solutions; (iv) the success of the Company's new customer generation
activities; (v) introductions or enhancements of products, or delays in the
introductions or enhancements of products, by the Company or its competitors;
(vi) changes in the Company's pricing policies or those of its competitors;
(vii) changes in the distribution channels through which products are sold;
(viii) the Company's ability to anticipate and effectively adapt to developing
markets and rapidly changing technologies; (ix) changes in networking or
communications technologies; (x) the Company's ability to attract, retain and
motivate qualified personnel; (xi) changes in the mix of products sold; (xii)
the publication of opinions about the Company and its products, or its
competitors and their products, by industry analysts or others; and (xiii)
changes in general economic conditions. Unlike other software companies with a
longer history of operations, the Company does not derive a significant portion
of its revenues from maintenance contracts, and therefore does not have a
significant ongoing revenue stream that may tend to mitigate quarterly
fluctuations in operating results. Furthermore, the Company is attempting to
expand its channels of distribution, and increases in the Company's revenues
will be dependent on its ability to implement successfully its distribution
strategy. Due to the buying patterns of certain of the Company's customers and
also to the Company's own sales incentive programs focused on annual sales
goals, revenues in the Company's fourth quarter could be higher than revenues in
the first quarter of the succeeding year. There also may be other factors that
significantly affect the Company's quarterly results which are difficult to
predict given the Company's limited operating history, such as seasonality and
the timing of receipt and delivery of orders within a fiscal quarter.
Consistent with software industry practice, the Company expects to operate
with a limited amount of backlog. As a result, quarterly sales and operating
results depend generally on the volume and timing of orders within the quarter,
the tendency of sales to occur late in fiscal quarters and the ability of the
Company to fill orders received within the quarter, all of which are difficult
to forecast and manage. The Company's expense levels are based in part on its
expectations of future orders and sales, which, given the Company's limited
operating history, are extremely difficult to predict. A substantial portion of
the Company's operating expenses are related to personnel, facilities, and sales
and marketing programs. This level of spending for such expenses cannot be
adjusted quickly and is, therefore, relatively fixed in the short term.
Accordingly, any significant shortfall in demand for the Company's products in
relation to the Company's expectations would have an immediate and material
adverse effect on the Company's business, results of operations and financial
condition.
Due to all of the foregoing factors, the Company believes that its
quarterly operating results are likely to vary significantly in the future.
Therefore, in some future quarter the Company's results of operations may fall
below the expectations of securities analysts and investors. In such event, the
trading price of the Company's Common Stock would likely be materially adversely
affected.
EMERGING NETWORK MANAGEMENT SOFTWARE MARKET
The market for the Company's products is in an early stage of development.
Although the rapid expansion and increasing complexity of computer networks in
recent years has increased the demand for network management software products,
the awareness of and the need for such products is a recent development. Because
the market for these products is only beginning to develop, it is difficult to
assess the size of this market, the appropriate features and prices for products
to address this market, the optimal distribution strategy and the competitive
environment that will develop. The development of this market and the Company's
growth will be significantly dependent on the willingness of network service
providers, including telecommunications carriers, internet service providers,
systems integrators and outsourcers, to integrate network performance analysis
and reporting software into their product and service offerings. Failure of the
network performance analysis and reporting market to grow or failure of the
Company to properly assess and address such market would have a material adverse
effect on the Company's business, results of operations and financial condition.
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DEPENDENCE ON TELECOMMUNICATIONS CARRIERS
A significant portion of the Company's revenues are, and are expected to
continue to be, attributable to sales of products to telecommunications
carriers. The Company's future performance is significantly dependent upon
telecommunications carriers' increased incorporation of the Company's solutions
as part of their package of product and service offerings to end users. The
failure of the Company's products to perform favorably in and become an accepted
component of the telecommunications carriers' product and service offerings, or
a slower than expected increase or a decrease in the volume of sales of the
Company's products and services to telecommunications carriers, could have a
material adverse effect on the Company's business, results of operations and
financial condition.
CONCENTRATED PRODUCT FAMILY
The Company currently derives substantially all of its revenues from its
Network Health product family, and the Company expects that revenues from these
products will continue to account for substantially all of the Company's
revenues for the foreseeable future. Broad market acceptance of these products
is, therefore, critical to the Company's future success, and any factor
adversely affecting sales or pricing levels of these products could have a
material adverse effect on the Company's business, results of operations and
financial condition. There can be no assurance that market acceptance of Network
Health will increase or even remain at current levels. Factors that may affect
the market acceptance of the Company's products include the availability and
price of competing products and technologies and the success of the sales
efforts of the Company and its marketing partners. Moreover, the Company
anticipates that its competitors will introduce additional competitive products,
particularly if demand for network management software products increases, which
may reduce future market acceptance of the Company's products. In addition, new
competitors could enter the Company's market and offer alternative products
which may impact the market acceptance of the Company's products. The Company's
future performance will also depend in part on the successful development,
introduction and market acceptance of new and enhanced products. There can be no
assurance that any such new or enhanced products will be successfully developed,
introduced and marketed, and failure to do so would have a material adverse
effect on the Company's business, results of operations and financial condition.
RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON STANDARD PROTOCOLS
The software industry is characterized by rapid technological change,
frequent introductions of new products, changes in customer demands and evolving
industry standards. The introduction of products embodying new technologies and
the emergence of new industry standards can render existing products obsolete
and unmarketable. Network Health's ability to analyze and generate reports, as
well as the quality of the reports, is dependent on Network Health's utilization
of the industry-standard SNMP protocol and the data resident in conventional
MIBs. Any change in these industry standards, the development of vendor-specific
proprietary MIB technology, or the emergence of new network technologies could
affect the compatibility of Network Health with these devices which, in turn,
could affect Network Health's ability to analyze and generate comprehensive
reports or the quality of the reports. Furthermore, although the Company's
products currently run on industry-standard UNIX operating systems and Windows
NT, any significant change in industry-standard operating systems could affect
the demand for, or the pricing of, the Company's products. Any of the foregoing
developments could have a material adverse effect on the Company's business,
results of operations and financial condition.
PRODUCT ENHANCEMENTS AND NEW PRODUCTS
Because of rapid technological change in the software industry and
potential changes in the network management software market and industry
standards, the life cycle of versions of Network Health is difficult to
estimate. The Company's future success will depend upon its ability to address
the increasingly sophisticated needs of its customers by developing and
introducing enhancements to Network Health on a timely basis that keep pace with
technological developments, emerging industry standards and customer
requirements. There can be no assurance that the Company will be successful in
developing and marketing enhancements to Network Health or in developing new
products that respond to technological changes, evolving industry standards or
customer requirements, that the Company will not experience difficulties that
could delay or prevent the successful development, introduction and sale of such
enhancements or new products, or that such enhancements or new products will
adequately address the requirements of the marketplace and achieve any
significant degree of market acceptance.
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COMPETITION; NEW ENTRANTS
The market for the Company's products is new, intensely competitive,
rapidly evolving and subject to technological change. Competitive and
alternative offerings are available from the major product categories of remote
monitoring (RMON) probe vendors, element management software, and other
performance analysis and reporting offerings. Another area of competition comes
from a number of companies offering network performance reporting services;
including International Network Services (INS). In addition, the Company expects
the large network management platform vendors to begin to offer products
directly competitive with the Company's products. These companies may bundle
their products with other hardware and software in a manner that may discourage
users from purchasing products offered by the Company. This strategy may be
particularly effective for companies with leading market shares in the network
hardware and software market, including Hewlett-Packard Company, International
Business Machines Corporation and Cabletron Systems, Inc. Developers of network
element management solutions such as Cisco Systems, Inc., 3Com Corporation and
Bay Networks, Inc. may also compete with the Company in the future. The Company
expects competition to persist, increase and intensify in the future with
possible price competition developing in the Company's markets. Many of the
Company's current and potential competitors have longer operating histories and
significantly greater financial, technical and marketing resources and name
recognition than the Company. The Company does not believe its market will
support a large number of competitors and their products. In the past, a number
of software markets have become dominated by one or a small number of suppliers,
and a small number of suppliers or even a single supplier may dominate the
Company's market. If the Company does not provide products that achieve success
in its market in the short term, the Company could suffer an insurmountable loss
in market share and brand name acceptance, which would result in a material
adverse effect on the Company's business, results of operations and financial
condition. There can be no assurance that the Company will be able to compete
effectively with current and future competitors.
UNCERTAIN PROTECTION OF INTELLECTUAL PROPERTY RIGHTS
The Company's success depends significantly upon its proprietary
technology. The Company relies on a combination of patent, copyright, trademark
and trade secret laws, non-disclosure agreements and other contractual
provisions to establish, maintain and protect its proprietary rights, all of
which afford only limited protection. The Company has four issued U.S. patents,
three pending U.S. patent applications, and various foreign counterparts. There
can be no assurance that patents will issue from these pending applications or
from any future applications or that, if issued, any claims allowed will be
sufficiently broad to protect the Company's technology. In addition, there can
be no assurance that any patents that have been or may be issued will not be
challenged, invalidated or circumvented, or that any rights granted thereunder
would provide protection of the Company's proprietary rights. Failure of any
patents to protect the Company's technology may make it easier for the Company's
competitors to offer equivalent or superior technology. The Company has
registered or applied for registration for certain trademarks, and will continue
to evaluate the registration of additional trademarks as appropriate. Despite
the Company's efforts to protect its proprietary rights, unauthorized parties
may attempt to copy aspects of the Company's products or services or to obtain
and use information that the Company regards as proprietary. Third parties may
also independently develop similar technology without breach of the Company's
proprietary rights. In addition, the laws of some foreign countries do not
protect proprietary rights to as great an extent as do the laws of the United
States. In addition, the Company's products are licensed under shrink wrap
license agreements that are not signed by licensees and therefore may not be
binding under the laws of certain jurisdictions.
Certain technologies used by the Company's products are licensed from third
parties, generally on a non-exclusive basis. The termination of any such
licenses, or the failure of the third-party licensors to adequately maintain or
update their products, could result in delay in the Company's ability to ship
certain of its products while it seeks to implement technology offered by
alternative sources, and any required replacement licenses could prove costly.
While it may be necessary or desirable in the future to obtain other licenses
relating to one or more of the Company's products or relating to current or
future technologies, there can be no assurance that the Company will be able to
do so on commercially reasonable terms or at all.
Although the Company does not believe that it is infringing the
intellectual property rights of others, claims of infringement are becoming
increasingly common as the software industry develops and legal protections,
including patents, are applied to software products.
Litigation may be necessary to protect the Company's proprietary
technology, and third parties may assert infringement claims against the Company
with respect to their proprietary rights. Any claims or litigation can be
time-consuming and expensive regardless of their merit. Infringement claims
against the Company can cause product release delays, require the Company to
redesign its products or require the Company to enter into royalty or license
agreements, which agreements may not be available on terms acceptable to the
Company or at all.
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RISK OF PRODUCT DEFECTS; PRODUCT LIABILITY
As a result of their complexity, software products may contain undetected
errors or failures when first introduced or as new versions are released. There
can be no assurance that, despite testing by the Company and testing and use by
current and potential customers, errors will not be found in new products after
commencement of commercial shipments or, if discovered, that the Company will be
able to successfully correct such errors in a timely manner or at all. The
occurrence of errors and failures in the Company's products could result in loss
of or delay in market acceptance of the Company's products, and alleviating such
errors and failures could require significant expenditure of capital and other
resources by the Company. The consequences of such errors and failures could
have a material adverse effect on the Company's business, results of operations
and financial condition.
Since the Company's products are used by its customers to predict future
network problems and avoid failures of the network to support critical business
functions, design defects, software errors, misuse of the Company's products,
incorrect data from network elements or other potential problems within or out
of the Company's control that may arise from the use of the Company's products
could result in financial or other damages to the Company's customers. The
Company does not maintain product liability insurance. Although the Company's
license agreements with its customers typically contain provisions designed to
limit the Company's exposure to potential claims as well as any liabilities
arising from such claims, such provisions may not effectively protect the
Company against such claims and the liability and costs associated therewith.
Accordingly, any such claim could have a material adverse effect upon the
Company's business, results of operations and financial condition. The Company
provides warranties for its products for a period of time (currently three
months) after the software is purchased. The Company's license agreements
generally do not permit product returns by the customer, and product returns and
warranty expense for fiscal 1995, 1996 and 1997 represented less than 1.0% of
total revenues during each of such periods. However, no assurance can be given
that product returns will not increase as a percentage of total revenues in
future periods.
RELIANCE ON STRATEGIC PARTNERS AND OTHER EVOLVING DISTRIBUTION CHANNELS
The Company's distribution strategy is to develop multiple distribution
channels, including sales through strategic marketing partners and value added
resellers and OEM's, such as Cabletron Systems, Inc.; telecommunications
carriers and network service providers, such as MCI Communications Corporation;
and independent software vendors, as well as international distributors
(collectively "channel partners"). The Company has developed a number of these
relationships and intends to continue to develop new channel partner
relationships. Accordingly, the success of the Company will be dependent in
large part on its ability to develop these additional distribution relationships
and on the performance and success of these third parties, particularly
telecommunications carriers and other network service providers. The Company's
channel partner relationships have been established recently, and the Company
cannot predict the extent to which its channel partners will be successful in
marketing the Company's products. The Company generally expects that its
agreements with its channel partners will be terminable by either party without
cause. None of the Company's channel partners are required to purchase minimum
quantities of the Company's products and none of these agreements contain
exclusive distribution arrangements. The Company's inability to attract
important and effective channel partners, or their inability to penetrate their
respective market segments, or the loss of any of the Company's channel
partners, as a result of competitive products offered by other companies or
products developed internally by these channel partners or otherwise, could
materially adversely affect the Company's business, results of operations and
financial condition.
MANAGEMENT OF POTENTIAL GROWTH
The Company recently has experienced significant growth in its sales and
operations and in the complexity of its products and product distribution
channels. The Company has recently increased and is continuing to increase the
size of its sales force and coverage territories. Furthermore, the Company has
recently established and is continuing to establish additional distribution
channels through third party relationships. The Company's growth, coupled with
the rapid evolution of the Company's markets, has placed, and is likely to
continue to place, significant strains on its administrative, operational and
financial resources and increase demands on its internal systems, procedures and
controls. If the Company is unable to manage future growth effectively, the
Company's business, results of operations and financial condition could be
materially adversely affected.
DEPENDENCE ON KEY PERSONNEL
The Company's performance is substantially dependent on the performance of
its key technical and senior management personnel, none of whom is bound by an
employment agreement. The loss of the services of any of such personnel could
have a material adverse effect on the business, results of operations and
financial condition of the Company. The Company does not maintain key person
life
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insurance policies on any of its employees. The Company's success is highly
dependent on its continuing ability to identify, hire, train, motivate and
retain highly qualified management, technical, and sales and marketing
personnel, including recently hired officers and other employees. Competition
for such personnel is intense, and there can be no assurance that the Company
will be able to attract, assimilate or retain highly qualified technical and
managerial personnel in the future. The inability to attract and retain the
necessary management, technical, and sales and marketing personnel could have a
material adverse effect on the Company's business, results of operations and
financial condition.
EXPANSION INTO INTERNATIONAL MARKETS
The Company intends to expand its operations outside of the United States
and enter additional international markets, primarily through the establishment
of additional reseller arrangements. The Company expects to commit additional
time and development resources to customizing its products and services for
selected international markets and to developing international sales and support
channels. There can be no assurance that such efforts will be successful.
In addition to the uncertainty as to the Company's ability to establish an
international presence, there are certain difficulties and risks inherent in
doing business internationally, including, but not limited to: (i) costs of
customizing products and services for international markets; (ii) dependence on
independent resellers; (iii) multiple and conflicting regulations; (iv) exchange
controls; (v) longer payment cycles; (vi) unexpected changes in regulatory
requirements; (vii) import and export restrictions and tariffs; (viii)
difficulties in staffing and managing international operations; (ix) greater
difficulty or delay in accounts receivable collection; (x) potentially adverse
tax consequences; (xi) the burden of complying with a variety of laws outside
the United States; (xii) the impact of possible recessionary environments in
economies outside the United States; and (xiii) political and economic
instability. In addition, the Company's ability to expand its business in
certain countries will require modification of its products, particularly
national language support. The Company's current export sales are denominated in
United States dollars and the Company currently expects to continue this
practice as it expands its international operations. To the extent that
international sales continue to be denominated in U.S. dollars, an increase in
the value of the United States dollar relative to other currencies could make
the Company's products and services more expensive and, therefore, potentially
less competitive in international markets. To the extent that future
international sales are denominated in foreign currency, the Company's operating
results will be subject to risks associated with foreign currency fluctuation
and the Company would consider entering into forward exchange contracts or
otherwise engaging in hedging activities. To date, as all export sales are
denominated in U.S. dollars, the Company has not entered into any such contracts
or engaged in any such activities. As the Company increases its international
sales, its total revenue may also be affected to a greater extent by seasonal
fluctuations resulting from lower sales that typically occur during the summer
months in Europe and other parts of the world.
POSSIBLE VOLATILITY OF STOCK PRICE
The Company completed an initial public offering of its common stock during
October of 1997. The market price of the shares of Common Stock may be highly
volatile and could be subject to wide fluctuations in response to variations in
results of operations, announcements of technological innovations or new
products by the Company or its competitors, changes in financial estimates by
securities analysts or other events or factors. In addition, the financial
markets have experienced significant price and volume fluctuations that have
particularly affected the market prices of equity securities of many high
technology companies and that often have been unrelated to the operating
performance of such companies or have resulted from the failure of the operating
results of such companies to meet market expectations in a particular quarter.
Broad market fluctuations or any failure of the Company's operating results in a
particular quarter to meet market expectations may adversely affect the market
price of the shares of Common Stock. In the past, following periods of
volatility in the market price of a company's securities, securities class
action litigation has often been instituted against such a 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, results of operations and financial condition.
FUTURE CAPITAL FUNDING
The Company plans to continue to expend substantial funds on the continued
development, sales and marketing of the Network Health product family. There can
be no assurance that the Company's existing capital resources, the proceeds from
the Company's initial public offering during October of 1997 and any funds that
may be generated from future operations together will be sufficient to finance
the Company's future operations or that other sources of funding will be
available on terms acceptable to the Company, if at all. In addition, future
sales of substantial amounts of the Company's securities in the public market
could adversely affect prevailing market prices and could impair the Company's
future ability to raise capital through the sale of its securities. The failure
to obtain such funding, if required, could have a material adverse effect on the
Company's business, results of operations and financial condition.
17
<PAGE> 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
18
<PAGE> 19
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 1998
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not a party to any litigation that it believes could have a
material adverse effect on the business, results of operations and financial
condition of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(d) Use of Proceeds
On October 16, 1997, the Company commenced an initial public offering
("IPO") of 2,900,000 shares of common stock, par value $.01 per share (the
"Common Stock"), of the Company pursuant to the Company's final prospectus dated
October 15, 1997 (the "Prospectus"). The Prospectus was contained in the
Company's Registration Statement on Form S-1, which was declared effective by
the Securities and Exchange Commission (SEC File No. 333-33227) on October 15,
1997. Of the 2,900,000 shares of Common Stock offered, 2,300,000 shares were
offered and sold by the Company and 600,000 shares were offered and sold by
certain stockholders of the Company. As part of the IPO, the Company granted the
several underwriters an overallotment option to purchase up to an additional
435,000 shares of Common Stock (the "Underwriters' Option"). The IPO closed on
October 21, 1997 upon the sale of 2,900,000 shares of Common Stock to the
underwriters. On October 24, 1997, the Representatives, on behalf of the several
underwriters, exercised the Underwriters' Option, purchasing 435,000 additional
shares of Common Stock from the Company. The aggregate offering price of the IPO
to the public was $40,600,000 (exclusive of the Underwriters' Option), with
proceeds to the Company and selling shareholders, after deduction of the
underwriting discount, of $29,946,000 (before deducting offering expenses
payable by the Company) and $7,812,000 respectively. The aggregate offering
price of the Underwriters' Option exercised was $6,090,000, with proceeds to the
Company, after deduction of the underwriting discount, of $5,663,700 (before
deducting offering expenses payable by the Company). The aggregate amount of
expenses incurred by the Company in connection with the issuance and
distribution of the shares of Common Stock offered and sold in the IPO were
approximately $3.6 million, including $2.7 million in underwriting discounts and
commissions and $950,000 in other offering expenses.
The net proceeds to the Company from the IPO, after deducting underwriting
discounts and commissions and other offering expenses were approximately $34.7
million.
To date, the Company has not utilized any of the net proceeds from the IPO.
The Company has invested all such net proceeds primarily in US treasury
obligations and other interest bearing investment grade securities.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
ITEM 5. OTHER INFORMATION
Not Applicable
19
<PAGE> 20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The exhibits listed in the accompanying Exhibit Index on page 20 are filed
or incorporated by reference as part of this Report.
(b) Reports on Form 8-K
None
20
<PAGE> 21
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 1998
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Concord Communications, Inc.
/s/ Gary E. Haroian
---------------------------------------
Date: November 16, 1998 Name: Gary E. Haroian
Title: Vice President of Finance
and Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
21
<PAGE> 22
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 1998
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ---------- -----------
27.01 Financial Data Schedule
22
<TABLE> <S> <C>
<ARTICLE> 5
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 7,075
<SECURITIES> 37,491
<RECEIVABLES> 4,803
<ALLOWANCES> 397
<INVENTORY> 0
<CURRENT-ASSETS> 696
<PP&E> 3,391
<DEPRECIATION> 1,111
<TOTAL-ASSETS> 51,948
<CURRENT-LIABILITIES> 10,935
<BONDS> 0
0
0
<COMMON> 68,805
<OTHER-SE> (27,792)
<TOTAL-LIABILITY-AND-EQUITY> 51,948
<SALES> 22,076
<TOTAL-REVENUES> 26,196
<CGS> 1,141
<TOTAL-COSTS> 3,052
<OTHER-EXPENSES> 19,125
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,623
<INCOME-PRETAX> 5,642
<INCOME-TAX> 214
<INCOME-CONTINUING> 5,428
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,428
<EPS-PRIMARY> .39
<EPS-DILUTED> .25
</TABLE>
