<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 June 30, 1999
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)
600 NICKERSON ROAD
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
13,452,167 SHARES OF THE REGISTRANT'S COMMON STOCK, $0.01 PAR VALUE, WERE
OUTSTANDING AS OF JUNE 30, 1999.
THIS DOCUMENT CONTAINS 20 PAGES.
THE EXHIBIT INDEX IS ON PAGE 21.
<PAGE> 2
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, JUNE 30, 1999
CONTENTS
Item Number Page
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Balance sheets:
June 30, 1999 and December 31, 1998 3
Statements of operations:
Three and six months ended June 30, 1999 and
June 30, 1998 4
Statements of cash flows:
Six months ended June 30, 1999 and June 30, 1998 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 19
SIGNATURE 20
EXHIBIT INDEX 21
2
<PAGE> 3
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONCORD COMMUNICATIONS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
ASSETS
<S> <C> <C>
Current Assets:
Cash and cash equivalents............................. $ 7,912,709 $ 11,164,349
Marketable securities................................. 51,103,539 39,237,680
Accounts receivable, net of allowance of approximately
$590,000 and $450,000, respectively................. 7,115,784 5,048,879
Prepaid expenses and other current assets............. 607,601 509,805
----------- ------------
Total current assets.............................. 66,739,633 55,960,713
----------- ------------
Equipment and Improvements, at cost:
Equipment............................................. 4,844,091 3,701,266
Leasehold improvements................................ 1,949,254 385,128
----------- ------------
6,793,345 4,086,394
Less-- Accumulated depreciation and amortization...... 2,024,493 1,365,222
----------- ------------
4,768,852 2,721,172
----------- ------------
$71,508,485 $ 58,681,885
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable...................................... $ 4,928,833 $ 3,553,673
Accrued expenses...................................... 5,735,000 4,086,983
Deferred revenue...................................... 6,489,417 5,296,469
----------- ------------
Total current liabilities......................... 17,153,250 12,937,125
----------- ------------
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 -- 13,376,768 and 13,040,374
shares, respectively................................ 133,768 130,405
Additional paid-in capital............................ 74,201,893 69,938,129
Deferred compensation................................. (77,205) (101,189)
Accumulated comprehensive income...................... (733,545) 149,606
Accumulated deficit................................... (19,169,676) (24,372,191)
----------- ------------
Total stockholders' equity ....................... 54,355,235 45,744,760
----------- ------------
$71,508,485 $ 58,681,885
=========== ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 4
CONCORD COMMUNICATIONS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------------------------------------------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
License revenues............. $ 11,877,074 $ 7,104,600 $ 22,857,164 $ 13,204,591
Service revenues............. 3,184,241 1,435,864 5,732,683 2,395,920
------------- ------------- ------------- -------------
Total revenues.......... 15,061,315 8,540,464 28,589,847 15,600,511
Cost of Revenues.................. 1,853,521 998,720 3,524,469 1,852,259
------------- ------------- ------------- -------------
Gross profit............ 13,207,794 7,541,744 25,065,378 13,748,252
------------- ------------- ------------- -------------
Operating Expenses:
Research and development..... 2,469,165 1,711,725 4,625,795 3,215,367
Sales and marketing.......... 6,309,725 3,938,812 11,907,098 7,446,108
General and administrative... 795,533 594,122 1,598,366 1,166,818
------------- ------------- ------------- -------------
Total operating expenses..... 9,574,423 6,244,659 18,131,259 11,828,293
------------- ------------- ------------- -------------
Operating income........ 3,633,371 1,297,085 6,934,119 1,919,959
------------- ------------- ------------- -------------
Other Income (Expense):
Interest income.............. 749,384 554,394 1,465,451 1,104,814
Interest expense............. -- -- -- (514)
Other........................ 1,650 974 (9,055) (39,541)
------------- ------------- ------------- -------------
Total other income...... 751,034 555,368 1,456,396 1,064,759
------------- ------------- ------------- -------------
Income before income
taxes.................. 4,384,405 1,852,453 8,390,515 2,984,718
Provision for income taxes... 1,666,000 -- 3,188,000 --
------------- ------------- ------------- -------------
Net income.............. $ 2,718,405 $ 1,852,453 $ 5,202,515 $ 2,984,718
============= ============= ============= =============
Net income per common and
potential common share:
Basic $ 0.20 $ 0.15 $ 0.39 $ 0.24
============= ============= ============= =============
Diluted $ 0.19 $ 0.13 $ 0.36 $ 0.21
============= ============= ============= =============
Weighted average common and
potential common shares
outstanding:
Basic 13,339,718 12,565,017 13,247,441 12,395,448
============= ============= ============= =============
Diluted 14,277,330 13,982,741 14,313,815 13,960,730
============= ============= ============= =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 5
CONCORD COMMUNICATIONS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------------
JUNE 30, JUNE 30,
1999 1998
-------- --------
<S> <C> <C>
Cash Flows from Operating Activities:
Net income $ 5,202,515 $ 2,984,718
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation and amortization (199,895) 380,415
Changes in current assets and liabilities
Accounts receivable (2,066,906) 28,478
Prepaid expenses and other current assets (97,796) (81,407)
Accounts payable 1,375,160 905,093
Accrued expenses 1,648,017 (691,236)
Deferred revenue 1,192,948 750,435
----------- -----------
Net cash provided by operating activities 7,054,043 4,276,496
----------- -----------
Cash Flows from Investing Activities:
Purchases of marketable securities (72,119,908) (25,628,502)
Sales of marketable securities 60,254,049 18,266,229
Purchases of equipment and improvements (2,706,951) (861,122)
----------- -----------
Net cash used in investing activities (14,572,810) (8,223,395)
----------- -----------
Cash Flows from Financing Activities:
Proceeds from exercise of stock options 4,267,127 515,865
----------- -----------
Net Decrease in Cash and Cash Equivalents (3,251,640) (3,431,034)
Cash and Cash Equivalents, beginning of period 11,164,349 7,858,186
----------- -----------
Cash and Cash Equivalents, end of period $ 7,912,709 $ 4,427,152
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid for taxes $ 151,050 $ --
=========== ===========
Supplemental Disclosure of Noncash Transactions:
Unrealized (loss) gain on available-for-sale
securities $ (883,151) $ 26,393
=========== ===========
Tax benefit associated with employee stock options $ 3,000,000 $ --
=========== ===========
Retirement of fully depreciated fixed assets $ -- $ 4,330,000
=========== ===========
</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, JUNE 30, 1999
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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, 1998 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 June 30, 1999 and December 31, 1998, and results of operations for the three
and six months ended June 30, 1999 and 1998. 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
1998 Annual Report on Form 10-K filed with the Securities and Exchange
Commission in March 1999.
2. NET INCOME PER SHARE
The Company follows the provisions of 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 dilutive effect of potential common
shares for the six months ended June 30, 1999 and June 30, 1998, consisting of
outstanding stock options, is determined using the treasury method. Calculations
of basic and diluted net income per common share and potential common share are
as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income............................ $ 2,718,405 $ 1,852,453 $ 5,202,515 $ 2,984,718
============ ============ ============ ============
Weighted average common shares
outstanding......................... 13,339,718 12,565,017 13,247,441 12,395,448
Potential common shares pursuant to stock
options............................. 937,612 1,417,724 1,066,374 1,565,282
------------ ----------- ------------ ------------
Diluted weighted average shares...... 14,277,330 13,982,741 14,313,815 13,960,730
============ =========== ============ ============
Basic net income per common share..... $ 0.20 $ 0.15 $ 0.39 $ 0.24
============ =========== ============ ============
Diluted net income per common
and potential common share......... $ 0.19 $ 0.13 $ 0.36 $ 0.21
============ =========== ============ ============
</TABLE>
3. COMPREHENSIVE INCOME
The Company follows the provisions of SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 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 six months ended
June 30, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ---------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 2,718,405 $ 1,852,453 $ 5,202,515 $ 2,984,718
Unrealized (loss) gain on
marketable securities (557,083) 19,679 (883,150) 26,393
------------ ------------ ------------ ------------
Comprehensive income $ 2,161,322 $ 1,832,774 $ 4,319,365 $ 2,958,325
============ ============ ============ ============
</TABLE>
6
<PAGE> 7
4. COMMITMENTS
In March, 1999 the Company signed a 7 year operating lease for their
principal operating facilities. Aggregate rental payments under the lease will
be $12.0 million.
5. TAX PROVISION
The Company has recorded a tax provision of $3.2 million in the six months
ended June 30, 1999, based on its effective tax rate for 1999, computed in
accordance with SFAS No. 109, Accounting for Income Taxes. Pursuant to SFAS No.
109, the Company has recorded the tax benefit associated with the exercise and
subsequent disqualifying disposition of incentive stock options by the Company's
employees (approximately $3.0 million) as a component of additional paid in
capital.
7
<PAGE> 8
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, JUNE 30, 1999
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,
scalable, Web-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 its future financial performance.
From time to time, however, the information provided by the Company or
statements made by its employees may contain forward looking statements. In
particular, some statements contained in this Form 10-Q and the Company's Annual
Report and Form 10-K, for the fiscal year ended December 31, 1998, are not
historical statements (including, but not limited to, statements concerning the
plan 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). This
document contains forward looking statements. Any statements contained herein
that do not describe historical facts are forward looking statements. The
Company makes such forward looking statements under the provisions of the "safe
harbor" section of the Private Securities Litigation Reform Act of 1995. The
forward looking statements contained herein are based on current expectations,
but are subject to a number of risks and uncertainties. The facts that could
cause actual results to differ materially from current expectations include the
following: risks of intellectual property rights and litigation, risks in
technology development and commercialization, risks in product development and
market acceptance of and demand for the Company's products, risks of downturns
in economic conditions generally, and in the software, networking and
telecommunications industries specifically, risks associated with competition
and competitive pricing pressures, risks associated with international sales and
other risks detailed in the Company's filings with the Securities and Exchange
Commission.
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 SIX MONTHS ENDED
------------------ -----------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
License revenues 78.9% 83.2% 79.9% 84.6%
Service revenues 21.1% 16.8% 20.1% 15.4%
--------------------------------------------------------------------------
Total revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 12.3% 11.7% 12.3% 11.9%
--------------------------------------------------------------------------
Gross profit 87.7% 88.3% 87.7% 88.1%
Operating expenses:
Research and development 16.4% 20.0% 16.2% 20.6%
Sales and marketing 41.9% 46.1% 41.6% 47.7%
General and administrative 5.3% 7.0% 5.6% 7.5 %
--------------------------------------------------------------------------
Income from operations 24.1% 15.2% 24.3% 12.3%
--------------------------------------------------------------------------
Other income, net 5.0% 6.5% 5.1% 6.8%
--------------------------------------------------------------------------
Income before income taxes 29.1% 21.7% 29.4% 19.1%
--------------------------------------------------------------------------
Provision for income taxes 11.1% -- 11.2% --
--------------------------------------------------------------------------
Net income 18.0% 21.7% 18.2% 19.1%
--------------------------------------------------------------------------
</TABLE>
8
<PAGE> 9
REVENUES. The Company's revenues consist of software license revenues and
service revenues. Software license revenues are recognized in accordance with
the American Institute of Certified Public Accountants' Statement of Position
("SOP") 97-2, Software Revenue Recognition. Under SOP 97-2, software license
revenues are recognized upon execution of a contract and delivery of software,
provided that the license fee is fixed and determinable, no significant
production, modification or customization of the software is required and
collection is considered probable by management. In 1999, software license
revenues are recognized in accordance with SOP 97-2, as modified by SOP 98-9,
Modification of SOP 97-2, Software Revenue Recognition with respect to Certain
Transactions. Service revenues are recognized as the services are performed.
Maintenance revenues are derived from customer support agreements generally
entered into in connection with initial license sales and subsequent renewals.
Maintenance revenues are recognized ratably over the term of the maintenance
period. Payments for maintenance fees are generally made in advance.
INTERNATIONAL REVENUES. The Company recognized $2.8 million and $1.3
million of revenues from international locations in the three months ended June
30, 1999 and 1998, representing 18.7% and 14.9% of total revenues, respectively.
The Company recognized $5.0 million and $2.4 million of revenues from
international locations in the six months ended June 30, 1999 and 1998,
representing 17.5% and 15.5% of total revenues, respectively. The Company's
revenues from international locations were primarily generated from customers
located in Europe. Revenues from customers located in Europe accounted for 14.9%
and 8.9% of total revenues in the three months ended June 30, 1999 and 1998,
respectively. Revenues from customers located in Europe accounted for 13.8% and
11.5% of total revenues in the six months ended June 30, 1999 and 1998,
respectively. The continued increase in revenues from international locations is
primarily the result of the Company's expansion of its operations outside the
United States which has included both the hiring of additional personnel as well
as the establishment of additional reseller agreements. The Company believes
that continued growth and profitability will require further expansion of its
sales in international markets. The Company expects to commit additional time
and development resources to customizing its products and services for selected
international markets.
TOTAL REVENUES. The Company's total revenues increased 76.4% to $15.1
million in the three months ended June 30, 1999 from $8.5 million in the three
months ended June 30, 1998. The Company's total revenues increased 83.3% to
$28.6 million in the six months ended June 30, 1999 from $15.6 million in the
six months ended June 30, 1998.
LICENSE REVENUES. The Company's license revenues are derived from the
licensing of software products. License revenues increased 67.2% to $11.9
million, or 78.9% of total revenues, in the three months ended June 30, 1999
from $7.1 million, or 83.2% of total revenues, in the three months ended June
30, 1998. License revenues increased 73.1% to $22.9 million, or 79.9% of total
revenues, in the six months ended June 30, 1999 from $13.2 million, or 84.6% of
total revenues, in the six months ended June 30, 1998. 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.
SERVICE REVENUES. The Company's service revenues consist of fees for
maintenance, training and professional services. Service revenues increased
121.7% to $3.2 million, or 21.1% of total revenues, in the three months ended
June 30, 1999 from $1.4 million, or 16.8% of total revenues, in the three months
ended June 30, 1998. Service revenues increased 139.3% to $5.7 million, or 20.1%
of total revenues, in the six months ended June 30, 1999 from $2.4 million, or
15.4% of total revenues, in the six months ended June 30, 1998. The increase in
service revenues was attributed to an increase in revenue from maintenance
contracts, training and professional services for new and existing customers.
COST OF REVENUES. Cost of revenues includes 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 85.6% to $1.9 million, or
12.3% of total revenues, in the three months ended June 30, 1999 from $999,000,
or 11.7% of total revenues, in the three months ended June 30, 1998, resulting
in gross margins of 87.7% and 88.3% in each respective period. Cost of revenues
increased 90.2% to $3.5 million, or 12.3% of total revenues, in the six months
ended June 30, 1999 from $1.9 million, or 11.9% of total revenues, in the six
months ended June 30, 1998, resulting in gross margins of 87.7% and 88.1% 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.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist primarily of personnel costs associated with software development.
Research and development expenses increased 44.2% to $2.5 million, or 16.4% of
total
9
<PAGE> 10
revenues, in the three months ended June 30, 1999 from $1.7 million, or 20.0% of
total revenues, in the three months ended June 30, 1998. Research and
development expenses increased 43.8% to $4.6 million, or 16.2% of total
revenues, in the six months ended June 30, 1999 from $3.2 million, or 20.6% of
total revenues, in the six months ended June 30, 1998. 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 43 to
58 for the period from June 30, 1998 to June 30, 1999. 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, advertising and other promotional
expenses. Sales and marketing expenses increased 60.2% to $6.3 million, or 41.9%
of total revenues, in the three months ended June 30, 1999 from $3.9 million, or
46.1% of total revenues, in the three months ended June 30, 1998. Sales and
marketing expenses increased 59.9% to $11.9 million, or 41.6% of total revenues,
in the six months ended June 30, 1999 from $7.4 million, or 47.7% of total
revenues, in the six months ended June 30, 1998. 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 53 to 98 people from June 30, 1998 to June
30, 1999.
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 34.0% to $796,000, or 5.3% of
total revenues, in the three months ended June 30, 1999 from $594,000, or 7.0%
of total revenues, in the three months ended June 30, 1998. General and
administrative expenses increased 36.9% to $1.6 million, or 5.6% of total
revenues, in the six months ended June 30, 1999 from $1.2 million, or 7.5% of
total revenues, in the six months ended June 30, 1998. The increase in absolute
dollars is associated with an increase of costs in general support areas.
Headcount in general and administrative functions increased from 13 to 16 people
from June 30, 1998 to June 30, 1999. General and administrative expenses
declined as a percentage of total revenues during the 1999 period due to a
significant increase in revenues during that period.
OTHER INCOME. Other income consists of interest earned on funds available
for investment. The Company had net other income of $751,000 for the three
months ended June 30, 1999 and net other income of $556,000 for the three months
ended June 30, 1998. The Company had net other income of $1.5 million for the
six months ended June 30, 1999 and net other income of $1.1 million for the six
months ended June 30, 1998. The increase in net other income is attributed to
the investment of proceeds from the Company's IPO.
LIQUIDITY AND CAPITAL RESOURCES
The Company financed its operations, prior to its initial public offering,
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 selling shareholders. The Company received net proceeds of approximately
$34.7 million. The Company had working capital of $48.0 million at June 30,
1999.
Net cash provided by operating activities was $7.1 million and $4.3 million
for the three months ended June 30, 1999 and 1998, respectively. Cash, cash
equivalents and marketable securities were $59.0 million and $40.5 million at
June 30, 1999 and 1998, respectively. Deferred revenues increased for the six
months ended June 30, 1999 by $1.2 million due to an increase in overall sales
activity; the increase consisted of $1.6 million from deferred maintenance
contracts and a decrease of $399,000 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 and also 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 primarily of the issuance of common stock and exercise of
options during the three months ended June 30, 1999 and 1998.
10
<PAGE> 11
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 is limited. The Company has determined that its
initial public offering did not cause another ownership change. The Company has
deferred tax assets of approximately $17.3 million composed 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 $17.3 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 (SFAS) No. 109, the Company considered both positive and negative
evidence in assessing the need for a valuation allowance at December 31, 1997
and 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 $16.6 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. Pursuant to the provisions of SFAS No. 109, the
Company used all of its remaining unrestricted NOL and credit carryforwards in
computing the 1998 tax provision. The Company is also subject to rapid
technology change, competition from substantially larger competitors, a limited
family of products and other related risks, as more thoroughly described in the
"Risk Factors" section of the Company's Form 10-K, for the fiscal year ended
December 31, 1998. The Company's 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.
The Company's net operating loss deferred tax asset includes approximately
$6.5 million pertaining to the benefit associated with the exercise and
subsequent disqualifying disposition of incentive stock options by the Company's
employees. When and if the Company realizes this asset, the resulting change in
the valuation allowance will be credited directly to additional paid-in capital,
pursuant to the provisions of SFAS No. 109.
The Company received a tax benefit of approximately $3.0 million pursuant
to the exercise of employee stock options. The Company recorded this benefit as
a component of additional paid in capital for the period ended June 30, 1999.
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 March 31, 1999, the Company's principal sources of liquidity included
cash and marketable securities. The Company believes that its current cash and
market securities and cash provided by future operations will be sufficient to
meet its working capital and anticipated capital expenditure requirements for
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 Information Technology (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.
11
<PAGE> 12
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 and future releases, 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 has finished assessing all existing
internal systems and 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 assessed its
options to remediate, the Year 2000 issue on its office and facilities
equipment. The Company expects to complete any needed modifications and upgrades
on its office and facilities equipment before the end of 1999.
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 have been 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 will be available to the Company up to and beyond the Year
2000, without interruption. A response has been received from approximately 75%
of these suppliers and service providers. 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 efforts to upgrade or replace existing systems
identified as non-Year 2000 compliant. Management is continuing to assess the
total Year 2000 compliance expense, but based on a review to date, does not
expect the amounts required to be expensed over the balance of 1999 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 has begun to develop and expects to complete any needed contingency
plans no later than the fall of 1999.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
12
<PAGE> 13
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. This document contains forward looking statements. Any statements
contained herein that do not describe historical facts are forward looking
statements. The Company makes such forward looking statements under the
provisions of the "safe harbor" section of the Private Securities Litigation
Reform Act of 1995. The forward looking statements contained herein are based on
current expectations, but are subject to a number of risks and uncertainties. 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) 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 1998 Annual Report on Form 10-K filed
with the Securities and Exchange Commission in March 1999.
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 June 31, 1999,
the Company had accumulated net losses of $17.0 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
years ended 1998 and 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
1999, the Company recorded a tax provision of $3.2 million in the six months
ended June 30, 1999.
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
13
<PAGE> 14
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.
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.
14
<PAGE> 15
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.
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, Lucent
Technologies, International Business Machines Corporation and Cabletron Systems,
Inc. Developers of network element management solutions such as Cisco Systems,
Inc., 3Com Corporation and Nortel 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
15
<PAGE> 16
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.
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 1998, 1997 and 1996 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, such as Newbridge Networks Corporation; telecommunications carriers,
such as MCI Communications Corporation; OEMs, such as Cabletron Systems, Inc.;
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
16
<PAGE> 17
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 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
17
<PAGE> 18
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Derivative Financial Instruments, Other Financial Instruments and
Derivative Commodity Instruments. The Company does not invest in derivative
financial instruments, other financial instruments or derivative commodity
instruments for which fair value disclosure would be required under SFAS No.
107. All of the Company's investments are in investment grade securities with
high credit ratings of relatively short duration that trade in highly liquid
markets and are carried at fair value on the Company's books. Accordingly, the
Company has no quantitative information concerning the market risk of
participating in such investments.
Primary Market Risk Exposures. The Company's primary market risk exposure
is in the area of interest rate risk. The Company's investment portfolio of cash
equivalents is subject to interest rate fluctuations, but the Company believes
this risk is immaterial due to the short-term nature of these investments.
Substantially all of the Company's business outside the United States is
conducted in U.S. dollar-denominated transactions, whereas the Company's
operating expenses in its international branches are denominated in local
currency. The Company has no foreign exchange contracts, option contracts or
other foreign hedging arrangements. The Company believes that the operating
expenses of its foreign operations are immaterial, and therefore any associated
market risk is unlikely to have a material adverse effect on the Company's
business, results of operations or financial condition.
18
<PAGE> 19
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, JUNE 30, 1999
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
The Company held its Annual Meeting of stockholders on April 27, 1999. At the
Annual Meeting, the stockholders of the Company elected three Class II
Directors, approved the Company's 1997 Stock Plan (as amended) and ratified the
selection of the firm of Arthur Andersen LLP as auditors for the Company for the
fiscal year ending December 31, 1999. The voting results were as follows:
Total Vote For Total Vote Withheld
-------------- -------------------
Election of Directors
Frederick W.W. Bolander 11,331,582 20,291
Deepak Kamra 11,331,582 20,291
Robert M. Wadsworth 11,331,582 20,291
Broker
For Against Abstain Non-Vote
--- ------- ------- --------
Approval of 1997 Stock
Plan, as amended 8,350,930 2,027,162 19,505 954,276
Ratification of Selection
of Arthur Andersen LLP 11,273,774 65,600 12,499 0
ITEM 5. OTHER INFORMATION
Not Applicable
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
19
<PAGE> 20
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, JUNE 30, 1999
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: August 13, 1999 Name: Gary E. Haroian
Title: Vice President of Finance
and Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
20
<PAGE> 21
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, JUNE 30, 1999
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.01 1997 Stock Plan of the Company, as amended on
March 01, 1999
27.01 Financial Data Schedule
21
<PAGE> 1
EXHIBIT 10.1
CONCORD COMMUNICATIONS, INC.
1997 STOCK PLAN
(AS AMENDED ON MARCH 12, 1998 AND MARCH 1, 1999)
1. PURPOSE; TERMINATION OF PRIOR PLAN. The purpose of the 1997 Stock Plan
(the "Plan") is to encourage key employees of Concord Communications, Inc. (the
"Company") and of any present or future parent or subsidiary of the Company
(collectively, "Related Corporations") and other individuals who render services
to the Company or a Related Corporation, by providing opportunities to
participate in the ownership of the Company and its future growth through (a)
the grant of options which qualify as "incentive stock options" ("ISOs") under
Section 422(b) of the Internal Revenue Code of 1986, as amended (the "Code");
(b) the grant of options which do not qualify as ISOs ("Non-Qualified Options");
(c) awards of stock in the Company ("Awards"); and (d) opportunities to make
direct purchases of stock in the Company ("Purchases"). Both ISOs and
Non-Qualified Options are referred to hereafter individually as an "Option" and
collectively as "Options." Options, Awards and authorizations to make Purchases
are referred to hereafter collectively as "Stock Rights." As used herein, the
terms "parent" and "subsidiary" mean "parent corporation" and "subsidiary
corporation," respectively, as those terms are defined in Section 424 of the
Code. The Company's 1995 Stock Plan (the "1995 Stock Plan") is terminated
effective as of October 16, 1997 and henceforth, the Company shall make no
grants under the 1995 Stock Plan. The 1995 Stock Plan shall, however, continue
to govern all options, awards and other grants granted and outstanding under the
1995 Stock Plan.
2. ADMINISTRATION OF THE PLAN.
A. BOARD OR COMMITTEE ADMINISTRATION. The Plan shall be administered
by the Board of Directors of the Company (the "Board") or, subject to
paragraph 2(D) (relating to compliance with Section 162(m) of the Code), by
a committee appointed by the Board of two or more of its members (the
"Committee"). Hereinafter, all references in this Plan to the "Committee"
shall mean the Board if no Committee has been appointed. Subject to
ratification of the grant or authorization of each Stock Right by the Board
(if so required by applicable state law), and subject to the terms of the
Plan, the Committee shall have the authority to (i) determine to whom (from
among the class of employees eligible under paragraph 3 to receive ISOs)
ISOs shall be granted, and to whom (from among the class of individuals and
entities eligible under paragraph 3 to receive Non-Qualified Options and
Awards and to make Purchases) Non-Qualified Options, Awards and
authorizations to make Purchases may be granted; (ii) determine the time or
times at which Options or Awards shall be granted or Purchases made; (iii)
determine the purchase price of shares subject to each Option or Purchase,
which prices shall not be less than the minimum price specified in
paragraph 6; (iv) determine whether each Option granted shall be an ISO or
a Non-Qualified Option; (v) determine (subject to paragraph 7) the time or
times when each Option shall become exercisable and the duration of the
exercise period; (vi) determine whether restrictions such as repurchase
options are to be imposed on shares subject to Options, Awards and
Purchases and the nature of such restrictions, if any; and (vii) interpret
the Plan and prescribe and rescind rules and regulations relating to it. If
the Committee determines to issue a Non-Qualified Option, it shall take
whatever actions it deems necessary, under Section 422 of the Code and the
regulations promulgated thereunder, to ensure that such Option is not
treated as an ISO. The interpretation and construction by the Committee of
any provisions of the Plan or of any Stock Right granted under it shall be
final unless otherwise determined by the Board. The Committee may from time
to time adopt such rules and regulations for carrying out the Plan as it
may deem best. No member of the Board or of the
1
<PAGE> 2
Committee shall be liable for any action or determination made in good
faith with respect to the Plan or any Stock Right granted under it.
B. COMMITTEE ACTIONS. The Committee may select one of its members as
its chairman, and shall hold meetings at such time and places as it may
determine. A majority of the Committee shall constitute a quorum and acts
of a majority of the members of the Committee at a meeting at which a
quorum is present, or acts reduced to or approved in writing by all the
members of the Committee (if consistent with applicable state law), shall
be the valid acts of the Committee. From time to time the Board may
increase the size of the Committee and appoint additional members thereof,
remove members (with or without cause) and appoint new members in
substitution therefor, fill vacancies however caused, or remove all members
of the Committee and thereafter directly administer the Plan.
C. GRANT OF STOCK RIGHTS TO BOARD MEMBERS. Notwithstanding the
provisions of paragraph 2.A., no Stock Rights shall be granted to any
person who is, at the time of the proposed grant, a member of the Board
unless such grant is approved by a majority vote of the disinterested
members of the Board. All grants of Stock Rights to members of the Board
shall in all respects be made in accordance with the provisions of this
Plan applicable to other eligible persons. Members of the Board who either
(i) are eligible to receive grants of Stock Rights pursuant to the Plan or
(ii) have been granted Stock Rights may vote on any matters affecting the
administration of the Plan or the grant of any Stock Rights pursuant to the
Plan, except that no such member shall act upon the granting to himself or
herself of Stock Rights, but any such member may be counted in determining
the existence of a quorum at any meeting of the Board during which action
is taken with respect to the granting to such member of Stock Rights.
Notwithstanding any other provision of this paragraph 2, in the event the
Company registers any class of any equity security pursuant to Section 12
of the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
any grants to members of the Board of Options made at any time from the
effective date of such registration until six months after the termination
of such registration shall be made only by the Board; provided, however,
that if a majority of the Board is eligible to participate in the Plan or
in any other stock option or other stock plan of the Company or any of its
affiliates, or has been so eligible at any time within the preceding year,
any grant to directors of Options must be made by, or only in accordance
with the recommendation of, a Committee consisting of three or more
persons, who may but need not be members of the Board or employees of the
Company, appointed by the Board but having full authority to act in the
matter, none of whom is eligible to participate in this Plan or any other
stock option or other stock plan of the Company or any of its affiliates,
or has been eligible at any time within the preceding year. The
requirements imposed by the preceding sentence shall also apply with
respect to grants to officers who are not also members of the Board. Once
appointed, the Committee shall continue to serve until otherwise directed
by the Board.
D. PERFORMANCE-BASED COMPENSATION. The Board, in its discretion, may
take such action as may be necessary to ensure that Stock Rights granted
under the Plan qualify as "qualified performance-based compensation" within
the meaning of Section 162(m) of the Code and applicable regulations
promulgated thereunder ("Performance-Based Compensation"). Such action may
include, in the Board's discretion, some or all of the following (i) if the
Board determines that Stock Rights granted under the Plan generally shall
constitute Performance-Based Compensation, the Plan shall be administered,
to the extent required for such Stock Rights to constitute
Performance-Based Compensation, by a Committee consisting solely of two or
more "outside directors" (as defined in applicable regulations promulgated
under Section 162(m) of the Code), (ii) if any Non-Qualified Options with
an exercise price less than the fair market value per share of Common Stock
are granted under the Plan and the Board determines that such Options
should constitute Performance-Based Compensation, such options shall be
made exercisable only upon the attainment of a pre-established, objective
performance goal established by the
2
<PAGE> 3
Committee, and such grant shall be submitted for, and shall be contingent
upon shareholder approval and (iii) Stock Rights granted under the Plan may
be subject to such other terms and conditions as are necessary for
compensation recognized in connection with the exercise or disposition of
such Stock Right or the disposition of Common Stock acquired pursuant to
such Stock Right, to constitute Performance-Based Compensation.
3. ELIGIBLE EMPLOYEES AND OTHERS. ISOs may be granted only to employees
of the Company or any Related Corporation. Non-Qualified Options, Awards and
authorizations to make Purchases may be granted to any employee, officer or
director (whether or not also an employee) or consultant of the Company or any
Related Corporation. The Committee may take into consideration a recipient's
individual circumstances in determining whether to grant a Stock Right. The
granting of any Stock Right to any individual or entity shall neither entitle
that individual or entity to, nor disqualify such individual or entity from,
participation in any other grant of Stock Rights.
4. STOCK. The stock subject to Stock Rights shall be authorized but
unissued shares of Common Stock of the Company, par value $.01 per share (the
"Common Stock"), or shares of Common Stock reacquired by the Company in any
manner. The aggregate number of shares which may be issued pursuant to the Plan
is 2,500,000, subject to adjustment as provided in paragraph 13. If any Option
granted under the Plan shall expire or terminate for any reason without having
been exercised in full or shall cease for any reason to be exercisable in whole
or in part or shall be repurchased by the Company, the unpurchased shares of
Common Stock subject to such Option shall again be available for grants of Stock
Rights under the Plan.
No employee of the Company or any Related Corporation may be granted
Options to acquire, in the aggregate, more than 70% of the aggregate number of
shares of Common Stock which may be issued pursuant to the Plan during any
fiscal year of the Company. If any Option granted under the Plan shall expire or
terminate for any reason without having been exercised in full or shall cease
for any reason to be exercisable in whole or in part or shall be repurchased by
the Company, the shares subject to such Option shall be included in the
determination of the aggregate number of shares of Common Stock deemed to have
been granted to such employee under the Plan.
5. GRANTING OF STOCK RIGHTS. Stock Rights may be granted under the Plan
at any time on or after October 16, 1997 and prior to October 15, 2007. The date
of grant of a Stock Right under the Plan will be the date specified by the
Committee at the time it grants the Stock Right; provided, however, that such
date shall not be prior to the date on which the Committee acts to approve the
grant.
6. MINIMUM OPTION PRICE; ISO LIMITATIONS.
A. PRICE FOR NON-QUALIFIED OPTIONS, AWARDS AND PURCHASES. Subject to
paragraph 2(D) (relating to compliance with Section 162(m) of the Code),
the exercise price per share specified in the agreement relating to each
Non-Qualified Option granted, and the purchase price per share of stock
granted in any Award or authorized as a Purchase, under the Plan may be
less than the fair market value of the Common Stock of the Company on the
date of grant; provided that, in no event shall such exercise price or such
purchase price be less than the lesser of (i) the book value per share of
Common Stock as of the end of the fiscal year of the Company immediately
preceding the date of such grant, or (ii) 50 percent of the fair market
value per share of Common Stock on the date of such grant.
B. PRICE FOR ISOS. The exercise price per share specified in the
agreement relating to each ISO granted under the Plan shall not be less
than the fair market value per share of Common Stock on the date of such
grant. In the case of an ISO to be granted to an employee owning stock
possessing more than ten percent (10%) of the total combined voting power
of all classes of stock of the Company or any Related Corporation, the
price per share specified in the agreement relating to such ISO shall not
be less
3
<PAGE> 4
than one hundred ten percent (110%) of the fair market value per share of
Common Stock on the date of grant. For purposes of determining stock
ownership under this paragraph, the rules of Section 424(d) of the Code
shall apply.
C. $100,000 ANNUAL LIMITATION ON ISO VESTING. Each eligible employee
may be granted Options treated as ISOs only to the extent that, in the
aggregate under this Plan and all incentive stock option plans of the
Company and any Related Corporation, ISOs do not become exercisable for the
first time by such employee during any calendar year with respect to stock
having a fair market value (determined at the time the ISOs were granted)
in excess of $100,000. The Company intends to designate any Options granted
in excess of such limitation as Non-Qualified Options, and the Company
shall issue separate certificates to the optionee with respect to Options
that are Non-Qualified Options and Options that are ISOs.
D. DETERMINATION OF FAIR MARKET VALUE. If, at the time an Option is
granted under the Plan, the Company's Common Stock is publicly traded,
"fair market value" shall be determined as of the date of grant or, if the
prices or quotes discussed in this sentence are unavailable for such date,
the last business day for which such prices or quotes are available prior
to the date of grant and shall mean (i) the average (on that date) of the
high and low prices of the Common Stock on the principal national
securities exchange on which the Common Stock is traded, if the Common
Stock is then traded on a national securities exchange; or (ii) the last
reported sale price (on that date) of the Common Stock on the Nasdaq
National Market, if the Common Stock is not then traded on a national
securities exchange; or (iii) the closing bid price (or average of bid
prices) last quoted (on that date) by an established quotation service for
over-the-counter securities, if the Common Stock is not reported on the
Nasdaq National Market. If the Common Stock is not publicly traded at the
time an Option is granted under the Plan, "fair market value" shall mean
the fair value of the Common Stock as determined by the Committee after
taking into consideration all factors which it deems appropriate,
including, without limitation, recent sale and offer prices of the Common
Stock in private transactions negotiated at arm's length.
7. OPTION DURATION. Subject to earlier termination as provided in
paragraphs 9 and 10 or in the agreement relating to such Option, each Option
shall expire on the date specified by the Committee, but not more than (i) ten
years from the date of grant in the case of Options generally and (ii) five
years from the date of grant in the case of ISOs granted to an employee owning
stock possessing more than ten percent (10%) of the total combined voting power
of all classes of stock of the Company or any Related Corporation, as determined
under paragraph 6(B). Subject to earlier termination as provided in paragraphs 9
and 10, the term of each ISO shall be the term set forth in the original
instrument granting such ISO, except with respect to any part of such ISO that
is converted into a Non-Qualified Option pursuant to paragraph 16.
8. EXERCISE OF OPTION. Subject to the provisions of paragraphs 9 through
12, each Option granted under the Plan shall be exercisable as follows:
A. VESTING. The Option shall either be fully exercisable on the date
of grant or shall become exercisable thereafter in such installments as the
Committee may specify.
B. FULL VESTING OF INSTALLMENTS. Once an installment becomes
exercisable, it shall remain exercisable until expiration or termination of
the Option, unless otherwise specified by the Committee.
C. PARTIAL EXERCISE. Each Option or installment may be exercised at
any time or from time to time, in whole or in part, for up to the total
number of shares with respect to which it is then exercisable.
D. ACCELERATION OF VESTING. The Committee shall have the right to
accelerate the date that any installment of any Option becomes exercisable;
provided that the Committee shall not, without the consent of an optionee,
accelerate the permitted exercise date of any installment of any Option
granted to
4
<PAGE> 5
any employee as an ISO (and not previously converted into a Non-Qualified
Option pursuant to paragraph 16) if such acceleration would violate the
annual vesting limitation contained in Section 422(d) of the Code, as
described in paragraph 6(C).
9. TERMINATION OF EMPLOYMENT. Unless otherwise specified in the agreement
relating to such ISO, if an ISO optionee ceases to be employed by the Company
and all Related Corporations other than by reason of death or disability as
defined in paragraph 10, no further installments of his or her ISOs shall become
exercisable, and his or her ISOs shall terminate after the passage of 60 days
from the date of termination of his or her employment, but in no event later
than on the specified expiration dates of such ISOs, except to the extent that
such ISOs (or unexercised installments thereof) have been converted into
Non-Qualified Options pursuant to paragraph 16. For purposes of this paragraph
9, a leave of absence with the written approval of the Committee shall not be
considered an interruption of employment under the Plan, provided that such
written approval contractually obligates the Company or any Related Corporation
to continue the employment of the employee after the approved period of absence.
Employment shall also be considered as continuing uninterrupted during any other
bona fide leave of absence (such as those attributable to illness, military
obligations or governmental service) provided that the period of such leave does
not exceed 90 days or, if longer, any period during which such optionee's right
to reemployment is guaranteed by statute or by contract. A bona fide leave of
absence with the written approval of the Committee shall not be considered an
interruption of employment under this paragraph 9, provided that such written
approval contractually obligates the Company or any Related Corporation to
continue the employment of the optionee after the approved period of absence.
ISOs granted under the Plan shall not be affected by any change of employment
within or among the Company and Related Corporations, so long as the optionee
continues to be an employee of the Company or any Related Corporation. Nothing
in the Plan shall be deemed to give any grantee of any Stock Right the right to
be retained in employment or other service by the Company or any Related
Corporation for any period of time.
10. DEATH; DISABILITY.
A. DEATH. If an ISO optionee ceases to be employed by the Company
and all Related Corporations by reason of his or her death, any ISO owned
by such optionee may be exercised, to the extent otherwise exercisable on
the date of death, by the estate, personal representative or beneficiary
who has acquired the ISO by will or by the laws of descent and
distribution, at any time prior to the earlier of (i) the specified
expiration date of the ISO or (ii) 180 days from the date of the optionee's
death.
B. DISABILITY. If an ISO optionee ceases to be employed by the
Company and all Related Corporations by reason of his or her disability,
such optionee shall have the right to exercise any ISO held by him or her
on the date of termination of employment, for the number of shares for
which he or she could have exercised it on that date, at any time prior to
the earlier of (i) the specified expiration date of the ISO or (ii) 180
days from the date of the termination of the optionee's employment. For the
purposes of the Plan, the term "disability" shall mean "permanent and total
disability" as defined in Section 22(e)(3) of the Code or any successor
statute.
11. ASSIGNABILITY. No ISO shall be assignable or transferable by the
optionee except by will or by the laws of descent and distribution, and during
the lifetime of the optionee shall be exercisable only by such optionee. Stock
Rights other than ISOs shall be transferable to the extent set forth in the
agreement relating to such Stock Right.
12. TERMS AND CONDITIONS OF OPTIONS. Options shall be evidenced by
instruments (which need not be identical) in such forms as the Committee may
from time to time approve. Such instruments shall conform to the terms and
conditions set forth in paragraphs 6 through 11 hereof and may contain such
other provisions as the Committee deems advisable which are not inconsistent
with the Plan, including restrictions applicable to
5
<PAGE> 6
shares of Common Stock issuable upon exercise of Options. The Committee may
specify that any Non-Qualified Option shall be subject to the restrictions set
forth herein with respect to ISOs, or to such other termination and cancellation
provisions as the Committee may determine. The Committee may from time to time
confer authority and responsibility on one or more of its own members and/or one
or more officers of the Company to execute and deliver such instruments. The
proper officers of the Company are authorized and directed to take any and all
action necessary or advisable from time to time to carry out the terms of such
instruments.
13. ADJUSTMENTS. Upon the occurrence of any of the following events, an
optionee's rights with respect to Options granted to such optionee hereunder
shall be adjusted as hereinafter provided, unless otherwise specifically
provided in the written agreement between the optionee and the Company relating
to such Option:
A. STOCK DIVIDENDS AND STOCK SPLITS. If the shares of Common Stock
shall be subdivided or combined into a greater or smaller number of shares
or if the Company shall issue any shares of Common Stock as a stock
dividend on its outstanding Common Stock, the number of shares of Common
Stock deliverable upon the exercise of Options shall be appropriately
increased or decreased proportionately, and appropriate adjustments shall
be made in the purchase price per share to reflect such subdivision,
combination or stock dividend.
B. CONSOLIDATIONS OR MERGERS. If the Company is to be consolidated
with or acquired by another entity in a merger or other reorganization in
which the holders of the outstanding voting stock of the Company
immediately preceding the consummation of such event, shall, immediately
following such event, hold, as a group, less than a majority of the voting
securities of the surviving or successor entity, or in the event of a sale
of all or substantially all of the Company's assets or otherwise (each, an
"Acquisition"), the Committee may take one or more of the following
actions: (i) provide for the acceleration and/or termination of any time
period relating to the exercise of the Options, (ii) provide for the
purchase of the Options, upon the optionee's request, for the amount in
cash that could have been received upon the exercise of the Options and
sale of the shares obtained thereby, (iii) adjust the terms of the Options
in a manner determined by the Committee, (iv) cause the Options to be
assumed, or new rights substituted therefor, by another entity or (v) make
such other provision as the Committee may consider equitable and in the
best interests of the Company.
C. RECAPITALIZATION OR REORGANIZATION. In the event of a
recapitalization or reorganization of the Company (other than a transaction
described in subparagraph B above) pursuant to which securities of the
Company or of another corporation are issued with respect to the
outstanding shares of Common Stock, an optionee upon exercising an Option
shall be entitled to receive for the purchase price paid upon such exercise
the securities he or she would have received if he or she had exercised
such Option prior to such recapitalization or reorganization.
D. MODIFICATION OF ISOS. Notwithstanding the foregoing, any
adjustments made pursuant to subparagraphs A, B or C with respect to ISOs
shall be made only after the Committee, after consulting with counsel for
the Company, determines whether such adjustments would constitute a
"modification" of such ISOs (as that term is defined in Section 424 of the
Code) or would cause any adverse tax consequences for the holders of such
ISOs. If the Committee determines that such adjustments made with respect
to ISOs would constitute a modification of such ISOs or would cause adverse
tax consequences to the holders, it may refrain from making such
adjustments.
E. RESTRICTED SECURITIES. If any person or entity owning restricted
Common Stock obtained by exercise of an Option made hereunder receives new
or additional or different shares or securities ("New Securities") in
connection with a transaction described in subparagraphs A, B or C above,
as a result of owning such restricted Common Stock, such New Securities
shall be subject to all of the conditions and
6
<PAGE> 7
restrictions applicable to the restricted Common Stock with respect to
which such New Securities were issued.
F. ISSUANCES OF SECURITIES. Except as expressly provided herein, no
issuance by the Company of shares of stock of any class, or securities
convertible into shares of stock of any class, shall affect, and no
adjustment by reason thereof shall be made with respect to, the number or
price of shares subject to Options. No adjustments shall be made for
dividends paid in cash or in property other than securities of the Company.
G. FRACTIONAL SHARES. No fractional shares shall be issued under the
Plan. Any fractional shares which, but for this subparagraph G, would have
been issued to an optionee pursuant to an Option, shall be deemed to have
been issued and immediately sold to the Company for their fair market
value, and the optionee shall receive from the Company cash in lieu of such
fractional shares.
H. ADJUSTMENTS. Upon the happening of any of the events described in
subparagraphs A, B or C above, the class and aggregate number of shares set
forth in paragraph 4 hereof that are subject to Stock Rights which
previously have been or subsequently may be granted under the Plan shall
also be appropriately adjusted to reflect the events described in such
subparagraphs. The Committee shall determine the specific adjustments to be
made under this paragraph 13 and, subject to paragraph 2, its determination
shall be conclusive.
14. MEANS OF EXERCISING OPTIONS. An Option (or any part or installment
thereof) shall be exercised by giving written notice to the Company at its
principal office address, or to such transfer agent as the Company shall
designate. Such notice shall identify the Option being exercised and specify the
number of shares as to which such Option is being exercised, accompanied by full
payment of the purchase price therefor either (a) in United States dollars in
cash or by check, (b) at the discretion of the Committee, through delivery of
shares of Common Stock having a fair market value equal as of the date of the
exercise to the cash exercise price of the Option, (c) at the discretion of the
Committee, by delivery of the optionee's personal recourse note bearing interest
payable not less than annually at no less than 100% of the lowest applicable
Federal rate, as defined in Section 1274(d) of the Code, (d) at the discretion
of the Committee and consistent with applicable law, through the delivery of an
assignment to the Company of a sufficient amount of the proceeds from the sale
of the Common Stock acquired upon exercise of the Option and an authorization to
the broker or selling agent to pay that amount to the Company, which sale shall
be at the participant's direction at the time of exercise, or (e) at the
discretion of the Committee, by any combination of (a), (b), (c) and (d) above.
If the Committee exercises its discretion to permit payment of the exercise
price of an ISO by means of the methods set forth in clauses (b), (c), (d) or
(e) of the preceding sentence, such discretion shall be exercised in writing at
the time of the grant of the ISO in question. The holder of an Option shall not
have the rights of a shareholder with respect to the shares covered by such
Option until the date of issuance of a stock certificate to such holder for such
shares. Except as expressly provided above in paragraph 13 with respect to
changes in capitalization and stock dividends, no adjustment shall be made for
dividends or similar rights for which the record date is before the date such
stock certificate is issued.
15. TERM AND AMENDMENT OF PLAN. This Plan was adopted by the Board in
July 1997 and by the stockholders of the Company on September 9, 1997. The Plan
was amended on March 12, 1998 to increase the number of shares authorized for
issuance under the Plan by 750,000 shares to 1,500,000, and such amendment was
approved by the stockholders of the Company at the Annual Meeting held on April
30, 1998. On March 1, 1999, the Board of Directors further amended the Plan to
increase the number of shares authorized for issuance under the Plan by
1,000,000 shares to 2,500,000 shares and to make certain other minor
modifications, subject to approval of the amendment of the Plan by the
stockholders of the Company at the next Meeting of Stockholders. If the approval
of the amendment by the stockholders is not obtained prior
7
<PAGE> 8
to March 1, 2000, any grants of ISOs under the Plan which include shares from
the additional number of shares authorized by the amendment made prior to that
date but subsequent to the date of the amendment will be rescinded. The Plan
shall expire at the end of the day on October 15, 2007 (except as to Options
outstanding on that date). Subject to the provisions of paragraph 5 above,
Options may be granted under the Plan prior to the date of stockholder approval
of the Plan. The Board may terminate or amend the Plan in any respect at any
time, except that, without the approval of the stockholders obtained within 12
months before or after the Board adopts a resolution authorizing any of the
following actions: (a) the total number of shares that may be issued under the
Plan may not be increased (except by adjustment pursuant to paragraph 13); (b)
the provisions of paragraph 3 regarding eligibility for grants of ISOs may not
be modified; (c) the provisions of paragraph 6(B) regarding the exercise price
at which shares may be offered pursuant to ISOs may not be modified (except by
adjustment pursuant to paragraph 13); and (d) the expiration date of the Plan
may not be extended. Except as otherwise provided in this paragraph 15, in no
event may action of the Board or stockholders alter or impair the rights of a
grantee, without such grantee's consent, under any Stock Right previously
granted to such grantee.
16. MODIFICATIONS OF ISOS; CONVERSION OF ISOS INTO NON-QUALIFIED
OPTIONS. Subject to paragraph 13(D), without the prior written consent of the
holder of an ISO, the Committee shall not alter the terms of such ISO (including
the means of exercising such ISO) if such alteration would constitute a
modification (within the meaning of Section 424(h)(3) of the Code). The
Committee, at the written request or with the written consent of any optionee,
may in its discretion take such actions as may be necessary to convert such
optionee's ISOs (or any installments or portions of installments thereof) that
have not been exercised on the date of conversion into Non-Qualified Options at
any time prior to the expiration of such ISOs, regardless of whether the
optionee is an employee of the Company or a Related Corporation at the time of
such conversion. Such actions may include, but shall not be limited to,
extending the exercise period of such ISOs. At the time of such conversion, the
Committee (with the consent of the optionee) may impose such conditions on the
exercise of the resulting Non-Qualified Options as the Committee in its
discretion may determine, provided that such conditions shall not be
inconsistent with this Plan. Nothing in the Plan shall be deemed to give any
optionee the right to have such optionee's ISOs converted into Non-Qualified
Options, and no such conversion shall occur until and unless the Committee takes
appropriate action. Upon the taking of such action, the Company shall issue
separate certificates to the optionee with respect to Options that are
Non-Qualified Options and Options that are ISOs. The Committee, with the consent
of the optionee, may also terminate any portion of any ISO that has not been
exercised at the time of such conversion.
17. APPLICATION OF FUNDS. The proceeds received by the Company from the
sale of shares pursuant to Options granted and Purchases authorized under the
Plan shall be used for general corporate purposes.
18. NOTICE TO COMPANY OF DISQUALIFYING DISPOSITION. By accepting an ISO
granted under the Plan, each optionee agrees to notify the Company in writing
immediately after such optionee makes a Disqualifying Disposition (as described
in Sections 421, 422 and 424 of the Code and regulations thereunder) of any
stock acquired pursuant to the exercise of ISOs granted under the Plan. A
Disqualifying Disposition is generally any disposition occurring on or before
the later of (a) the date two years following the date the ISO was granted or
(b) the date one year following the date the ISO was exercised.
19. WITHHOLDING OF ADDITIONAL INCOME TAXES. Upon the exercise of a
Non-Qualified Option, the transfer of a Non-Qualified Stock Option pursuant to
an arm's-length transaction, the grant of an Award, the making of a Purchase of
Common Stock for less than its fair market value, the making of a Disqualifying
Disposition (as defined in paragraph 18), the vesting or transfer of restricted
stock or securities acquired on the exercise of an Option hereunder, or the
making of a distribution or other payment with respect to such stock or
securities, the Company may withhold, or may require the grantee to pay,
additional withholding taxes in respect of amounts that constitute compensation
includible in gross income. The Committee in its
8
<PAGE> 9
discretion may condition (i) the exercise of an Option, (ii) the transfer of a
Non-Qualified Stock Option, (iii) the grant of an Award, (iv) the making of a
Purchase of Common Stock for less than its fair market value, or (v) the vesting
or transferability of restricted stock or securities acquired by exercising an
Option, on the grantee's making satisfactory arrangement for such withholding.
Such arrangement may include payment by the grantee in cash or by check of the
amount of the withholding taxes or, at the discretion of the Committee, by the
grantee's delivery of previously held shares of Common Stock or the withholding
from the shares of Common Stock otherwise deliverable upon exercise of a Option
shares having an aggregate fair market value equal to the amount of such
withholding taxes.
20. GOVERNMENTAL REGULATION. The Company's obligation to sell and deliver
shares of the Common Stock under this Plan is subject to the approval of any
governmental authority required in connection with the authorization, issuance
or sale of such shares. Government regulations may impose reporting or other
obligations on the Company with respect to the Plan. For example, the Company
may be required to send tax information statements to employees and former
employees that exercise ISOs under the Plan, and the Company may be required to
file tax information returns reporting the income received by grantees of
Options in connection with the Plan.
21. GOVERNING LAW. The validity and construction of the Plan and the
instruments evidencing Stock Rights shall be governed by the laws of the
Commonwealth of Massachusetts, or the laws of any jurisdiction in which the
Company or its successors in interest may be organized.
9
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<EXCHANGE-RATE> 1
<CASH> 7,913
<SECURITIES> 51,103
<RECEIVABLES> 7,706
<ALLOWANCES> 590
<INVENTORY> 0
<CURRENT-ASSETS> 608
<PP&E> 6,793
<DEPRECIATION> 2,024
<TOTAL-ASSETS> 71,508
<CURRENT-LIABILITIES> 17,153
<BONDS> 0
0
0
<COMMON> 73,525
<OTHER-SE> (19,170)
<TOTAL-LIABILITY-AND-EQUITY> 71,508
<SALES> 22,857
<TOTAL-REVENUES> 28,590
<CGS> 1,045
<TOTAL-COSTS> 3,525
<OTHER-EXPENSES> 18,131
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,456
<INCOME-PRETAX> 8,390
<INCOME-TAX> 3,188
<INCOME-CONTINUING> 5,202
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,202)
<EPS-BASIC> .36
<EPS-DILUTED> .36
</TABLE>
