<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the quarterly period ended September 30, 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
14,351,553 SHARES OF THE REGISTRANT'S COMMON STOCK, $0.01 PAR VALUE, WERE
OUTSTANDING AS OF OCTOBER 31, 1999.
THIS DOCUMENT CONTAINS 24 PAGES.
THE EXHIBIT INDEX IS ON PAGE 23.
<PAGE> 2
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 1999
CONTENTS
Item Number Page
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Balance sheets:
September 30, 1999 and December 31, 1998 3
Statements of operations:
Three and nine months ended September 30, 1999 and
September 30, 1998 4
Statements of cash flows:
Nine months ended September 30, 1999 and September 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 19
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 2. Changes in Securities and Use of Proceeds 20
Item 3. Defaults Upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURE 22
EXHIBIT INDEX 23
2
<PAGE> 3
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONCORD COMMUNICATIONS, INC.
BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents .......................... $ 6,181,221 $11,164,349
Marketable securities .............................. 54,523,521 39,237,680
Accounts receivable, net of allowance of
approximately $660,000 and $450,000, respectively . 9,838,566 5,048,879
Prepaid expenses and other current assets .......... 910,159 509,805
----------- -----------
Total current assets ............................. 71,453,467 55,960,713
----------- -----------
Equipment and Improvements, at cost:
Equipment .......................................... 6,057,544 3,701,266
Leasehold improvements ............................. 2,926,921 385,128
----------- -----------
8,984,465 4,086,394
Less-- Accumulated depreciation and amortization .. 2,573,843 1,365,222
----------- -----------
6,410,622 2,721,172
----------- -----------
$77,864,089 $58,681,885
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable.................................... $ 3,437,644 $ 3,553,673
Accrued expenses.................................... 7,231,241 4,086,983
Deferred revenue.................................... 7,520,716 5,296,469
----------- -----------
Total current liabilities................... 18,189,601 12,937,125
----------- -----------
Stockholders' Equity:
Preferred stock, $.01 par value --
Authorized -- 1,000,000 shares
no shares issued or outstanding
Common stock, $.01 par value -- -- --
Authorized -- 50,000,000 shares
Issued and outstanding -- 13,484,031 and
13,040,374 shares, respectively.................... 134,677 130,405
Additional paid-in capital...................... 76,383,071 69,938,129
Deferred compensation........................... (65,213) (101,189)
Accumulated other comprehensive income.......... (875,806) 149,606
Accumulated deficit............................. (15,902,241) (24,372,191)
----------- -----------
Total stockholders' equity ................. 59,674,488 45,744,760
----------- -----------
$77,864,089 $58,681,885
=========== ===========
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 NINE MONTHS ENDED
---------------------------- ----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
Revenues:
<S> <C> <C> <C> <C>
License revenues........... $13,085,991 $ 8,871,444 $35,943,156 $22,076,035
Service revenues........... 3,930,607 1,724,165 9,663,289 4,120,085
----------- ----------- ----------- -----------
Total revenues............ 17,016,598 10,595,609 45,606,445 26,196,120
Cost of Revenues............ 2,302,878 1,199,744 5,827,347 3,052,002
----------- ----------- ----------- -----------
Gross profit.............. 14,713,720 9,395,865 39,779,098 23,144,118
----------- ----------- ----------- -----------
Operating Expenses:
Research and development... 2,887,207 1,871,055 7,513,001 5,086,423
Sales and marketing........ 6,332,727 4,647,777 18,239,826 12,093,884
General and administrative. 1,008,919 778,287 2,607,285 1,945,105
----------- ----------- ----------- -----------
Total operating expenses... 10,228,853 7,297,119 28,360,112 19,125,412
----------- ----------- ----------- -----------
Operating income.......... 4,484,867 2,098,746 11,418,986 4,018,705
----------- ----------- ----------- -----------
Other Income (Expense):
Interest income............ 802,488 572,814 2,267,940 1,677,628
Interest expense........... -- -- -- (514)
Other...................... (11,920) (14,919) (20,975) (54,460)
----------- ----------- ----------- -----------
Total other income........ 790,568 557,895 2,246,964 1,622,654
----------- ----------- ----------- -----------
Income before income taxes 5,275,435 2,656,641 13,665,590 5,641,359
Provision for income taxes. 2,008,000 213,800 5,196,000 213,800
----------- ----------- ----------- -----------
Net income................ $ 3,267,435 $ 2,442,841 $ 8,469,950 $ 5,427,559
=========== =========== =========== ===========
Net income per common and
potential common share:
Basic $ 0.24 $ 0.19 $ 0.64 $ 0.43
=========== =========== =========== ===========
Diluted $ 0.23 $ 0.17 $ 0.59 $ 0.39
=========== =========== =========== ===========
Weighted average common and
potential common shares
outstanding:
Basic 13,458,074 12,790,004 13,320,566 12,526,567
=========== =========== =========== ===========
Diluted 14,307,794 14,135,361 14,314,721 14,018,940
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 5
CONCORD COMMUNICATIONS, INC.
STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
--------------------------
SEPTEMBER 30, SEPTEMBER 30,
1999 1998
------------ -----------
Cash Flows from Operating Activities:
Net income $ 8,469,950 $ 5,427,559
Adjustments to reconcile net income to net cash
provided by operations:
Depreciation and amortization 219,185 757,354
Changes in current assets and liabilities:
Accounts receivable (4,789,687) (1,364,943)
Prepaid expenses and other current assets (400,354) (414,332)
Accounts payable (116,029) 1,797,488
Accrued expenses 3,144,258 (236,618)
Deferred revenue 2,224,247 1,942,600
------------ -----------
Net cash provided by operating activities 8,751,570 7,909,108
------------ -----------
Cash Flows from Investing Activities:
Purchases of marketable securities (184,753,484) (29,550,566)
Sales of marketable securities 169,467,643 21,066,337
Purchases of equipment and improvements (4,898,071) (949,914)
------------ -----------
Net cash used in investing activities (20,183,912) (9,434,143)
------------ -----------
Cash Flows from Financing Activities:
Proceeds from exercise of stock options 6,449,214 741,854
------------ -----------
Net Decrease in Cash and Cash Equivalents (4,983,128) (783,181)
Cash and Cash Equivalents, beginning of period 11,164,349 7,858,186
------------ -----------
Cash and Cash Equivalents, end of period $ 6,181,221 $ 7,075,005
============ ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid for taxes $ 226,180 $ --
============ ===========
Supplemental Disclosure of Noncash Transactions:
Unrealized (loss) gain on available-for-sale $ (1,025,412) $ 316,317
============ ===========
Tax benefit associated with employee stock options $ 5,000,000 $ --
============ ===========
Retirement of fully depreciated fixed assets $ -- $ 4,330,000
============ ===========
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 6
CONCORD COMMUNICATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
FORM 10-Q, SEPTEMBER 30, 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 September 30, 1999 and December 31, 1998, and results of operations for the
three and nine months ended September 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 nine months ended September 30, 1999 and September 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net income $ 3,267,435 $ 2,442,841 $ 8,469,950 $ 5,427,559
=========== =========== =========== ===========
Weighted average common shares outstanding 13,458,074 12,790,004 13,320,566 12,526,567
Potential common shares pursuant to stock options 849,720 1,345,357 994,155 1,492,373
----------- ----------- ----------- -----------
Diluted weighted average shares 14,307,794 14,135,361 14,314,721 14,018,940
=========== =========== =========== ===========
Basic net income per common share $ 0.24 $ 0.19 $ 0.64 $ 0.43
=========== =========== =========== ===========
Diluted net income per common
and potential common share $ 0.23 $ 0.17 $ 0.59 $ 0.39
=========== =========== =========== ===========
</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 nine months ended
September 30, 1999 and 1998 is as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net income $3,267,435 $2,442,841 $8,469,950 $5,427,559
Unrealized (loss) gain
on marketable securities (142,261) 298,924 (1,025,412) 325,317
---------- ---------- ---------- ----------
Comprehensive income $3,125,174 $2,741,765 $7,444,538 $5,752,876
========== ========== ========== ==========
</TABLE>
6
<PAGE> 7
4. COMMITMENTS
In March, 1999 the Company signed a 7 year operating lease for its principal
operating facilities. Aggregate rental payments under the lease will be $12.0
million. Following the abandonment of the Company's existing office space, the
Company recorded a third quarter charge of $700,000, representing the
remaining lease commitment, less expected sublease income.
5. TAX PROVISION
The Company has recorded a tax provision of $5.2 million in the nine months
ended September 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 $5.0 million) as a component of additional paid in
capital.
6. ACQUISITION OF EMPIRE TECHNOLOGIES
On October 19, 1999, Concord Communications, Inc., a Massachusetts
corporation ("Concord" or the "Company"), entered into an Agreement and Plan of
Reorganization (the "Merger Agreement") providing for the merger (the "Merger")
of E Acquisition Corp., a Georgia corporation and wholly-owned subsidiary of
the Company ("Merger Sub") with and into Empire Technologies, Inc. ("Empire").
the merger was effected on October 29, 1999 (the "Effective Date") pursuant to
a Certificate of Merger filed with the Secretary of State of the State of
Georgia on that date. Pursuant to the Merger Agreement, at the effective time
of the Merger, each issued and outstanding share of the common stock, no par
value per share, of Empire (the "Empire Common Stock") was converted into
815,248 shares (the "Conversion Ratio") of the common stock, $.01 par value per
share, of the Company (the "Concord Common Stock"). Since there were 1,000
outstanding shares of Empire Common Stock immediately prior to the effective
time of the Merger, Concord issued an aggregate of 815,248 shares of Concord
Common Stock to the stockholders of Empire in the Merger in a private placement
transaction pursuant to Section 4(2) under the Securities Act of 1933. Empire is
a leading provider of solutions for proactive self-management of UNIX and
Windows NT systems, as well as mission-critical applications. The merger was
accounted for as a pooling of interests. Because the acquisition occurred after
September 30, 1999, the financial statements herein do not reflect the
restatement of the Company's historical statements. The following table sets
forth certain proforma statement of operations data as if the combination had
occurred on September 30, 1999:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
Revenue
<S> <C> <C> <C> <C>
Concord Communications, Inc. $17,016,598 $10,595,609 $45,606,445 $26,196,120
Empire Technologies, Inc. 1,324,877 591,559 2,580,802 1,435,753
----------- ----------- ----------- -----------
Total $18,341,475 $17,608,157 $48,187,247 $27,631,873
=========== =========== =========== ===========
Net Income
Concord Communications, Inc. $ 3,400,595 $ 2,442,841 $ 8,603,110 $ 5,427,559
Empire Technologies, Inc. 319,640 149,379 735,197 1,112,006
----------- ----------- ----------- -----------
Total $ 3,720,235 $ 2,592,220 $ 9,338,307 $ 6,539,565
=========== =========== =========== ===========
Net income per common and
potential common share:
Basic $ 0.26 $ 0.19 $ 0.66 $ 0.49
=========== =========== =========== ===========
Diluted $ 0.25 $ 0.17 $ 0.62 $ 0.44
=========== =========== =========== ===========
Weighted average common and
potential common shares
outstanding:
Basic 14,273,322 13,605,252 14,135,814 13,341,815
=========== =========== =========== ===========
Diluted 15,123,042 14,950,609 15,129,969 14,834,188
=========== =========== =========== ===========
</TABLE>
7
<PAGE> 8
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 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 NINE MONTHS ENDED
------------------------------ ------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
Revenues:
<S> <C> <C> <C> <C>
License revenues 76.9% 83.7% 78.8% 84.3%
Service revenues 23.1% 16.3% 21.2% 15.7%
---- ---- ---- ----
Total revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 13.5% 11.3% 12.8% 11.7%
---- ---- ---- ----
Gross profit 86.5% 88.7% 87.2% 88.3%
Operating expenses:
Research and development 17.0% 17.7% 16.5% 19.4%
Sales and marketing 37.2% 43.9% 40.0% 46.2%
General and administrative 5.9% 7.3% 5.7% 7.4%
---- ---- ---- ----
Income from operations 26.4% 19.8% 25.0% 15.3%
---- ---- ---- ----
Other income, net 4.6% 5.3% 5.0% 6.2%
---- ---- ---- ----
Income before income taxes 31.0% 25.1% 30.0% 21.5%
---- ---- ---- ----
Provision for income taxes 11.8% 2.0% 11.4% 0.8%
---- ---- ---- ----
Net income 19.2% 23.1% 18.6% 20.7%
---- ---- ---- ----
</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 $2.2
million of revenues from international locations in the three months ended
September 30, 1999 and 1998, representing 16.7% and 20.5% of total revenues,
respectively. The Company recognized $7.8 million and $4.6 million of revenues
from international locations in the nine months ended September 30, 1999 and
1998, representing 17.2% and 17.5% 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 13.2% and 14.3% of total revenues in the three months ended September 30,
1999 and 1998, respectively. Revenues from customers located in Europe accounted
for 13.6% and 12.6% of total revenues in the nine months ended September 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 60.6% to $17.0
million in the three months ended September 30, 1999 from $10.6 million in the
three months ended September 30, 1998. The Company's total revenues increased
74.1% to $45.6 million in the nine months ended September 30, 1999 from $26.2
million in the nine months ended September 30, 1998.
LICENSE REVENUES. The Company's license revenues are derived from the
licensing of software products. License revenues increased 67.8% to $13.1
million, or 76.9% of total revenues, in the three months ended September 30,
1999 from $8.9 million, or 83.7% of total revenues, in the three months ended
September 30, 1998. License revenues increased 62.8% to $35.9 million, or 78.8%
of total revenues, in the nine months ended September 30, 1999 from $22.1
million, or 84.3% of total revenues, in the nine months ended September 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
128.0% to $3.9 million, or 23.1% of total revenues, in the three months ended
September 30, 1999 from $1.7 million, or 16.3% of total revenues, in the three
months ended September 30, 1998. Service revenues increased 134.5% to $9.7
million, or 21.2% of total revenues, in the nine months ended September 30, 1999
from $4.1 million, or 15.7% of total revenues, in the nine months ended
September 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 91.9% to $2.3 million, or 13.5% of
total revenues, in the three months ended September 30, 1999 from $1.2 million,
or 11.3% of total revenues, in the three months ended September 30, 1998,
resulting in gross margins of 86.5% and 88.7% in each respective period. Cost of
revenues increased 90.9% to $5.8 million, or 12.8% of total revenues, in the
nine months ended September 30, 1999 from $3.1 million, or 11.7% of total
revenues, in the nine months ended September 30, 1998, resulting in gross
margins of 87.2% and 88.3% in each respective period. The increase in cost of
revenues 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 54.3% to $2.9 million, or 17.0% of total
9
<PAGE> 10
revenues, in the three months ended September 30, 1999 from $1.9 million, or
17.7% of total revenues, in the three months ended September 30, 1998. Research
and development expenses increased 47.7% to $7.5 million, or 16.5% of total
revenues, in the nine months ended September 30, 1999 from $5.1 million, or
19.4% of total revenues, in the nine months ended September 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 48 to 65 for the period from September 30, 1998 to September
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 36.3% to $6.3 million, or 37.2% of total
revenues, in the three months ended September 30, 1999 from $4.6 million, or
43.9% of total revenues, in the three months ended September 30, 1998. Sales and
marketing expenses increased 50.8% to $18.2 million, or 40.0% of total revenues,
in the nine months ended September 30, 1999 from $12.1 million, or 46.2% of
total revenues, in the nine months ended September 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 62 to 103 people from
September 30, 1998 to September 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 29.6% to $1.0 million, or 5.9% of
total revenues, in the three months ended September 30, 1999 from $778,000, or
7.3% of total revenues, in the three months ended September 30, 1998. General
and administrative expenses increased 34.0% to $2.6 million, or 5.7% of total
revenues, in the nine months ended September 30, 1999 from $1.9 million, or 7.4%
of total revenues, in the nine months ended September 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 18
people from September 30, 1998 to September 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 $790,000 for the three
months ended September 30, 1999 and net other income of $558,000 for the three
months ended September 30, 1998. The Company had net other income of $2.2
million for the nine months ended September 30, 1999 and net other income of
$1.6 million for the nine months ended September 30, 1998. The increase in net
other income is attributed to the investment of cashflows from the Company's
operations.
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 $53.3 million at September 30,
1999.
Net cash provided by operating activities was $8.8 million and $7.9 million
for the nine months ended September 30, 1999 and 1998, respectively. Cash, cash
equivalents and marketable securities were $60.7 million and $44.6 million at
September 30, 1999 and 1998, respectively. Deferred revenues increased for the
nine months ended September 30, 1999 by $2.2 million due to an increase in
overall sales activity; the increase consisted of $2.5 million from deferred
maintenance contracts and a decrease of $318,000 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
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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 nine months ended September 30, 1999 and 1998.
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
$8.9 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 $5.0 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 September 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 September 30, 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
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products, its internal systems and applications or the systems of its third
party suppliers and service providers to properly operate or manage data beyond
1999.
NETWORK HEALTH PRODUCT. In 1997, the Company initiated the necessary
development to ensure Year 2000 compliance in the Network Health family of
applications and believes it has achieved Year 2000 compliance in Network Health
4.1, which was released in August 1998. The Company's existing customers can
receive this release 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 100% 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.
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CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
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 September 30,
1999, the Company had accumulated net losses of $14.0 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 $5.2 million in the nine months
ended September 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
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focused on annual sales goals, revenues in the Company's fourth quarter could be
higher than revenues in the first quarter of the succeeding year. There also may
be other factors that significantly affect the Company's quarterly results which
are difficult to predict given the Company's limited operating history, such as
seasonality and the timing of receipt and delivery of orders within a fiscal
quarter.
Consistent with software industry practice, the Company expects to operate
with a limited amount of backlog. As a result, quarterly sales and operating
results depend generally on the volume and timing of orders within the quarter,
the tendency of sales to occur late in fiscal quarters and the ability of the
Company to fill orders received within the quarter, all of which are difficult
to forecast and manage. The Company's expense levels are based in part on its
expectations of future orders and sales, which, given the Company's limited
operating history, are extremely difficult to predict. A substantial portion of
the Company's operating expenses are related to personnel, facilities, and sales
and marketing programs. This level of spending for such expenses cannot be
adjusted quickly and is, therefore, relatively fixed in the short term.
Accordingly, any significant shortfall in demand for the Company's products in
relation to the Company's expectations would have an immediate and material
adverse effect on the Company's business, results of operations and financial
condition.
Due to all of the foregoing factors, the Company believes that its quarterly
operating results are likely to vary significantly in the future. Therefore, in
some future quarter the Company's results of operations may fall below the
expectations of securities analysts and investors. In such event, the trading
price of the Company's Common Stock would likely be materially adversely
affected.
EMERGING NETWORK MANAGEMENT SOFTWARE MARKET
The market for the Company's products is in an early stage of development.
Although the rapid expansion and increasing complexity of computer networks in
recent years has increased the demand for network management software products,
the awareness of and the need for such products is a recent development. Because
the market for these products is only beginning to develop, it is difficult to
assess the size of this market, the appropriate features and prices for products
to address this market, the optimal distribution strategy and the competitive
environment that will develop. The development of this market and the Company's
growth will be significantly dependent on the willingness of network service
providers, including telecommunications carriers, internet service providers,
systems integrators and outsourcers, to integrate network performance analysis
and reporting software into their product and service offerings. Failure of the
network performance analysis and reporting market to grow or failure of the
Company to properly assess and address such market would have a material adverse
effect on the Company's business, results of operations and financial condition.
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,
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introduced and marketed, and failure to do so would have a material adverse
effect on the Company's business, results of operations and financial condition.
RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON STANDARD PROTOCOLS
The software industry is characterized by rapid technological change,
frequent introductions of new products, changes in customer demands and evolving
industry standards. The introduction of products embodying new technologies and
the emergence of new industry standards can render existing products obsolete
and unmarketable. Network Health's ability to analyze and generate reports, as
well as the quality of the reports, is dependent on Network Health's utilization
of the industry-standard SNMP protocol and the data resident in conventional
MIBs. Any change in these industry standards, the development of vendor-specific
proprietary MIB technology, or the emergence of new network technologies could
affect the compatibility of Network Health with these devices which, in turn,
could affect Network Health's ability to analyze and generate comprehensive
reports or the quality of the reports. Furthermore, although the Company's
products currently run on industry-standard UNIX operating systems and Windows
NT, any significant change in industry-standard operating systems could affect
the demand for, or the pricing of, the Company's products. Any of the foregoing
developments could have a material adverse effect on the Company's business,
results of operations and financial condition.
PRODUCT ENHANCEMENTS AND NEW PRODUCTS
Because of rapid technological change in the software industry and potential
changes in the network management software market and industry standards, the
life cycle of versions of Network Health is difficult to estimate. The Company's
future success will depend upon its ability to address the increasingly
sophisticated needs of its customers by developing and introducing enhancements
to Network Health on a timely basis that keep pace with technological
developments, emerging industry standards and customer requirements. There can
be no assurance that the Company will be successful in developing and marketing
enhancements to Network Health or in developing new products that respond to
technological changes, evolving industry standards or customer requirements,
that the Company will not experience difficulties that could delay or prevent
the successful development, introduction and sale of such enhancements or new
products, or that such enhancements or new products will adequately address the
requirements of the marketplace and achieve any significant degree of market
acceptance.
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
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applications or from any future applications or that, if issued, any claims
allowed will be sufficiently broad to protect the Company's technology. In
addition, there can be no assurance that any patents that have been or may be
issued will not be challenged, invalidated or circumvented, or that any rights
granted thereunder would provide protection of the Company's proprietary rights.
Failure of any patents to protect the Company's technology may make it easier
for the Company's competitors to offer equivalent or superior technology. The
Company has registered or applied for registration for certain trademarks, and
will continue to evaluate the registration of additional trademarks as
appropriate. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or
services or to obtain and use information that the Company regards as
proprietary. Third parties may also independently develop similar technology
without breach of the Company's proprietary rights. In addition, the laws of
some foreign countries do not protect proprietary rights to as great an extent
as do the laws of the United States. In addition, the Company's products are
licensed under shrink wrap license agreements that are not signed by licensees
and therefore may not be binding under the laws of certain jurisdictions.
Certain technologies used by the Company's products are licensed from third
parties, generally on a non-exclusive basis. The termination of any such
licenses, or the failure of the third-party licensors to adequately maintain or
update their products, could result in delay in the Company's ability to ship
certain of its products while it seeks to implement technology offered by
alternative sources, and any required replacement licenses could prove costly.
While it may be necessary or desirable in the future to obtain other licenses
relating to one or more of the Company's products or relating to current or
future technologies, there can be no assurance that the Company will be able to
do so on commercially reasonable terms or at all.
Although the Company does not believe that it is infringing the intellectual
property rights of others, claims of infringement are becoming increasingly
common as the software industry develops and legal protections, including
patents, are applied to software products.
Litigation may be necessary to protect the Company's proprietary technology,
and third parties may assert infringement claims against the Company with
respect to their proprietary rights. Any claims or litigation can be
time-consuming and expensive regardless of their merit. Infringement claims
against the Company can cause product release delays, require the Company to
redesign its products or require the Company to enter into royalty or license
agreements, which agreements may not be available on terms acceptable to the
Company or at all.
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
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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 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
17
<PAGE> 18
date, as all export sales are denominated in U.S. dollars, the Company has not
entered into any such contracts or engaged in any such activities. As the
Company increases its international sales, its total revenue may also be
affected to a greater extent by seasonal fluctuations resulting from lower sales
that typically occur during the summer months in Europe and other parts of the
world.
POSSIBLE VOLATILITY OF STOCK PRICE
The Company completed an initial public offering of its common stock during
October of 1997. The market price of the shares of Common Stock may be highly
volatile and could be subject to wide fluctuations in response to variations in
results of operations, announcements of technological innovations or new
products by the Company or its competitors, changes in financial estimates by
securities analysts or other events or factors. In addition, the financial
markets have experienced significant price and volume fluctuations that have
particularly affected the market prices of equity securities of many high
technology companies and that often have been unrelated to the operating
performance of such companies or have resulted from the failure of the operating
results of such companies to meet market expectations in a particular quarter.
Broad market fluctuations or any failure of the Company's operating results in a
particular quarter to meet market expectations may adversely affect the market
price of the shares of Common Stock. In the past, following periods of
volatility in the market price of a company's securities, securities class
action litigation has often been instituted against such a company. Such
litigation could result in substantial costs and a diversion of management's
attention and resources, which would have a material adverse effect on the
Company's business, results of operations and financial condition.
FUTURE CAPITAL FUNDING
The Company plans to continue to expend substantial funds on the continued
development, sales and marketing of the Network Health product family. There can
be no assurance that the Company's existing capital resources, the proceeds from
the Company's initial public offering during October of 1997 and any funds that
may be generated from future operations together will be sufficient to finance
the Company's future operations or that other sources of funding will be
available on terms acceptable to the Company, if at all. In addition, future
sales of substantial amounts of the Company's securities in the public market
could adversely affect prevailing market prices and could impair the Company's
future ability to raise capital through the sale of its securities. The failure
to obtain such funding, if required, could have a material adverse effect on the
Company's business, results of operations and financial condition.
RISK ASSOCIATED WITH RECENT ACQUISITION AND POSSIBLE ACQUISITIONS
The Company has recently completed the acquisition of Empire Technologies,
Inc. Acquisitions involve a number of special risks, including diversion of
management's attention, failure to successfully integrate acquired personnel,
information systems and operations of the acquired business, failure to retain
key acquired personnel, unanticipated events or circumstances, legal liabilities
and amortization of acquired intangible assets, some or all of which could have
a material adverse effect on the Company's business, results of operations and
financial condition. There can be no assurance that the Company will not
encounter difficulties in integrating the operations and products of any
acquisition or that the benefits from any integration (including the Empire
acquisition) will be realized. In addition, the Company may in the future engage
in selective acquisitions of other businesses that are complementary to those of
the Company. There can be no assurance that the Company will be able to identify
additional suitable acquisition candidates available for sale at reasonable
prices, consummate any acquisition or successfully integrate any acquired
business into the Company's operations. If the Company were to proceed with one
or more significant future acquisitions in which the consideration consisted of
cash, a substantial portion of the Company's available cash could be used to
consummate the acquisitions. If the Company were to consummate one or more
significant acquisitions in which the consideration consisted of stock,
stockholders of the Company could suffer dilution of their interests in the
Company. Most business acquisitions must be accounted for using the purchase
method of accounting. Most of the businesses that might become attractive
acquisition candidates for the Company are likely to have significant intangible
assets, and acquisition of these businesses, if accounted for as a purchase,
would typically result in substantial intangible asset amortization charges to
the Company, reducing future earnings or increasing future losses. In addition,
such acquisitions could involve acquisition-related charges, such as one-time
acquired research and development charges. The magnitude and timing of these
charges will affect 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, SEPTEMBER 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
(c) Issuance in Securities
On October 19, 1999, Concord Communications, Inc., a Massachusetts
corporation ("Concord" or the "Company"), entered into an Agreement and Plan of
Reorganization (the "Merger Agreement") providing for the merger (the "Merger")
of E Acquisition Corp., a Georgia corporation and wholly-owned subsidiary of
the Company ("Merger Sub") with and into Empire Technologies, Inc. ("Empire").
The Merger was effected on October 29, 1999 (the "Effective Date") pursuant to
a Certificate of Merger filed with the Secretary of State of the State of
Georgia on that date. Pursuant to the Merger Agreement, at the effective time
of the Merger, each issued and outstanding share of the common stock, no par
value per share, of Empire (the "Empire Common Stock") was converted into
815,248 shares (the "Conversion Ratio") of the common stock, $.01 par value per
share, of the Company (the "Concord Common Stock"). Since there were 1,000
outstanding shares of Empire Common Stock immediately prior to the effective
time of the Merger, Concord issued an aggregate of 815,248 shares of Concord
Common Stock to the stockholders of Empire in the Merger in a private placement
transaction pursuant to Section 4(2) under the Securities Act of 1933. Empire
is a leading provider of solutions for proactive self-management of UNIX and
Windows NT systems, as well as mission-critical applications. The merger was
accounted for as a pooling of interest.
(d) Use of Proceeds
On October 16, 1997, the Company commenced an initial public offering
("IPO") of 2,900,000 shares of common stock, par value $.01 per share (the
"Common Stock"), of the Company pursuant to the Company's final prospectus dated
October 15, 1997 (the "Prospectus"). The Prospectus was contained in the
Company's Registration Statement on Form S-1, which was declared effective by
the Securities and Exchange Commission (SEC File No. 333-33227) on October 15,
1997. Of the 2,900,000 shares of Common Stock offered, 2,300,000 shares were
offered and sold by the Company and 600,000 shares were offered and sold by
certain stockholders of the Company. As part of the IPO, the Company granted the
several underwriters an overallotment option to purchase up to an additional
435,000 shares of Common Stock (the "Underwriters' Option"). The IPO closed on
October 21, 1997 upon the sale of 2,900,000 shares of Common Stock to the
underwriters. On October 24, 1997, the Representatives, on behalf of the several
underwriters, exercised the Underwriters' Option, purchasing 435,000 additional
shares of Common Stock from the Company. The aggregate offering price of the IPO
to the public was $40,600,000 (exclusive of the Underwriters' Option), with
proceeds to the Company and selling shareholders, after deduction of the
underwriting discount, of $29,946,000 (before deducting offering expenses
payable by the Company) and $7,812,000 respectively. The aggregate offering
price of the Underwriters' Option exercised was $6,090,000, with proceeds to the
Company, after deduction of the underwriting discount, of $5,663,700 (before
deducting offering expenses payable by the Company). The aggregate amount of
expenses incurred by the Company in connection with the issuance and
distribution of the shares of Common Stock offered and sold in the IPO were
approximately $3.6 million, including $2.7 million in underwriting discounts and
commissions and $950,000 in other offering expenses.
The net proceeds to the Company from the IPO, after deducting underwriting
discounts and commissions and other offering expenses were approximately $34.7
million.
To date, the Company has not utilized any of the net proceeds from the IPO.
The Company has invested all such net proceeds primarily in US treasury
obligations and other interest bearing investment grade securities.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
ITEM 5. OTHER INFORMATION
Not Applicable
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
Form 8-k was filed on October 29, 1999 for disclosure of the merger with
Empire Technologies, Inc.
19
<PAGE> 20
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 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: November 15, 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, SEPTEMBER 30, 1999
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
27.01 Financial Data Schedule
21
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<ARTICLE> 5
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<EXCHANGE-RATE> 1
<CASH> 6,181
<SECURITIES> 54,524
<RECEIVABLES> 10,498
<ALLOWANCES> 660
<INVENTORY> 0
<CURRENT-ASSETS> 910
<PP&E> 8,984
<DEPRECIATION> 2,573
<TOTAL-ASSETS> 77,864
<CURRENT-LIABILITIES> 18,190
<BONDS> 0
0
0
<COMMON> 76,517
<OTHER-SE> (16,843)
<TOTAL-LIABILITY-AND-EQUITY> 77,864
<SALES> 35,943
<TOTAL-REVENUES> 45,606
<CGS> 1,788
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<OTHER-EXPENSES> 28,360
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<INCOME-TAX> 5,196
<INCOME-CONTINUING> 8,470
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,470
<EPS-BASIC> .59
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