<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of report (Date of earliest event reported): February 28, 2000
Concord Communications, Inc.
----------------------------------------------------------
(Exact Name of Registrant as Specified in Charter)
Massachusetts 0-23067 04-2710876
- ---------------------------- ------------ -------------------
(State or Other Jurisdiction (Commission (IRS Employer
of Incorporation) File Number) Identification No.)
600 Nickerson Road, Marlboro, Massachusetts 01752
- ------------------------------------------- ----------
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (508) 460-4646
<PAGE> 2
ITEM 5. OTHER EVENTS.
This Current Report on Form 8-K of Concord Communications, Inc. (the
"Company") is being filed to disclose (a) the audited consolidated balance
sheets of the Company as of December 31, 1999 and 1998 and the related audited
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1999, 1998 and 1997, with
accompanying notes, and (b) management's discussion and analysis of financial
condition and results of operations relating to such financial statements.
<PAGE> 3
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
EXHIBITS.
---------
EXHIBIT NO. DESCRIPTION
----------- -----------
99.1 The following audited financial statements of Concord
Communications, Inc.:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1999 and
1998
Consolidated Statements of Income for the years ended
December 31, 1999, 1998 and 1997
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years
ended December 31, 1999, 1998 and 1997
Notes to the Consolidated Financial Statements
99.2 Management's Discussion and Analysis of Financial
Condition and Results of Operations
<PAGE> 4
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
CONCORD COMMUNICATIONS, INC.
Dated: February 28, 2000
By: /s/ Gary E. Haroian
------------------------------------------
Gary E. Haroian
Senior Vice President, Finance and
Administration, Chief Financial Officer,
Clerk and Treasurer
<PAGE> 5
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
----------- -----------
99.1 The following audited financial statements of Concord
Communications, Inc.:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1999 and
1998
Consolidated Statements of Income for the years ended
December 31, 1999, 1998 and 1997
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years
ended December 31, 1999, 1998 and 1997
Notes to the Consolidated Financial Statements
99.2 Management's Discussion and Analysis of Financial
Condition and Results of Operations
<PAGE> 1
Exhibit 99.1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Concord Communications, Inc.:
We have audited the accompanying consolidated balance sheets of Concord
Communications, Inc. (a Massachusetts corporation) as of December 31, 1999 and
December 31, 1998, and the related consolidated statements of income,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Concord Communications, Inc. as
of December 31, 1999 and December 31, 1998, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1999, in conformity with accounting principles generally accepted in United
States.
Arthur Andersen LLP
Boston, Massachusetts
January 17, 2000
F-1
<PAGE> 2
CONCORD COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------
ASSETS
<S> <C> <C>
Current Assets:
Cash, cash equivalents and marketable securities ..... $ 62,044,141 $51,248,773
Accounts receivable, net of allowance of approximately
$930,000 and $450,000 in 1999 and 1998, respectively 13,465,999 5,391,723
Prepaid expenses and other current assets ............ 1,286,070 509,805
------------ ------------
Total current assets ............................. 76,796,210 57,150,301
------------ ------------
Equipment and Improvements, at cost:
Equipment ............................................ 7,897,533 3,792,080
Leasehold improvements ............................... 3,005,915 388,894
------------ ------------
10,903,448 4,180,974
Less-- Accumulated depreciation and amortization ..... 3,294,551 1,407,430
------------ ------------
7,608,897 2,773,544
------------ ------------
$ 84,405,107 $59,923,845
============ ============
LIABILITIES
AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable ..................................... $ 4,542,644 $ 3,599,636
Accrued expenses ..................................... 6,885,827 5,087,984
Deferred revenue ..................................... 9,925,297 5,485,585
------------ ------------
Total current liabilities......................... 21,353,768 14,173,205
------------ ------------
Commitments and Contingencies (Note 8)
Stockholders' Equity
Preferred Stock, $.01 par value --
Authorized -- 1,000,000 shares
Issued and outstanding-- None -- --
Common stock, $.01 par value--
Authorized -- 50,000,000 shares
Issued and outstanding -- 14,406,192
and 13,040,374 shares, in 1999 and 1998,
respectively ........................................ 144,062 130,405
Additional paid-in capital ........................... 77,799,827 69,998,035
Deferred compensation ................................ (53,221) (101,189)
Accumulated other comprehensive income................ (1,386,125) 149,606
Accumulated deficit .................................. (13,453,204) (24,426,217)
------------ ------------
Total stockholders' equity ....................... 63,051,339 45,750,640
------------ ------------
$ 84,405,107 $ 59,923,845
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
<PAGE> 3
CONCORD COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED
-----------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1999 1998 1997
----------- ----------- ------------
<S> <C> <C> <C>
Revenues:
License revenues ............................ $52,707,905 $34,597,958 $18,454,613
Service revenues ............................ 14,635,150 6,859,394 2,225,287
----------- ----------- -----------
Total revenues ......................... 67,343,055 41,457,352 20,679,900
Cost of Revenues ................................. 8,085,987 4,676,335 2,925,169
----------- ----------- -----------
Gross profit ........................... 59,257,068 36,781,017 17,754,731
----------- ----------- -----------
Operating Expenses:
Research and development .................... 11,409,464 7,386,706 5,068,489
Sales and marketing ......................... 25,687,262 17,522,653 10,173,182
General and administrative .................. 3,678,544 2,802,023 2,058,402
Stock-based compensation (Note 3)............ 2,549,000 1,001,000 --
Acquisition-related charges (Note 3)......... 550,601 -- --
----------- ----------- -----------
Total operating expenses .................... 43,874,871 28,712,382 17,300,073
----------- ----------- -----------
Operating income ....................... 15,382,197 8,068,635 454,658
----------- ----------- -----------
Other Income (Expense):
Interest income ............................. 3,136,026 2,355,816 428,253
Interest expense ............................ -- (514) (126,836)
Other ....................................... (19,268) (65,251) 4,248
----------- ----------- -----------
Total other income, net ................ 3,116,758 2,290,051 305,665
----------- ----------- -----------
Income before income taxes ............. 18,498,955 10,358,686 760,323
Provision for income taxes ....................... 5,592,703 532,600 --
----------- ----------- -----------
Net income ....................................... $12,906,252 $ 9,826,086 $ 760,323
=========== =========== ===========
Pro forma provision for income taxes on
Subchapter S-Corporation income (unaudited) ...... 146,325 41,400 --
----------- ----------- -----------
Pro forma net income (unaudited) ................. $12,759,927 $ 9,784,686 $ 760,323
=========== =========== ===========
Net income per common and potential
common share:
Basic .......................................... $ 0.91 $ 0.73 $ 0.20
=========== =========== ===========
Diluted ........................................ $ 0.85 $ 0.66 $ 0.06
=========== =========== ===========
Pro forma diluted (unaudited) .................. $ 0.85 $ 0.66 $ 0.06
=========== =========== ===========
Weighted average common and potential
common shares outstanding:
Basic .......................................... 14,160,755 13,457,495 3,884,915
============ =========== ===========
Diluted ........................................ 15,139,325 14,892,238 12,134,727
============ =========== ===========
Pro forma diluted (unaudited) .................. 15,139,325 14,892,238 12,134,727
============ =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 4
CONCORD COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK UNREALIZED
--------------------- ADDITIONAL GAIN ON
NUMBER $.01 PAR PAID-IN DEFERRED MARKETABLE
OF SHARES VALUE CAPITAL COMPENSATION SECURITIES
---------- -------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 28, 1996...... 844,482 $ 8,445 $18,156,951 -- --
Issuance of common stock,
net of issuance costs of
$955,359........................ 2,735,000 27,350 34,626,991 -- --
Accretion of dividends on
preferred stock................. -- -- -- -- --
Conversion of redeemable
convertible preferred stock
to common stock................. 8,108,258 81,083 14,838,203 -- --
Exercise of stock options........ 331,448 3,315 188,594 -- --
Deferred compensation
related to grants of stock
options......................... -- -- 191,875 (191,875) --
Amortization of deferred
compensation related to
grants of stock options......... -- -- -- 42,718 --
Unrealized gains on
available-for-sale
securities...................... -- -- -- -- 19,750
Distribution to shareholders..... -- -- -- -- --
Net income...................... -- -- -- -- --
---------- -------- ----------- --------- -----------
Comprehensive Income -- -- -- -- --
BALANCE, DECEMBER 31, 1997....... 12,019,188 120,193 68,002,614 (149,157) 19,750
Shares issued in connection
with employee stock plans....... 1,021,186 10,212 1,495,421 -- --
Tax benefit associated with
employee stock options.......... -- -- 500,000 -- --
Amortization of deferred
compensation related to
grants of stock options......... -- -- -- 47,968 --
Unrealized gains on
available-for-sale
securities...................... -- -- -- -- 129,856
Distribution to shareholders..... -- -- -- -- --
Net income...................... -- -- -- -- --
---------- -------- ----------- --------- -----------
Comprehensive Income -- -- -- -- --
BALANCE, DECEMBER 31, 1998....... 13,040,374 130,405 69,998,035 (101,189) 149,606
Shares issued in connection
with employee stock plan........ 1,365,818 13,657 2,901,792 -- --
Tax benefit associated with
employee stock options.......... -- -- 4,900,000 -- --
Amortization of deferred
compensation related to
grants of stock options......... -- -- -- 47,968 --
Unrealized gains on
available-for-sale
securities...................... -- -- -- -- (1,535,731)
Distribution to shareholders..... -- -- -- -- --
Net income...................... -- -- -- -- --
---------- -------- ----------- --------- -----------
Comprehensive Income -- -- -- -- --
BALANCE, DECEMBER 31, 1999....... 14,406,192 $144,062 $77,799,827 $ (53,221) $(1,386,125)
========== ======== =========== ========= ===========
<CAPTION>
ACCUMULATED
OTHER
ACCUMULATED COMPREHENSIVE COMPREHENSIVE
DEFICIT INCOME TOTAL INCOME
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 28, 1996....... $(32,943,433) -- $(14,778,037) --
Issuance of common stock,
net of issuance costs of
$955,359........................ -- -- 34,654,341 --
Accretion of dividends on
preferred stock................. (441,557) -- (441,557) --
Conversion of redeemable
convertible preferred stock
to common stock................. -- -- 14,919,286 --
Exercise of stock options........ -- -- 191,909 --
Deferred compensation
related to grants of stock
options......................... -- -- -- --
Amortization of deferred
compensation related to
grants of stock options......... -- -- 42,718 --
Unrealized gains on
available-for-sale
securities...................... -- 19,750 19,750 19,750
Distribution to shareholders..... (119,698) -- (119,698) --
Net income...................... 760,323 -- 760,323 760,323
------------ ----------- ------------ -----------
Comprehensive Income -- 19,750 -- 780,073
BALANCE, DECEMBER 31, 1997....... (32,744,365) -- 35,249,035 --
Shares issued in connection
with employee stock plans....... -- -- 1,505,633 --
Tax benefit associated with
employee stock options.......... -- -- 500,000 --
Amortization of deferred
compensation related to
grants of stock options......... -- -- 47,968 --
Unrealized gains on
available-for-sale
securities...................... -- 129,856 129,856
Distribution to shareholders..... (1,507,938) -- (1,507,938) --
Net income...................... 9,826,086 -- 9,826,086 --
------------ ----------- ------------ -----------
Comprehensive Income -- 149,606 -- 9,955,942
BALANCE, DECEMBER 31, 1998....... (24,426,217) -- 45,750,640 --
------------ ----------- ------------ -----------
Shares issued in connection
with employee stock plan........ -- -- 2,915,449 --
Tax benefit associated with
employee stock options.......... -- -- 4,900,000 --
Amortization of deferred
compensation related to
grants of stock options......... -- -- 47,968 --
Unrealized gains on
available-for-sale
securities...................... -- (1,535,731) (1,535,731) (1,535,731)
Distribution to shareholders..... (1,933,239) -- (1,933,239) --
Net income...................... 12,906,252 -- 12,906,252 12,906,252
------------ ----------- ------------ -----------
Comprehensive Income -- $(1,386,125) -- $11,372,521
BALANCE, DECEMBER 31, 1999....... $(13,453,204) -- $ 63,051,339 --
============ =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 5
CONCORD COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED
----------------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1999 1998 1997
------------ ------------- -------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net income ....................................... $ 12,906,252 $ 9,826,026 $760,323
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization.................. 1,935,089 756,669 591,798
Unrealized (loss) gain on available-for-sale
securities ................................... (1,535,731) 129,856 19,750
Changes in current assets and liabilities:
Accounts receivable ......................... (8,074,276) (1,640,779) (1,423,916)
Prepaid expenses and other current assets ... (776,265) (227,495) (132,769)
Accounts payable ............................ 943,008 1,787,061 207,536
Accrued expenses ............................ 6,697,843 2,351,472 1,306,493
Deferred revenue ............................ 4,439,712 3,132,156 1,001,678
------------- ------------- -------------
Net cash provided by operating activities . 16,535,632 16,114,966 2,330,893
------------- ------------- -------------
Cash Flows from Investing Activities:
Purchases of equipment and improvements ............ (6,722,474) (1,891,606) (1,119,863)
Purchases of investments in marketable securities .. (252,350,710) (53,139,637) (116,402,905)
Sales of investments in marketable securities ...... 238,648,717 42,712,930 87,741,538
------------- ------------ -------------
Net cash used in investing activities ..... (20,424,467) (12,318,313) (29,781,230)
------------- ------------ -------------
Cash Flows from Financing Activities:
Proceeds from bank borrowings ...................... -- -- 583,707
Repayments of bank borrowings ...................... -- -- (1,508,209)
Distribution to shareholders ...................... (1,933,239) (1,507,938) (119,698)
Proceeds from issuance of common stock ............. -- -- 34,654,341
Proceeds from shares issued in connection with
employee stock plans ............................. 2,915,449 1,505,633 191,909
------------- ------------- -------------
Net cash provided by (used in) financing
activities .............................. 982,210 (2,305) 33,802,050
------------- ------------- -------------
Net (Decrease) Increase in Cash and Cash Equivalents . (2,906,625) 3,794,348 6,351,713
Cash and Cash Equivalents, beginning of year ......... 12,011,093 8,216,745 1,865,032
------------- ------------- -------------
Cash and Cash Equivalents, end of year ............... $ 9,104,468 $ 12,011,093 $ 8,216,745
============= ============= =============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest ............................. $ -- $ -- $ 126,836
============= ============= =============
Cash paid for taxes ................................ $ 341,837 $ 46,159 $ 1,539
============= ============= =============
Supplemental Disclosure of Noncash Transactions:
Accretion of dividends on preferred stock .......... $ -- $ -- $ 441,557
============= ============= =============
Deferred compensation related to grants of stock
options .......................................... $ -- -- $ 191,875
============= ============= =============
Conversion of redeemable convertible preferred stock
to common stock .................................. $ -- $ -- $ 14,919,286
============= ============= =============
Unrealized (loss) gain on available-for-sale
securities ....................................... $ (1,535,731) $ 129,856 $ 19,750
============= ============= =============
Tax benefit associated with employee stock options . $ 4,900,000 $ 500,000 $ --
============= ============= =============
Retirement of fully depreciated fixed assets ....... $ -- $ 4,330,000 $ --
============= ============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 6
CONCORD COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
(1) ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Concord Communications, Inc. (the Company or Concord) is primarily
engaged in the development and sale of next-generation performance management
solutions to companies principally in the United States and Europe.
The Company is subject to the risks associated with emerging,
technology-oriented companies. Primary among these risks are competition from
substitute products and the ability to successfully develop and market the
Company's current and future products.
(a) Principles of Consolidation
The accompanying consolidated financial statements include the accounts
of the Company and all its wholly owned subsidiaries. All material intercompany
accounts and transactions have been eliminated in consolidation.
(b) Cash, Cash Equivalents and Marketable Securities
The Company follows the provisions of Statement of Financial Accounting
Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities. The Company has classified its cash equivalents and marketable
securities as available-for-sale and recorded them at fair value, with the
unrealized gains and losses reported as a separate component of stockholders'
equity. The Company considers cash and highly liquid investments, purchased with
an original maturity of 90 days or less, to be cash and cash equivalents. Cash
and cash equivalents are $9,104,468 and $12,011,093 at December 31, 1999 and
December 31, 1998, respectively.
(c) Revenue Recognition
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") No. 97-2, Software Revenue Recognition, as modified by SOP 98-9,
Modification of SOP 97-2,Software Revenue Recognition with respect to Certain
Transactions. 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
F-6
<PAGE> 7
customization of the software is required and collection is considered probable
by management. 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.
(d) Equipment and Improvements
Equipment and improvements are recorded at cost. Depreciation is
provided for on a straight-line basis over the useful lives of the assets, which
are estimated to be three to five years for all assets except leasehold
improvements, which are amortized over the life of the lease.
(e) Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(f) Concentration of Credit Risk and Significant Customers
SFAS No. 105, Disclosure of Information about Financial Instruments
with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of
Credit Risk, requires disclosure of any significant off-balance-sheet and credit
risk concentrations. The Company has no significant off-balance-sheet
concentration of credit risk such as foreign exchange contracts, option
contracts or other foreign hedging arrangements. The Company maintains its cash,
cash equivalent and marketable securities with established financial
institutions. The Company does not believe it has accounts receivable collection
risk in excess of existing reserves. For the years ended December 31, 1999,
December 31, 1998 and December 31, 1997, no individual customer accounted for
more than 10% of revenue or accounts receivable.
(g) Software Development Costs
SFAS No. 86, Accounting for the Costs of Computer Software to be sold,
Leased or Otherwise Marketed, requires the capitalization of certain computer
software development costs incurred after technological feasibility is
established. The Company believes that once technological feasibility of a
software product has been established, the additional development costs incurred
to bring the product to a commercially acceptable level are not significant.
There were no capitalized software development costs at December 31, 1999 or
December 31, 1998.
F-7
<PAGE> 8
(h) Net Income per Share
The Company computes earnings per share following the provisions of
SFAS No. 128, Earnings per Share. 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 in 1999 and 1998 consisting of outstanding stock options
and in 1997 consisting of outstanding stock options and redeemable convertible
preferred stock, is determined using the treasury method and the if-converted
method, respectively, in accordance with SFAS No. 128. Pro forma diluted net
income per common and potential common share assumes earnings from Empire
Technologies, Inc., an acquired Subchapter S-Corporation accounted for as a
pooling-of-interests (Note 3), were taxed at the Company's effective tax rate.
Calculations of basic, diluted and pro forma diluted net income per common share
and potential common share are as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Net income ....................................... $12,906,252 $ 9,826,086 $ 760,323
----------- ----------- -----------
Pro forma provision for income taxes on
Subchapter S-Corporation income (unaudited) 146,325 41,400 --
----------- ----------- -----------
Pro forma net income (unaudited) ................. $12,759,927 $ 9,784,686 $ 760,323
=========== =========== ===========
Weighted average common shares
outstanding ................................... 14,160,755 13,457,495 3,884,915
Potential common shares pursuant
to stock options .............................. 978,570 1,434,743 1,830,774
Potential common shares pursuant to conversion of
redeemable convertible preferred stock ........ -- -- 6,419,038
----------- ----------- -----------
Diluted weighted average shares ................. 15,139,325 14,892,238 12,134,727
=========== =========== ===========
Basic net income per common share ................ $ 0.91 $ 0.73 $ 0.20
=========== =========== ===========
Diluted net income per common
and potential common share .................... $ 0.85 $ 0.66 $ 0.06
=========== =========== ===========
Pro forma diluted net income per
common and potential common share ............. $ 0.85 $ 0.66 $ 0.06
=========== =========== ===========
</TABLE>
Diluted weighted average shares outstanding do not include 722,572,
4,003 and 44,818 common equivalent shares for the years ended December 31, 1999,
1998 and 1997, respectively, as their effect would have been antidilutive.
F-8
<PAGE> 9
(2) MARKETABLE SECURITIES
It is the Company's intent to maintain a liquid investment portfolio
to support current operations and to take advantage of investment opportunities;
therefore, all marketable securities are considered to be available-for-sale and
are classified as current assets.
The amortized cost, unrealized gains (losses) and fair value of
marketable securities available-for-sale as of December 31, 1999 with maturity
dates from January 1, 2000 through April 20, 2004, are as follows:
<TABLE>
<CAPTION>
AMORTIZED COST UNREALIZED GAINS (LOSSES) FAIR VALUE
-------------- ------------------------- -----------
<S> <C> <C> <C>
US government obligations $18,121,819 $ (699,459) $17,422,360
Corporate bonds and notes 39,164,353 (686,666) 38,477,687
----------- ----------- -----------
57,286,172 (1,386,125) 55,900,047
Less: Amounts classified as
cash equivalents 2,960,374 -- 2,960,374
----------- ----------- -----------
Available-for-sale
marketable securities $54,325,798 $(1,386,125) $52,939,673
=========== =========== ===========
</TABLE>
The amortized cost, unrealized gains (losses) and fair value of
marketable securities available-for-sale as of December 31, 1998 with maturity
dates from January 1, 1999 through September 15, 2003, are as follows:
<TABLE>
<CAPTION>
AMORTIZED COST UNREALIZED GAINS (LOSSES) FAIR VALUE
-------------- ------------------------- -----------
<S> <C> <C> <C>
US government obligations $ 9,423,374 $ 11,559 $ 9,434,933
Corporate bonds and notes 31,949,720 138,047 32,087,767
----------- -------- -----------
41,373,094 149,606 41,522,700
Less: Amounts classified as
cash equivalents 2,285,020 -- 2,285,020
----------- -------- -----------
Available-for-sale
marketable securities $39,088,074 $149,606 $39,237,680
=========== ======== ===========
</TABLE>
(3) ACQUISITION OF EMPIRE TECHNOLOGIES, INC.
On October 29, 1999, the Company issued 815,248 shares of common stock
for all of the issued and outstanding shares of Empire Technologies, Inc.
("Empire") in a transaction accounted for as a pooling-of-interests.
Accordingly, all prior-period financial statements presented have been restated
as required by Accounting Principles Board Opinion No. 16, Accounting for
Business Combinations. All intercompany transactions have been eliminated as a
part of the restatement.
As a part of the transaction, the Company incurred direct,
acquisition-related charges of approximately $551,000. All of such costs have
been expensed. Also, as part of the transaction, the Company assumed an
obligation related to Empire's existing stock appreciation rights plan. Pursuant
to the terms of the only grant under this plan, the Company settled this
obligation in cash within 30 days of closing. The expense relating to the grant
was recognized from the date of grant through the date of settlement.
F-9
<PAGE> 10
Separate and combined results of Concord and Empire during the periods
preceding the merger were as follows:
<TABLE>
<CAPTION>
CONCORD EMPIRE ELIMINATIONS COMBINED
----------- ---------- ------------ -----------
<S> <C> <C> <C> <C>
1999 (Through 10/29/1999)
Net Revenues $49,616,491 $2,713,962 (133,160) $52,197,293
Net Income 7,519,519 471,655 7,991,174
1998
Net Revenues $39,481,330 $1,976,022 $41,457,352
Net Income 9,078,471 747,615 9,826,086
1997
Net Revenues $19,569,594 $1,110,306 $20,679,900
Net Income 130,755 629,568 760,323
</TABLE>
(4) STOCK OPTION PLANS
In 1995, the Company's Board of Directors (the Board) approved the 1995
Stock Plan, which provides for the granting of incentive stock options (ISOs)
and nonqualified stock options. Prior to the adoption of the 1995 Stock Plan,
the Board granted options under the 1982 Employee Incentive Stock Option Plan,
the 1986 Nonqualified Stock Option Plan and the 1986 Stock Plan. Following the
completion of the IPO, the Company adopted the 1997 Stock Plan, the 1997
Employee Stock Purchase Plan and the 1997 Nonemployee Director Stock Option
Plan. As amended, these plans allow for issuances of up to 2,500,000, 375,000
and 95,000 shares of common stock, respectively; the Company has reserved such
shares for future issuance.
Under the 1995 and 1997 Stock Plans (the Plans), the Company may issue
options to purchase up to 2,963,798 shares of common stock, of which 137,658
options are available for grant as of December 31, 1999. ISOs may be granted at
an exercise price not less than the fair market value per share of common stock
on the date of grant, as determined by the Board. The price per share relating
to each nonqualified option granted under the Plans shall not be less than the
lesser of (i) the book value per share of common stock as of the end of the
Company's fiscal year immediately preceding the date of grant or (ii) 50% of the
fair market value per share of common stock on the date of grant. Vesting of the
options is determined by the Board, and the options expire 8 years from the date
of grant. An employee may convert his or her unexercised ISOs into nonqualified
options at any time prior to the expiration of such ISOs.
F-10
<PAGE> 11
In October 1995, the Financial Accounting Standards Board issued SFAS
No. 123, Accounting for Stock-Based Compensation, which requires the measurement
of the fair value of stock options or warrants to be included in the statement
of operations or disclosed in the notes to the financial statements. As
permitted by SFAS No. 123, the Company will continue to account for stock-based
compensation for employees under Accounting Principles Board Opinion No. 25 and
has elected the disclosure-only alternative under SFAS No. 123 for options
granted using the Black-Scholes option pricing model prescribed by SFAS No. 123.
The weighted average fair value per share of options granted during 1999, 1998
and 1997 was $45.27, $31.08 and $5.64, respectively. The weighted average
assumptions are as follows:
1999 1998 1997
------------- ------------- ------------
Risk-free interest rate......... 6.0% 6.0% 5.1 - 6.0%
Expected dividend yield......... -- -- --
Expected lives.................. 7 years 7 years 7 years
Expected volatility............. 82% 80% 80%
Had compensation cost for these plans been determined consistent with
SFAS No. 123, the Company's net income (loss) and basic, diluted and pro forma
diluted net income (loss) per common and potential common share would have been
as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------------- ------------ ---------
<S> <C> <C> <C>
Net income, as reported................................ $12,906,252 $9,826,086 $760,323
=========== ========== ========
Net (loss) income, pro forma........................... $ (302,081) 7,007,947 308,939
=========== ========== ========
Net income per share, as reported
Basic................................................. $ 0.91 $ 0.73 $ 0.20
=========== ========== ========
Diluted............................................... $ 0.85 $ 0.66 $ 0.06
=========== ========== ========
Pro forma diluted..................................... $ 0.85 $ 0.66 $ 0.06
=========== ========== ========
Net (loss) income per share, pro forma
Basic................................................. $ (0.02) $ 0.52 $ .08
=========== ========== ========
Diluted............................................... $ (0.02) $ 0.47 $ .03
=========== ========== ========
Pro forma diluted..................................... $ (0.02) $ 0.47 $ .03
=========== ========== ========
</TABLE>
Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
may not be representative of that to be expected in future years.
The following table summarizes information about options outstanding at
December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- -------------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
RANGE OF NUMBER REMAINING EXERCISE PRICE NUMBER EXERCISE PRICE
EXERCISE PRICE OUTSTANDING CONTRACTUAL LIFE PER SHARE OUTSTANDING PER SHARE
-------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$ .10 - 1.90 322,395 4.60 $ .93 127,168 $.91
4.10 - 17.38 290,735 5.68 10.87 93,761 10.46
18.38 - 23.50 347,205 6.13 21.73 121,146 21.71
</TABLE>
F-11
<PAGE> 12
<TABLE>
<S> <C> <C> <C> <C> <C>
23.88 - 33.38 62,957 6.44 27.94 19,601 27.41
34.88 - 36.91 901,801 7.64 36.85 6,237 35.11
37.25 - 52.38 239,300 7.42 45.17 6,355 44.23
52.63 - 64.25 661,747 7.25 55.00 625 56.75
--------- -------
2,826,140 374,893
========= =======
</TABLE>
The following schedule summarizes the activity under the stock option
plans for the three-year period ended December 31, 1999:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF PRICE PER PRICE
SHARE SHARE PER SHARE
---------- -------------- -----------
<S> <C> <C> <C>
Outstanding at December 28, 1996 1,704,342 $ .10 - 1.90 $ .23
Granted................... 784,700 1.90 - 21.88 7.29
Exercised................. (331,448) .10 - 1.90 .58
Terminated................ (26,494) .10 - 8.50 2.56
--------- -------------- -----
Outstanding at December 31, 1997 2,131,100 .10 - 21.88 2.76
Granted................... 563,750 17.06 - 56.75 23.71
Exercised................. (984,473) .10 - 21.38 .98
Terminated................ (36,588) .10 - 41.00 6.73
--------- -------------- ---------
Outstanding at December 31, 1998 1,673,789 $ .10 - 56.75 $10.79
Granted................... 1,781,555 17.06 - 64.25 43.90
Exercised................. (532,684) .10 - 44.38 3.81
Terminated................ (96,520) .10 - 58.25 27.94
--------- -------------- ---------
Outstanding at December 31, 1999 2,826,140 $ .10 - 64.25 $32.53
========= ============== =========
Exercisable at December 31, 1999 374,893 $ .10 - 64.25 $12.80
========= ============== =========
Exercisable at December 31, 1998 164,957 $ .10 - 21.38 $ 4.73
========= ============== =========
Exercisable at December 31, 1997 517,816 $ .10 - 1.90 $ .19
========= ============== =========
</TABLE>
In 1997, the Company granted one officer and one director options to
purchase in total 143,750 shares of common stock at an exercise price of $1.90
per share. At the date of grant, the estimated fair value per share of the
Company's common stock exceeded the exercise price of the options, and
accordingly, the Company has recorded deferred compensation of $191,875 related
to this difference at the date of grant. For the years ended December 31, 1999
and 1998, the Company has recorded compensation expense of $47,968 and $47,968,
respectively, related to these options grants.
The exercise price of all other options outstanding represents the fair
market value per share of common stock as of the date of grant.
(5) INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes. This standard requires, among other things,
recognition of future tax effects, measured by enacted tax rates, attributable
to deductible temporary differences between the financial statement and income
tax bases of assets and liabilities.
The approximate income tax effects of these temporary differences are
as follows:
F-12
<PAGE> 13
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1999 1998
------------- -------------
<S> <C> <C>
Net operating loss and federal tax credit carryforwards. $ 8,073,000 $ 12,719,000
Accruals not yet deductible for tax purposes............ 2,102,000 1,027,000
Depreciation............................................ 62,000 92,000
Deferred revenue........................................ 1,695,000 1,373,000
Capitalized research and development expenses........... 1,939,000 2,088,000
Valuation allowance..................................... (13,871,000) (17,299,000)
------------ ------------
$ -- $ --
============ ============
</TABLE>
The Company has available net operating loss carryforwards of
approximately $14,300,000 and federal research and development tax credit
carryforwards of approximately $2,225,000 as of December 31, 1999 to reduce
future income tax liabilities. These carryforwards are subject to review and
possible adjustment by the appropriate taxing authorities and expire from 1999
through 2013 as follows:
RESEARCH AND
NET OPERATING LOSS DEVELOPMENT TAX
FISCAL YEAR CARRYFORWARDS CREDIT CARRYFORWARDS
- ----------- ------------------ --------------------
2000............................ $ 3,659,000 --
2001............................ 2,870,000 $1,252,000
2002-2006....................... 1,369,000 150,000
2007-2013....................... 6,367,000 823,000
----------- ----------
$14,265,000 $2,225,000
=========== ==========
Pursuant to the Tax Reform Act of 1986, the utilization of net
operating loss carryforwards for tax purposes may be subject to an annual
limitation if a cumulative change of ownership of more than 50% occurs over a
three-year period. As a result of the Company's 1995 preferred stock financings,
such a change in ownership has occurred. As a result of this ownership change,
the use of the net operating loss carryforwards will be limited. The Company has
determined that its initial public offering did not cause another ownership
change. The Company has deferred tax assets of approximately $13.9 million
comprised primarily of net operating loss carryforwards and research and
development credits. The Company has fully reserved for these deferred tax
assets by recording a valuation allowance of $13.9 million, as the Company
believes that it is more likely than not that it will not be able to realize
this asset.
Pursuant to paragraphs 20 to 25 of Statement of Financial Accounting
Standards No. 109, the Company considered both positive and negative evidence in
assessing the need for a valuation allowance at December 31, 1998 and 1999. The
factors that weighed most heavily on the Company's decision to record a full
valuation allowance were (i) the substantial restrictions on the use of its
existing net operation loss (NOL) carryforwards and (ii) the uncertainty of
future profitability.
As a result of the ownership change described above, the future use of
approximately $10.9 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
F-13
<PAGE> 14
Company is also subject to rapid technological change, competition from
substantially larger competitors, a limited family of products and other related
risks, as more thoroughly described in the "Risk Factors" section of the
Company's Form 10-K, for the fiscal year ended December 31, 1999. 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 $3.4 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 $4.9 million and
$500,000 in 1999 and 1998, respectively, pursuant to the exercise of employee
stock options. The Company recorded this benefit as a component of additional
paid-in capital.
The difference between the expected combined federal and state tax rate
and the Company's effective tax rate in 1999 relates primarily to the use of
currently-generated tax credits and tax assets acquired as a part of the Empire
acquisition (Note 3). The difference in 1998 and 1997 relates primarily to the
use of substantially all of the Company's unrestricted NOL carryforwards.
(6) COMMITMENTS AND CONTINGENCIES
(a) Leases
In March, 1999 the Company signed a 7 year operating lease for its
principal operating facilities. Following the abandonment of the Company's
former office space, the Company recorded a third quarter charge of $700,000,
representing the remaining lease commitment, less expected sublease income. The
approximate future minimum rental payments under both leases are as follows:
AMOUNT
------------
2000.......................................... 1,773,000
2001.......................................... 2,321,000
2002.......................................... 2,327,000
2003.......................................... 2,036,000
2004.......................................... 2,073,000
Thereafter.................................... 3,218,000
------------
$ 13,749,000
============
F-14
<PAGE> 15
Rent expense was approximately $2.4 million, $464,000 and $346,000 for
the years ended December 31, 1999, December 31, 1998 and December 31, 1997,
respectively.
(b) Royalties
The Company has entered into several software license agreements that
provide the Company with exclusive worldwide licenses to distribute or utilize
certain patented computer software. The Company is required to pay royalties on
all related sales. Under one software license agreement, as amended, the Company
is obligated to make minimum quarterly royalty payments from 1995 through 1999.
The minimum payments are noncancelable and nonrefundable, but any minimum
payments in excess of amounts due for actual license sales in any quarter may be
used as a credit against future royalty fees in excess of the specified minimum
payments. The minimum royalty payments were paid in full in 1999. Royalty
expense under royalty agreements was approximately $1.0 million, $665,000 and
$903,000 for fiscal 1999, 1998 and 1997, respectively.
(c) Legal Proceedings
From time to time, the Company may be exposed to litigation relating to
its products and operations. The Company is not engaged in any legal proceedings
that are expected, individually or in the aggregate, to have a material adverse
effect on the Company's financial conditions or results of operations.
(7) ACCRUED EXPENSES
Accrued expenses consist of the following:
DECEMBER 31, DECEMBER 31,
1999 1998
------------ ------------
Payroll and payroll-related............. $1,932,735 $2,269,845
Royalties............................... 569,656 412,656
Outside commissions..................... 286,854 568,450
Customer deposits....................... 142,224 254,340
Deferred rent........................... 456,957 --
Loss on lease abandonment............... 700,000 --
Other................................... 2,797,401 1,582,693
---------- ----------
$6,885,827 $5,087,984
========== ==========
(8) EMPLOYEE BENEFIT PLAN
The Company maintains an employee benefit plan under Section 401(k) of
the Internal Revenue Code covering all eligible employees, as defined. The Plan
allows for employees to defer a portion of their salary up to 15% of pretax
compensation. While the Company has the discretion to make contributions to the
plan, no such contributions were made in 1999, 1998 or 1997.
F-15
<PAGE> 16
(9) VALUATION AND QUALIFYING ACCOUNTS
The following table sets forth activity in the Company's accounts
receivable reserve account:
BALANCE AT BALANCE AT
BEGINNING CHARGES TO END OF
OF YEAR EXPENSES DEDUCTIONS YEAR
---------- ---------- ---------- ------------
1997......... $210,116 $ 70,000 $ -- $280,116
1998......... $280,116 $169,884 $ -- $450,000
1999......... $450,000 $480,000 $ -- $930,000
(10) SEGMENT REPORTING AND INTERNATIONAL INFORMATION
The Company adopted SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information in the fiscal year ended December 31, 1998.
SFAS 131 establishes standards for reporting information regarding operating
segments in annual financial statements and requires selected information for
those segments to be presented in interim financial reports issued to
stockholders. SFAS 131 also establishes standards for related disclosures about
products and services and geographic areas. Operating segments are identified as
components of an enterprise about which separate discrete financial information
is available for evaluation by the chief operating decision maker, or decision
making group, in making decisions how to allocate resources and assess
performance. The Company's chief decision making group, as defined under SFAS
131, is the Executive Management Committee. To date, the Executive Management
Committee has viewed the Company's operations as principally one segment,
software sales and associated services. As a result, the financial information
disclosed herein, materially represents all of the financial information related
to the Company's principal operating segment. Revenues from international
locations were $16.3 million, $7.3 million and $2.4 million in 1999, 1998 and
1997, respectively. The Company's revenues from international locations were
primarily generated from customers located in Europe. Revenues from customers
located in Europe accounted for 13.1%, 12.6% and 10.3% of total revenues in
1999, 1998 and 1997, respectively. No one country accounts for greater than 10%
of total revenues. Substantially all of the Company's assets are located in the
United States.
(11) SUBSEQUENT EVENT
On February 4, 2000 the Company completed a merger with privately-held
FirstSense Software. FirstSense is a provider of application and service
response management solutions. The Company has reserved for issuance in
connection with the merger, 1,940,000 shares of Concord's common stock. The
transaction is being accounted for as a pooling-of-interests.
F-16
<PAGE> 1
Exhibit 99.2
CONCORD COMMUNICATIONS, INC.
FORM 8-K, DECEMBER 31, 1999
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
The Company develops, markets and supports next-generation performance
management solutions. Substantially all of the Company's revenues have been
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 herein and in the Company's Annual Report
and Form 10-K, for the fiscal year ended December 31, 1999, 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,
risks associated with the Company's recent acquisitions and other risks detailed
in the Company's filings with the Securities and Exchange Commission.
On October 19, 1999, 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
<PAGE> 2
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 of
common stock, $.01 par value per share, of the Company (the "Concord Common
Stock"). 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 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. All transactions between the two companies have been
eliminated in the combined results. The Results of Operations reflect these
combined results.
SUBSEQUENT EVENT
On February 4, 2000, the Company completed a merger with privately-held
FirstSense Software, Inc. FirstSense is a provider of application and service
response management solutions. The Company has reserved for issuance in
connection with the merger, 1,940,000 shares of Concord's common stock. The
transaction is being accounted for as a pooling-of-interests.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
financial data as percentages of the Company's total revenue.
All prior-period financial statements presented have been restated for the
acquisition of Empire Technologies, Inc. (See Note 3 to financial statements)
FISCAL YEAR
---------------------------
1999 1998 1997
---- ---- ----
Revenues:
License revenues 78.3 % 83.5 % 89.2 %
Service revenues 21.7 % 16.5 % 10.8 %
---------------------------
Total revenues 100.0 % 100.0 % 100.0 %
Cost of revenues 12.0 % 11.3 % 14.1 %
---------------------------
Gross Profit 88.0 % 88.7 % 85.9 %
---------------------------
Operating expenses:
Research and development 16.9 % 17.8 % 24.5 %
Sales and marketing 38.1 % 42.3 % 49.2 %
General and administrative 5.5 % 6.8 % 10.0 %
Stock-based compensation 3.8 % 2.4 % --
Acquisition-related charges 0.8 % -- --
---------------------------
Operating income 22.9 % 19.5 % 2.2 %
Other income, net 4.6 % 5.5 % 1.5 %
---------------------------
Income before income taxes 27.5 % 25.0 % 3.7 %
Provision for income taxes 8.8 % 1.3 % --
---------------------------
Net income 18.7 % 23.7 % 3.7 %
===========================
<PAGE> 3
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") No. 97-2, Software Revenue Recognition, as modified by SOP 98-9,
Modification of SOP 97-2,Software Revenue Recognition with respect to Certain
Transactions. 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.
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 $16.3 million, $7.3 million
and $2.4 million of revenues from international locations in 1999, 1998 and
1997, representing 24.2%, 17.6% and 11.6% 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 13.1%, 12.6% and 10.3% of total revenues in 1999, 1998 and 1997,
respectively. The continued increase in revenues from international locations as
a percentage of total revenues 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. Total revenues were $67.3 million, $41.5 million and $20.7
million in 1999, 1998 and 1997, respectively, representing increases of 62.4%
from 1998 to 1999 and 100.5% from 1997 to 1998.
LICENSE REVENUES. The Company's license revenues are derived from the
licensing of software products. License revenues were $52.7 million, $34.6
million and $18.5 million, in 1999, 1998 and 1997, respectively, representing
increases of 52.3% from 1998 to 1999 and 87.5% from 1997 to 1998. License
revenues accounted for 78.3%, 83.5% and 89.2% of total revenues in 1999, 1998
and 1997, respectively. The increase in license revenues in absolute dollars
resulted from increased sales to new customers and additional sales to existing
customers for new products and upgrades of existing licenses. The decrease in
license revenues as a percent of total revenues was the result of a significant
increase in service revenues due to larger service opportunities in the
installed customer base. There were no price increases for products during 1999.
<PAGE> 4
SERVICE REVENUES. The Company's service revenues consist of fees for
maintenance, training and professional services. Service revenues were $14.6
million, $6.9 million and $2.2 million in 1999, 1998 and 1997, respectively,
representing increases of 113.4% from 1998 to 1999 and 208.2% from 1997 to 1998.
Service revenues accounted for 21.7%, 16.5% and 10.8% of total revenues in 1999,
1998 and 1997, respectively. The increase in service revenues was attributed to
an increase in revenue from maintenance contracts, training and professional
services generated by new and existing service offerings into an expanded
installed customer base.
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, training and professional services contracts. Royalty costs are
composed of third party software costs. Cost of revenues were $8.1 million, $4.7
million and $2.9 million in 1999, 1998 and 1997, respectively, representing
increases of 72.9% from 1998 to 1999 and 59.9% from 1997 to 1998. Cost of
revenues accounted for 12.0%, 11.3% and 14.1% of total revenues in 1999, 1998
and 1997, respectively, resulting in gross margins of 88.0%, 88.7% and 85.9% in
each respective period. The increase in cost of revenues, as well as the
decrease in the gross margin percentages from 1998 to 1999 was primarily the
result of increased spending in customer support to be more responsive to
growing customer needs. The improvement in the gross margin percentages from
1997 to 1998 was attributable to lower royalty unit costs associated with the
higher sales volumes during the 1998 period.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist primarily of personnel costs associated with software development.
Research and development expenses were $11.4 million, $7.4 million and $5.1
million in 1999, 1998 and 1997, respectively, representing an increase of 54.5%
from 1998 to 1999 and 45.7% from 1997 to 1998. Research and development expenses
accounted for 20.7%, 20.2% and 24.5% of total revenues in 1999, 1998 and 1997,
respectively. The increase in absolute dollars was primarily due to increased
headcount in research and development from 57 to 81 people from 1998 to 1999 and
42 to 57 people from 1997 to 1998. The Company anticipates that it will continue
to commit substantial resources to research and development in the future and
that product development expenses may increase in absolute dollars in future
periods.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of salaries, commissions to sales personnel and agents, travel,
tradeshow participation, public relations and other promotional expenses. Sales
and marketing expenses were $25.7 million, $17.5 million and $10.2 million in
1999, 1998 and 1997, respectively, representing an increase of 46.6% from 1998
to 1999 and 72.2% from 1997 to 1998. Sales and marketing expenses accounted for
38.1%, 42.3% and 49.2% of total revenues in 1999, 1998 and 1997, respectively.
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
<PAGE> 5
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 and improved lead
generation. Headcount in sales and marketing at the end of 1999, 1998 and 1997
was 119, 76 and 45 people, respectively.
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 were $3.7 million, $2.8 million and $2.1
million in 1999, 1998 and 1997, respectively, representing an increase of 31.3%
from 1998 to 1999 and 36.1% from 1997 to 1998. General and administrative
expenses accounted for 5.5%, 6.8% and 10.0% of total revenues in 1999, 1998 and
1997, respectively. The increase in absolute dollars reflects personnel growth
and associated costs in general support areas. General and administrative
expenses declined as a percentage of total revenues due to a significant
increase in revenues.
ACQUISITION-RELATED EXPENSES. Acquisition-related expenses included
accounting, legal and investment banking fees associated with the acquisition of
Empire Technologies, Inc.
OTHER INCOME (EXPENSE), NET. Other income consists of interest earned on
funds available for investment net of interest expense in connection with the
financing of capital equipment. The Company realized net other income of $3.1
million, $2.3 million and $306,000, respectively, in 1999, 1998 and 1997.
INCOME TAXES. The difference between the expected combined federal and
state tax rate and the Company's effective tax rate in 1999 relates primarily to
the use of currently-generated tax credits and tax assets acquired as a part of
the Empire acquisition. The difference in 1998 and 1997 relates primarily to the
use of substantially all of the Company's unrestricted NOL carryforwards. In
addition, the Company received a tax benefit of approximately $500,000 pursuant
to the exercise of employee stock options in 1998 and a tax benefit of
approximately $4.9 million pursuant to the exercise of employee stock options in
1999. The Company recorded this benefit as a component of additional paid in
capital.
LIQUIDITY AND CAPITAL RESOURCES
The Company has 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.
<PAGE> 6
The Company received net proceeds of approximately $34.7 million. The Company
had working capital of $55.4 million at December 31, 1999.
Net cash provided by operating activities was $11.6 million, $16.1 million
and $2.3 million in 1999, 1998 and 1997, respectively. Cash, cash equivalents
and marketable securities were $62.0 million, $51.2 million and $36.9 million in
1999, 1998 and 1997, respectively. Deferred revenues increased for the year
ended December 31, 1999 by $4.4 million due to an increase in overall sales
activity; $4.1 million of this increase came from deferred maintenance contracts
and $294,000 was the result of 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 1999 and 1998 and from the proceeds from and repayments of bank
borrowings in connection with equipment purchases during 1997.
Pursuant to the Tax Reform Act of 1986, the utilization of net operating
loss carryforwards for tax purposes may be subject to an annual limitation if a
cumulative change of ownership of more than 50% occurs over a three-year period.
As a result of the Company's 1995 preferred stock financings, such a change in
ownership has occurred. As a result of this ownership change, the use of the net
operating loss carryforwards will be limited. The Company has determined that
its initial public offering did not cause another ownership change. The Company
has deferred tax assets of approximately $13.9 million comprised primarily of
net operating loss carryforwards and research and development credits. The
Company has fully reserved for these deferred tax assets by recording a
valuation allowance of $13.9 million, as the Company believes that it is more
likely than not that it will not be able to realize this asset.
Pursuant to paragraphs 20 to 25 of Statement of Financial Accounting
Standards No. 109, the Company considered both positive and negative evidence in
assessing the need for a valuation allowance at December 31, 1998 and 1999. The
factors that weighed most heavily on the Company's decision to record a full
valuation allowance were (i) the substantial restrictions on the use of its
existing net operation loss (NOL) carryforwards and (ii) the uncertainty of
future profitability.
As a result of the ownership change described above, the future use of
approximately $10.9 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
<PAGE> 7
unrestricted NOL and credit carryforwards in computing the 1998 tax provision.
The Company is also subject to rapid technology changes, 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, 1999. 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
$3.4 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 difference between the expected combined federal and state tax rate and
the Company's effective tax rate in 1999 relates primarily to the use of
currently-generated tax credits and tax assets acquired as a part of the Empire
acquisition. The difference in 1998 and 1997 relates primarily to the use of
substantially all of the Company's unrestricted NOL carryforwards.
In addition, the Company received a tax benefit of approximately $500,000
pursuant to the exercise of employee stock options in 1998 and a tax benefit of
approximately $4.9 million pursuant to the exercise of employee stock options in
1999. The Company recorded this benefit as a component of additional paid-in
capital.
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 December 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.
<PAGE> 8
YEAR 2000 COMPLIANCE / YEAR 2000 READINESS DISCLOSURE STATEMENT
The Company was aware of the issues associated with the programming code in
existing computer systems and software products as the millennium (Year 2000)
approached. The Company set up a task force which consisted of the Director of
IT and Operations, the Manager of System Applications and representative
personnel from each functional area. This task force addressed 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 also assessed its Year 2000 associated costs,
risks and potential contingency plans. Despite the Company's efforts with
respect to the Year 2000 issue, there can be no assurance that the Company's
business, results of operations or financial condition would not be materially
adversely affected by the failure of the Company's products, its internal
systems and applications or the systems of its third party suppliers and service
providers to properly operate or manage data beyond 1999.
NETWORK HEALTH PRODUCT. In 1997, the Company initiated the necessary development
to ensure Year 2000 compliance in the Network Health family of applications and
believes it has achieved Year 2000 compliance in Network Health 4.1 which was
released in August 1998. The Company's existing customers can receive this
release, at no charge, through their annual software maintenance contract. The
Company requires its customers to purchase software maintenance in order to
receive product support. Specifically, the Company defines Year 2000 Compliance
as the following: no value for current date will cause any interruption in
operation; date-based functionality must behave consistently for dates prior to,
during, and after Year 2000; in all interfaces and data storage, the century in
any date must be specified either explicitly or by unambiguous algorithms or
inferencing rules; Year 2000 must be recognized as a leap year. The Company's
definition of Year 2000 Compliance is adopted from the British Standard
Institute's Definition of Year 2000 Conformity Requirements (PD2000-1). A copy
of the standard is available for review on the Company's website. The Company
makes no guarantee of, claims no responsibility for, and disclaims any liability
to its customers, with respect to Year 2000 compliance of operating platforms,
hardware, software, or other products not developed by the Company, including
equipment monitored by the Network Health product. None of the Company's
customers have reported any Year 2000 related problems with the Company's
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
identified, modified, upgraded, and/or replaced any systems that had been
identified as non-Year 2000 compliant to minimize the possibility of a
<PAGE> 9
material disruption to its business. The Company finished assessing all existing
internal systems and completed 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 could also have
been affected by the Year 2000 issue. The Company identified and remedied any
Year 2000 issues on its office and facilities equipment.
SYSTEMS OF EXTERNAL SUPPLIERS AND SERVICE PROVIDERS. The Company 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 also initiated communications with facilities service providers upon
which the Company relies for daily operations. All external suppliers and
service providers had been asked to provide a written assurance that they were
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 was received from 100% of these suppliers
and service providers. There were no Y2000 associated problems with systems
operated by other companies upon which the Company relies.
ASSOCIATED COSTS. To date, the Company has not incurred any material costs
related to the assessment, upgrade or replacement of existing systems identified
as non-Year 2000 compliant. Management has assessed the total Year 2000
compliance expense and found that the amounts required to be expensed in 1999
did not have an adverse material effect on its business, results of operations
or financial condition.
ASSOCIATED RISKS. The Company believes it has identified and resolved all Year
2000 issues that could have materially adversely affected its business,
financial condition or results of operations. However, management realizes it
may not be possible to determine, at this time, with complete certainty that all
Year 2000 problems affecting the Company were corrected. 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 worked to identify
scenarios with significant risks, which could have required contingency plans
and had contingency plans in place before the end of 1999.
