<PAGE>
================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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: 000-29678
SCC COMMUNICATIONS CORP.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 84-0796285
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
6285 LOOKOUT ROAD 80301
BOULDER, COLORADO
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (303) 581-5600
Indicate by check mark whether the 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 (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of October 31, 1999, there were 11,055,280 shares of the Registrant's
Common Stock outstanding.
================================================================================
<PAGE>
INDEX
PART 1 - FINANCIAL INFORMATION
Item 1 - Financial Statements
Balance Sheets as of September 30, 1999 (Unaudited) and December 31,
1998
Statements of Operations for the three-months ended September 30,
1999 and 1998 and the nine-months ended September 30, 1999 and 1998
(Unaudited)
Statements of Cash Flows for the nine-months ended September 30,
1999 and 1998 (Unaudited)
Notes to Financial Statements (Unaudited)
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings
Item 2 - Changes in Securities and Use of Proceeds
Item 3 - Defaults on Senior Securities
Item 4 - Submission of Matters to a Vote of Security Holders
Item 5 - Other Information
Item 6 - Exhibits and Reports on Form 8-K
Signatures
2
<PAGE>
SCC COMMUNICATIONS CORP.
BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
----------------- ------------------
<S> <C> <C>
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 8,200 $ 10,266
Short-term investments.................................... 10,671 7,761
Accounts receivable, net of allowance for doubtful
accounts of approximately $100 and $50 in 1999 and 1998, 2,772 4,820
respectively.............................................
Unbilled project revenue.................................. 810 1,035
Prepaids and other........................................ 885 484
Deferred income taxes -- current portion.................. 2,108 2,025
-------- --------
Total current assets.................................... 25,446 26,391
-------- --------
PROPERTY AND EQUIPMENT, at cost:
Computer hardware and equipment........................... 25,010 23,687
Furniture and fixtures.................................... 926 800
Leasehold improvements.................................... 911 920
-------- --------
26,847 25,407
Less -- Accumulated depreciation.......................... (14,553) (11,056)
-------- --------
Total property and equipment........................... 12,294 14,351
-------- --------
OTHER ASSETS............................................... 90 112
LONG-TERM INVESTMENTS...................................... 1,001 2,054
DEFERRED INCOME TAXES -- NONCURRENT........................ 1,950 1,504
SOFTWARE DEVELOPMENT COSTS, net of accumulated
amortization of $515 and $346 in 1999 and 1998, 940 683
respectively.............................................. -------- --------
$ 41,721 $ 45,095
======== ========
</TABLE>
The accompanying notes to financial statements are an integral part of these
balance sheets.
3
<PAGE>
SCC COMMUNICATIONS CORP.
BALANCE SHEETS
(dollars in thousands)
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------------- ----------------
<S> <C> <C>
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.................................................................. $ 672 $ 1,211
Payroll-related accruals.......................................................... 814 734
Other accrued liabilities......................................................... 1,742 2,546
Property and other tax liabilities................................................ 689 696
Current portion of capital lease obligations...................................... 1,759 1,618
Deferred contract revenue......................................................... 876 1,908
-------- -------
Total current liabilities................................................. 6,552 8,713
LONG-TERM DEBT:
Capital lease obligations, net of current portion................................. 2,074 2,791
-------- -------
Total liabilities......................................................... 8,626 11,504
-------- -------
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value; 15,000,000 shares authorized; none issued or
outstanding....................................................................... -- --
Common stock, $.001 par value; 30,000,000 shares authorized; 11,051,068 and
10,886,353 shares issued in 1999 and 1998, respectively........................... 11 10
Additional paid-in capital........................................................ 43,665 43,320
Stock subscriptions receivable.................................................... (37) (59)
Accumulated deficit............................................................... (10,544) (9,680)
-------- -------
Total stockholders' equity................................................ 33,095 33,591
-------- -------
$ 41,721 $45,095
======== =======
</TABLE>
The accompanying notes to financial statements are an integral part of these
balance sheets.
4
<PAGE>
SCC COMMUNICATIONS CORP.
STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
Unaudited
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
1999 1998 1999 1998
-------- -------- -------- --------
REVENUE:
<S> <C> <C> <C> <C>
Data management services.............................................. $ 8,175 $ 7,377 $ 23,723 $ 22,858
Licenses and implementation services.................................. 122 1,123 379 2,901
-------- -------- -------- --------
Total revenue.................................................. 8,297 8,500 24,102 25,759
COSTS AND EXPENSES:
Cost of data management services...................................... 6,155 5,260 18,002 15,299
Cost of licenses and implementation services.......................... 16 265 116 939
Sales and marketing................................................... 1,307 1,073 4,008 3,109
General and administrative............................................ 1,225 1,243 3,786 3,574
-------- -------- -------- --------
Total costs and expenses....................................... 8,703 7,841 25,912 22,921
-------- -------- -------- --------
INCOME (LOSS) FROM OPERATIONS........................................... (406) 659 (1,810) 2,838
OTHER INCOME (EXPENSE):
Interest and other income............................................. 269 298 804 362
Interest and other expense............................................ (125) (118) (386) (764)
-------- -------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES....................................... (262) 839 (1,392) 2,436
PROVISION (BENEFIT) FOR INCOME TAXES.................................... (99) 8 (529) 120
-------- -------- -------- --------
NET INCOME (LOSS) BEFORE EXTRAORDINARY ITEM............................. (163) 831 (863) 2,316
LOSS FROM EARLY EXTINGUISHMENT OF DEBT.................................. -- -- -- (1,442)
-------- -------- -------- --------
NET INCOME (LOSS)....................................................... $ (163) $ 831 $ (863) $ 874
======== ======== ======== ========
Dividends accrued on Series D, E and F
mandatorily redeemable convertible preferred stock.................... -- -- -- (355)
Common stock warrant put price adjustment............................... -- -- -- (77)
-------- -------- -------- --------
NET INCOME (LOSS) APPLICABLE TO COMMON STOCK............................ $ (163) $ 831 $ (863) $ 442
======== ======== ======== ========
NET INCOME (LOSS) PER SHARE BEFORE EXTRAORDINARY ITEM (Note 2):
Basic................................................................. $ (0.01) $ 0.08 $ (0.08) $ 0.36
======== ======== ======== ========
Diluted............................................................... $ (0.01) $ 0.07 $ (0.08) $ 0.24
======== ======== ======== ========
NET INCOME (LOSS) PER SHARE (Note 2):
Basic................................................................. $ (0.01) $ 0.08 $ (0.08) $ 0.09
======== ======== ======== ========
Diluted............................................................... $ (0.01) $ 0.07 $ (0.08) $ 0.09
======== ======== ======== ========
SHARES USED IN COMPUTING NET INCOME (LOSS) PER SHARE (Note 2):
Basic................................................................. 11,050,697 10,746,425 10,963,830 5,172,500
========== ========== ========== =========
Diluted............................................................... 11,050,697 11,322,876 10,963,830 9,757,457
========== ========== ========== =========
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
5
<PAGE>
SCC COMMUNICATIONS CORP.
STATEMENTS OF CASH FLOWS
(dollars in thousands)
Unaudited
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
--------------------------
1999 1998
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income (loss)......................................................................... $ (863) $ 874
Adjustments to reconcile net income (loss) to net cash provided by
Operating activities --
Amortization and depreciation........................................................... 3,806 3,155
Amortization of note payable discount................................................... -- 148
Write off of note payable discount...................................................... -- 1,282
Accretion of and interest accrued on investments........................................ (214) (259)
Loss on disposal of assets.............................................................. 38 --
Deferred income tax benefit............................................................. (529) --
Provision for estimated losses on contracts............................................. -- (38)
Provision for doubtful accounts......................................................... 50 17
Change in --
Accounts receivable................................................................... 1,998 (2,116)
Unbilled project revenue.............................................................. 225 (139)
Prepaids and other.................................................................... (379) (453)
Accounts payable...................................................................... (109) (203)
Accrued liabilities................................................................... (408) 278
Deferred contract revenue............................................................. (1,032) (1,559)
----------- -----------
Net cash provided by operating activities........................................... 2,583 987
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment..................................................... (1,516) (2,085)
Purchase of marketable securities......................................................... (8,643) (12,482)
Sale of marketable securities............................................................. 7,000 --
Software development costs................................................................ (426) (251)
----------- -----------
Net cash used in investing activities............................................... (3,585) (14,818)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on notes payable....................................................... -- (4,986)
Principal payments on capital lease obligations........................................... (1,432) (1,248)
Exercise of stock options................................................................. 258 29
Proceeds from initial public offering, net of underwriter's discount...................... -- 26,952
Costs related to initial public offering.................................................. -- (935)
Proceeds received from employee stock purchase plan....................................... 88 --
Payments received from stock subscriptions................................................ 22 38
----------- -----------
Net cash provided by (used in) financing activities................................. (1,064) 19,850
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........................................ (2,066) 6,019
CASH AND CASH EQUIVALENTS, beginning of period.............................................. 10,266 2,503
----------- -----------
CASH AND CASH EQUIVALENTS, end of period.................................................... $ 8,200 $ 8,522
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest.................................................. $ 351 $ 943
=========== ===========
Cash paid during the period for taxes..................................................... $ 356 $ 92
=========== ===========
SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING AND INVESTING ACTIVITIES:
Dividends accrued on Series D, E and F Convertible Preferred Stock........................ $ -- $ 355
=========== ===========
Property acquired with capital leases..................................................... $ 856 $ 3,400
=========== ===========
Accrual of costs related to initial public offering....................................... $ -- $ 28
=========== ===========
Conversion of preferred stock to common stock............................................. $ -- $ 14,944
=========== ===========
Conversion of common stock warrants to common stock....................................... $ -- $ 1,549
=========== ===========
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
6
<PAGE>
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The unaudited financial statements included herein reflect all adjustments,
consisting only of normal recurring adjustments, which in the opinion of
management are necessary to fairly present the Company's financial position,
results of operations and cash flows for the periods presented. Certain
information and footnote disclosures normally included in audited financial
information prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the Securities and Exchange
Commission's rules and regulations. The results of operations for the period
ended September 30, 1999 are not necessarily indicative of the results to be
expected for any subsequent quarter or for the entire fiscal year ending
December 31, 1999. These financial statements should be read in conjunction
with the financial statements and notes thereto for the year ended December 31,
1998, which are included in the Company's Annual Report on Form 10-K.
NOTE 2 - EARNINGS PER SHARE
"Basic income (loss) per share" is determined by dividing net income (loss)
available to common shareholders by the weighted average number of common shares
outstanding during each period. "Diluted income (loss) per share" includes the
effects of potentially issuable common stock, but only if dilutive (i.e., a loss
per share is never reduced). The treasury stock method, using the average price
of the Company's common stock for the period, is applied to determine dilution
from options and warrants. The if-converted method is used for convertible
securities. Potentially dilutive common stock options that were excluded from
the calculation of diluted income per share because their effect is antidilutive
totaled 816,088 and 37,622 for the three months ended September 30, 1999 and
1998, respectively, and 1,132,604 and 149,270 for the nine months ended
September 30, 1999 and 1998, respectively.
A reconciliation of the numerators and denominators used in computing per
share net income from continuing operations before extraordinary item is as
follows:
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------- --------------------------------
1999 1998 1999 1998
----------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Numerator:
Net income (loss) before
extraordinary item (numerator for
diluted income (loss) per share).. $ (163,000) $ 831,000 $ (863,000) $2,316,000
Dividends on Convertible preferred
stock............................. -- -- -- (355,000)
Common stock warrant put price
adjustment........................ -- -- -- (77,000)
----------- ----------- ----------- ----------
Numerator for basic income (loss)
per share......................... $ (163,000) $ 831,000 $ (863,000) $1,884,000
=========== =========== =========== ==========
Denominator for basic income (loss)
per share:
Weighted average common shares
outstanding....................... 11,050,697 10,746,425 10,963,830 5,172,500
=========== =========== =========== ==========
Denominator for diluted income
(loss) per share:
Convertible Preferred Stock....... -- -- -- 3,921,698
Weighted average common shares
outstanding....................... 11,050,697 10,746,408 10,963,830 5,172,493
Options issued to employees....... -- 576,468 -- 539,611
Putable common stock warrant...... -- -- -- 123,655
----------- ----------- ----------- ----------
Denominator for diluted
income (loss) per share...... 11,050,697 11,322,876 10,963,830 9,757,457
=========== =========== =========== ==========
</TABLE>
7
<PAGE>
Income (loss) per common share was computed as follows:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------ ------------------------
1999 1998 1999 1998
---------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Basic income (loss) per share:
Income (loss) per share before
extraordinary item........................... $ (0.01) $ 0.08 $ (0.08) $ 0.36
========== =========== ========== ==========
Net loss per share from extraordinary item.... $ -- $ -- $ -- $ (0.27)
========== =========== ========== ==========
Basic net loss per share................. $ (0.01) $ 0.08 $ (0.08) $ 0.09
========== =========== ========== ==========
Diluted income (loss) per share:
Income (loss) per share before
extraordinary item........................... $ (0.01) $ 0.07 $ (0.08) $ 0.24
========== =========== ========== ==========
Net loss per share from extraordinary item.... $ -- $ -- $ -- $ (0.15)
========== =========== ========== ==========
Diluted net income (loss) per share...... $ (0.01) $ 0.07 $ (0.08) $ 0.09
========== =========== ========== ==========
</TABLE>
NOTE 3 - REPORTABLE SEGMENTS
The Company has two reportable segments, data management services and licenses
and implementation services. The Company measures its reportable segments based
on revenue for each segment and costs directly related to each segment. General
and administrative, sales and marketing and other costs are not measured by
segment. Data management services include the provisioning of an outsourcing
solution for 9-1-1 data management to customers, including ILECs, CLECs and
wireless carriers. Licenses and implementation services include the licensing,
customization and installation of the Company's 9-1-1 software solutions.
Substantially all of the Company's customers are in the United States.
These segments are managed separately because the nature of and resources used
for each segment is unique. Data management services include ongoing data
management and monitoring of systems and other enhanced services. Under data
management services, the customer's data is transferred to the Company's systems
and the Company owns the systems used to manage the data. Under licenses and
implementation services, the customer performs data management and systems
monitoring activities. The customer also owns the hardware, licenses the
Company's software and maintains the data on its internal systems under this
segment.
Revenue and costs are segregated in the Statement of Operations for the two
reportable segments. The Company does not segregate assets between the
segments, as it is impractical to do so.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.
FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO,
THOSE DISCUSSED UNDER THE CAPTION "FACTORS THAT MAY AFFECT FUTURE RESULTS"
CONTAINED HEREIN.
Overview
SCC is the leading provider of 9-1-1 operations support systems ("OSS")
services to incumbent local exchange carriers ("ILECs"), competitive local
exchange carriers ("CLECs") and wireless carriers in the United States. The
Company manages the data that enable a 9-1-1 call to be routed to the
appropriate public safety agency with accurate and timely information about the
caller's identification and location. The Company was incorporated in July 1979
in the State of Colorado under the name Systems Concepts of Colorado, Inc. and
was reincorporated in September 1993 in the State of Delaware under the name SCC
Communications Corp. Prior to 1995, substantially all of the Company's revenue
was derived from the sale of software licenses and related implementation
services to ILECs and public safety agencies. During 1994, the Company began
investing in infrastructure to provide its 9-1-1 OSS solution to telephone
operating companies seeking to outsource such operations. The Company signed its
first 9-1-1 data management services contract in August 1994 and added to the
number of records under management in subsequent years. The Company began to
recognize revenue from wireless carriers in the third quarter of 1997.
SCC's data management services revenue is derived from contracts with ILECs,
CLECs and wireless carriers pursuant to which the Company provides an
outsourcing solution for its customers' 9-1-1 data management. Revenue included
in data management services generally includes a non-recurring initial fee for
the design and implementation of the 9-1-1 OSS, conversion of the customer's
data to the Company's systems, hiring and training of personnel, and other costs
required to prepare for the processing of customer data. Non-recurring fees are
recognized on the percentage-of-completion method over the period required to
perform the tasks necessary to prepare for the processing of customer data. The
Company also generally receives a monthly service fee based on the number of
subscriber records under management, which is recognized in the period in which
the services are rendered. Data management services revenue also may include
revenue from enhanced products and services, which are recognized in the period
in which the services are performed. Related costs are expensed as they are
incurred. Data management services revenue comprised 98% and 89% of the
Company's total revenue in the nine months ended September 30, 1999 and 1998,
respectively.
SCC's licenses and implementation services revenue is derived from contracts
with ILECs pursuant to which the Company provides a 9-1-1 software license or
related products and services such as implementation, training, software
enhancements and interfaces to its customers' systems. Licenses and
implementation services revenue is recognized using the percentage-of-completion
method. The related costs include third-party licenses, direct labor and related
expenses, and are expensed as incurred. Subsequent to system installation, the
Company provides its customers with maintenance services that are recognized
ratably over the related contract period on a straight-line basis. The Company's
licenses and implementation services revenue is derived from a limited number of
customers and consequently the concentration of customers can result in
quarterly fluctuations based on the timing of the signing of new contracts and
completion of existing contracts. Margins on such contracts also may fluctuate
based on the elements included in the contract. Licenses and implementation
services revenue comprised 2% and 11% of the Company's total revenue in the nine
months ended September 30, 1999 and 1998, respectively.
During the nine months ended September 30, 1999, the Company recognized
approximately 78% of total revenue from Ameritech, BellSouth Inc. and U.S. WEST,
each of which accounted for greater than 10% of the Company's total revenue in
such period. During the nine months ended September 30, 1998, the Company
recognized approximately 84% of total revenue from Ameritech, AT&T, BellSouth
Inc. and U.S. WEST, each of which accounted for greater than 10% of the
Company's total revenue in such period. In the third quarter of 1998, one of
the Company's licenses and implementation services customers, Bell Atlantic, who
merged with Nynex, announced its decision to standardize its 9-1-1 hardware and
software platform utilizing non-SCC systems that had been used by Nynex prior to
the merger. This transition will occur over the course of 1999, during which
time SCC will continue to support the systems installed in Bell Atlantic and
will co-operate fully to ensure a smooth transition of these systems. Bell
Atlantic comprised approximately 8% of the Company's total revenue in the year
ended December 31, 1998. See "Factors that May Affect Future Results --
Reliance on Significant Customers."
9
<PAGE>
As of December 31, 1998, the Company had net operating loss carryforwards of
$8.5 million available to offset future net income for U.S. federal income tax
purposes. Thus, the Company's income tax provision for past fiscal years
consisted of alternative minimum taxes, state income taxes in states where the
Company has not had net operating loss carryforwards to offset net income, and
foreign taxes. As of December 31, 1998, the Company reversed all but $450,000 of
the valuation allowance on its deferred tax assets as the Company believes that
it is more likely than not that such tax benefits will be realized. The Company
evaluates the valuation allowance each accounting period and adjusted the
valuation allowance for the utilization of the net operating loss carryforward
for the nine months ended September 30, 1999. There is no assurance that the
Company's remaining deferred tax benefit will be offset by future taxable income
or will not be restricted in the future due to transactions entered into by the
Company or changes in tax legislation.
In June and July 1998, the Company completed an initial public offering of its
common stock, which generated proceeds of $26.0 million, net of the
underwriter's discount and other estimated offering costs and including the
exercise of the underwriters' overallotment option. See "Liquidity and Capital
Resources."
Historically, substantially all of the Company's revenue has been generated
from sales to customers in the United States. However, the Company has generated
revenue in Canada and intends to enter additional international markets, which
may require significant management attention and financial resources.
International sales are subject to a variety of risks. See "Factors That May
Affect Future Results -- Risks Associated with International Sales."
Although the Company experienced a profit in 1998, the Company generated a net
loss of $863,000 in the nine months ended September 30, 1999 and has experienced
significant fluctuations in its quarterly results. The Company's operating
results may continue to fluctuate as a result of many factors, including the
length of the sales cycles for new or existing customers, the size, timing or
duration of significant customer contracts, fluctuations in number of subscriber
records under management, timing or duration of service offerings, rate of
adoption of wireless services by Public Safety Answering Points, efforts
expended to accelerate the introduction of certain new products, ability of the
Company to hire, train and retain qualified personnel, increased competition,
changes in operating expenses, changes in Company strategy, the financial
performance of the Company's customers, changes in telecommunications
legislation and regulations that may affect the competitive environment for the
Company's services, and general economic factors. The Company's contracts for
data management services generally include a non-recurring initial fee, and
therefore, the Company may recognize significantly increased revenue for a short
period of time upon commencing services for a new customer.
The Company's expense levels are based in significant part on its expectations
regarding future revenue. The Company's revenue is difficult to forecast because
the market for the Company's services is evolving rapidly and the length of the
Company's sales cycle, the size and timing of significant customer contracts and
license fees and the timing of recognition of non-recurring initial fees vary
substantially among customers. Accordingly, the Company may be unable to adjust
spending in a timely manner to compensate for any unexpected shortfall in
revenue. Any significant shortfall could therefore have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, the Company hired a significant number of employees in 1998 and
expects to continue hiring additional employees during 1999. The Company expects
that this increase will affect the Company's operating margins for the short
term. There can be no assurance that the Company can resume reporting operating
profits, and failure to do so could have a material adverse effect on the
Company's business, financial condition and results of operations.
Three Months Ended September 30, 1999 Compared to Three Months Ended September
30, 1998
Revenue
Total Revenue. Total revenue decreased 2%, from $8.5 million in the third
quarter of 1998 to $8.3 million in the third quarter of 1999.
Data Management Services Revenue. Data management services revenue increased
11%, from $7.4 million in the third quarter of 1998 to $8.2 million in the third
quarter of 1999, representing 87% and 99% of total revenue for such periods,
respectively. Data management services revenue increased due to an increase in
the number of records under management for ILEC and CLEC customers and an
increase in non-recurring fees from CLEC customers due to the signing of new
contracts. These increases were partially offset by monthly minimum fees from a
wireless carrier in the third quarter of 1998 that expired at the end of 1998.
10
<PAGE>
Licenses and Implementation Services. Revenue from licenses and
implementation services decreased 89%, from $1.1 million in the third quarter of
1998 to $122,000 in the third quarter of 1999, as the Company had no licenses
and implementation services contracts in process during the third quarter of
1999 other than warranty contracts.
Costs and Expenses
Cost of Data Management Services. Cost of data management services consists
primarily of labor and costs of interconnection with customers' systems and the
Company's infrastructure. Cost of data management services increased 17%, from
$5.3 million in the third quarter of 1998 to $6.2 million in the third quarter
of 1999, representing 62% and 74% of total revenue for such periods,
respectively, and 71% and 75% of data management services revenue in the third
quarter of 1998 and 1999, respectively. The dollar increase was due to the
reallocation of resources from licenses and implementation services to data
management services, increased depreciation expense and additional telephone
lines to accommodate growth in the Company's wireless and wireline operations
and additional headcount and related costs incurred in anticipation of growth
for both wireline and wireless services. The percentage increase occurred
primarily because the rollout of the Company's wireless and enhanced services
has been slower than anticipated, although the Company has built the
infrastructure to service the anticipated demand. In addition, in the third
quarter of 1998, the Company recorded monthly minimum fees from a wireless
customer which expired at the end of 1998.
Cost of Licenses and Implementation Services. Cost of licenses and
implementation services consists primarily of labor, license fees for third
party software and related expenses. Cost of licenses and implementation
services decreased 94%, from $265,000 in the third quarter of 1998 to $16,000 in
the third quarter of 1999, representing 3% and 0.2% of total revenue for such
periods, respectively. Additionally, cost of licenses and implementation
services revenue represented 24% and 13% of licenses and implementation services
revenue in the third quarter of 1998 and 1999, respectively. The dollar
decrease occurred because the Company had no licenses and implementation
services contracts in process during the third quarter of 1999 other than
warranty contracts.
Sales and Marketing. Sales and marketing expenses consist primarily of
expenses related to salaries and commissions, travel, trade shows and sales
collateral. Sales and marketing expenses increased 22%, from $1.1 million in
the third quarter of 1998 to $1.3 million in the third quarter of 1999,
representing 13% and 16% of total revenue in such quarters, respectively. The
dollar increase was due to the addition of marketing personnel, the creation of
a government affairs department to interpret and influence legislation primarily
related to the Company's wireless operations and related legal expenses and the
addition of sales staff for enhanced services.
General and Administrative. General and administrative expenses consist
primarily of expenses related to the Company's information systems, finance,
human resources, legal, executive and financial planning departments. General
and administrative expenses remained constant at $1.2 million in the third
quarter of both 1998 and 1999, representing 15% of total revenue in the third
quarter of both 1998 and 1999. The Company experienced increases due to the
addition of information technology staff and related expenses and the creation
of an investor relations department. These increases were offset by a decrease
in payroll and other expenses related to the resignation of the Company's chief
operating officer and chief financial officer.
Other income (expense), net. Net other income (expense) consists primarily of
interest expense from the Company's borrowings and leases for capital equipment,
offset by interest income earned on the Company's cash balances. Net other
income decreased 20% from $180,000 in the third quarter of 1998 to $144,000 in
the third quarter of 1999, representing 2% of total revenue for the third
quarter of both 1998 and 1999. The dollar decrease was due to the Company
having less cash and equivalents at September 30, 1999 compared to September
30,1998 due to the use of funds for the repayment of a capital lease and
building and facilities improvements.
Provision (Benefit) for Income Taxes. The Company's income tax provision was
$8,000 in the third quarter of 1998 compared to a net income tax benefit of
$99,000 in the third quarter of 1999. The Company recorded an income tax
benefit in the third quarter of 1999 as it believes that it is more likely than
not that the net operating loss carryforward generated will be utilized against
future earnings.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September 30,
1998
Revenue
11
<PAGE>
Total Revenue. Total revenue decreased 6%, from $25.8 million in the nine
months ended September 30, 1998 to $24.1 million in the nine months ended
September 30, 1999.
Data Management Services Revenue. Data management services revenue increased
4% from 22.9 million in the nine months ended September 30, 1998 to 23.7 million
in the nine months ended September 30, 1999, representing 89% and 98% of total
revenue for such periods, respectively. Data management services revenue
increased due to an increase in the number of records under management for ILEC
and CLEC customers. These increases were offset by monthly minimum fees from a
wireless carrier in the first nine months of 1998 that expired at the end of
1998 and a decrease in non-recurring fees related to wireless and wireline
services.
Licenses and Implementation Services. Revenue from licenses and
implementation services decreased 87%, from $2.9 million in the nine months
ended September 30, 1998 to $379,000 in the nine months ended September 30,
1999, as the Company had no licenses and implementation services contracts in
process during the nine months ended September 30, 1999 other than warranty
contracts.
Costs and Expenses
Cost of Data Management Services. Cost of data management services increased
18%, from $15.3 million in the nine months ended September 30, 1998 to $18.0
million in the nine months ended September 30, 1999, representing 59% and 75% of
total revenue for such periods, respectively, and 67% and 76% of data management
services revenue in the nine months ended September 30, 1998 and 1999,
respectively. The dollar increase was due to increased depreciation expense and
telephone lines to accommodate growth in the Company's wireless and wireline
operations and additional headcount and related costs incurred in anticipation
of growth for both wireline and wireless services. The percentage increase
occurred primarily because the rollout of the Company's wireless and enhanced
services has been slower than anticipated, although the Company has built the
infrastructure to service the anticipated demand. In addition, in the first
nine months of 1998, the Company received monthly minimum fees from a wireless
customer which expired at the end of 1998.
Cost of Licenses and Implementation Services. Cost of licenses and
implementation services decreased 88%, from $939,000 in the nine months ended
September 30, 1998 to $116,000 in the nine months ended September 30, 1999,
representing 4% and 0.5% of total revenue for such periods, respectively.
Additionally, cost of licenses and implementation services represented 32% and
31% of licenses and implementation services revenue in the nine months ended
September 30, 1998 and 1999, respectively. The dollar decrease occurred because
the Company had no licenses and implementation services contracts in process
during the nine months ended September 30, 1999 other than warranty contracts.
Sales and Marketing. Sales and marketing expenses increased 29%, from $3.1
million in the nine months ended September 30, 1998 to $4.0 million in the nine
months ended September 30, 1999, representing 12% and 17% of total revenue in
such periods, respectively. The dollar increase was due to the addition of
marketing personnel, the creation of a government affairs department to
interpret and influence legislation primarily related to the Company's wireless
operations and related legal expenses, addition of sales staff for enhanced
services and an increase in tradeshow expenses.
General and Administrative. General and administrative expenses increased 6%
from $3.6 million in the nine months ended September 30, 1998 to $3.8 million in
the nine months ended September 30, 1999, representing 14% and 16% of total
revenue for such periods, respectively. The Company experienced increases due
to (i) the addition of information technology personnel and related expenses,
(ii) increased legal and accounting costs related to quarterly and annual
reporting requirements as the Company became a publicly traded company in June
1998, (iii) increased legal staffing and other fees related to regulatory and
legislative issues concerning the implementation of the Company's services in
the State of Texas and (iv) the creation of an investor relations department.
These increases were partially offset by a decrease in expenses related to the
resignation of the Company's chief operating officer and chief financial
officer.
Other income (expense), net. Net other expense was $402,000 in the nine
months ended September 30, 1998 compared to net other income of $418,000 in the
nine months ended September 30, 1999, representing (2)% and 2% of total revenue
for such periods, respectively. The dollar increase in net other income was
primarily due to a decrease in interest expense related to the repayment of
certain bank debt and capital leases that were outstanding through the second
quarter of 1998 and interest earned from the investment of funds received from
the Company's initial public offering in June and July of 1998.
12
<PAGE>
Provision (Benefit) for Income Taxes. The Company's income tax provision was
$120,000 in the nine months ended September 30, 1998 compared to a net income
tax benefit of $529,000 in the nine months ended September 30, 1999. The
Company recorded an income tax benefit in the nine months ended September 30,
1999 as it believes that it is more likely than not that the net operating loss
carryforward generated will be utilized against future earnings.
Extraordinary Item. The Company recorded a charge of $1.4 million in the
third quarter of 1998 related to the write-off of the remaining debt discount
and other costs associated with the early extinguishment of the Company's bank
debt.
Liquidity and Capital Resources
Since its inception the Company has funded its operations with cash provided
by operations, supplemented by equity and debt financing and leases on capital
equipment. As of September 30, 1999, the Company had $19.9 million in cash and
cash equivalents and investments in marketable securities.
In June 1998, the Company completed an initial public offering of 2,100,000
shares of its Common Stock, which generated proceeds of $22.5 million to the
Company, net of the underwriter's discount and other offering costs. The
Company used approximately $4.4 million of the proceeds to repay its bank loans
and $160,000 for the related prepayment penalty. In July 1998, the underwriters
of the Company's initial public offering exercised their over-allotment option.
Under the over-allotment option, the Company sold an additional 315,000 shares
of its Common Stock, generating net proceeds of $3.5 million.
The Company repaid $1.4 million and $1.8 million of other bank debt and
capital lease obligations during the nine months ended September 30, 1999 and
1998, respectively. Additionally, the Company used $1.9 million and $2.3
million during the nine months ended September 30,1999 and 1998, respectively,
for the purchase of capital assets and software development. The Company
anticipates that its level of spending for capital expenditures will continue
during 1999, although it currently has no material commitments for capital
expenditures.
The Company has a line of credit with a bank equal to $2.0 million, which is
available to meet operating needs. The interest rate on amounts borrowed under
the line of credit is equal to the bank's prime rate or the one, two or three
month Libor rate plus 2.25% per annum. The line of credit matures April 15,
2000 and is collateralized by certain assets of the Company. As of September
30, 1999, no borrowings were outstanding on the line of credit.
The Company believes that the remaining net proceeds from its initial public
offering, together with cash generated from operations, will be sufficient to
fund its anticipated working capital needs, capital expenditures and any
potential future acquisitions through at least the next twelve months. In the
event the Company's plans or assumptions change or prove to be inaccurate, or if
the Company consummates any unplanned acquisitions of businesses or assets, the
Company may be required to seek additional sources of capital. Sources of
additional capital may include public and private equity and debt financings,
sales of nonstrategic assets and other financing arrangements.
Year 2000 Capability
Many currently installed computer and software products are coded to accept
only two digit entries in the date code field. These date code fields will need
to accept four digit entries to distinguish twenty-first century dates from
twentieth century dates. As a result, by the end of 1999, computer systems
and/or software used by many companies may need to be upgraded to comply with
such "Year 2000" requirements. Significant uncertainty exists in the software
industry concerning the potential effects associated with such compliance.
The Company uses off-the-shelf and custom software developed internally and by
third parties for its production systems. The Company has completed its
assessment of and has implemented a plan for the programming and testing of its
internally developed software to make it Year 2000 compliant. In addition, the
Company has identified which of its third party production systems it believes
have date-sensitive applications to determine where Year 2000 issues may exist.
The Company has contacted the third-party suppliers and has received responses
from most of those suppliers, including the suppliers that the Company considers
critical. The Company has received and installed patches for the systems that
are not Year 2000 compliant.
The Company estimates that its total costs to convert its production systems
to be Year 2000 compliant, including primarily internal labor, third party
hardware and internal and third party software costs, was approximately
$400,000. The Company completed the conversion of its production systems in the
third quarter of 1999 and continues to evaluate any changes to the systems.
However, there can be no assurance that unidentified Year 2000
13
<PAGE>
problems will not cause the Company to incur material expenses in responding to
such problems or otherwise have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, to the
extent that such software and systems do not become Year 2000 compliant, there
can be no assurance that potential systems interruptions, the Company's
potential inability to meet its contractual obligations or the cost necessary to
update such software will not have a material adverse effect on the Company's
business, financial condition and results of operations. Certain of the
Company's current contracts with its customers require that the Company warrant
Year 2000 capability by a certain date. Any failure to achieve Year 2000
compliance by such date could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company has completed the necessary upgrades of its information technology
("IT") and non-IT systems to be Year 2000 compliant. Non-IT systems include fax
machines, photocopiers, telephone switches, security systems and other common
office devices. The Company also contacted third party suppliers to confirm
their Year 2000 compliance. Failure of one or more of these internal systems to
become Year 2000 compliant could impair the Company's ability to communicate
with its customers and perform critical business operations and could cause the
Company to process information manually or limit access to data.
The Company is developing contingency plans with respect to Year 2000 issues
for certain of its systems and is continually monitoring the risks involved.
Some of these contingency plans include manual processing until such time that
the system becomes compliant. The Company will freeze all software changes in
the fourth quarter of 1999 and perform recontamination testing of its production
systems to ensure that any changes made to the systems since the last Year 2000
testing have not impaired the Year 2000 compliance of the systems. To
supplement the Company's normal on-call procedures, key employees of the Company
will be on site where critical systems are located through the Year 2000
changeover. The Company is also making support arrangements with its critical
third party suppliers to ensure that support is available if unanticipated
problems arise.
Although the Company expects to identify and resolve all Year 2000 issues that
could materially affect its business operations, the Company believes it is not
possible to determine with complete certainty that all Year 2000 issues will be
identified or corrected in time. If the costs to convert the Company's systems
to be Year 2000 compliant are greater than anticipated or if the Company's
systems do not contain all necessary date code changes in time, there is no
assurance that system interruptions or an inability to meet contractual
obligations would not occur or that such occurrences would not have a material
adverse effect on the Company's business, financial condition and results of
operations. See "Risk Factors -- Year 2000 Capability."
Recently Issued Accounting Pronouncements
Statement of Financial Accounting Standards No. 133 and No. 137
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). The Statement establishes
accounting and reporting standards for derivative financial instruments and
hedging activities related to those instruments as well as other hedging
activities. It requires an entity to recognize all derivatives as either assets
or liabilities in the statement of financial position and measures those
instruments at fair value. In June 1999, the FASB issued Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133 - An
amendment of FASB Statement No. 133" ("SFAS No. 137"). SFAS No. 137 delays the
effective date of SFAS No. 133 to financial quarters and financial years
beginning after June 15, 2000. The Company does not typically enter into
arrangements that would fall under the scope of Statement No. 133 and thus,
management believes that Statement No. 133 will not significantly affect its
financial condition and results of operations.
Statement of Position 98-9
In December 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-9 ("SOP 98-9"), "Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions." SOP 98-9
amends certain paragraphs of Statement of Position 97-2 ("SOP 97-2"), "Software
Revenue Recognition," to require the application of a residual method of
accounting for software revenue when certain conditions exist. SOP 98-9 also
amends Statement of Position 98-4 ("SOP 98-4"), "Deferral of the Effective Date
of a Provision of SOP 97-2" to extend the deferral of the application of certain
passages of SOP 97-2 provided by SOP 98-4 through fiscal years beginning on or
before March 15, 1999. All other provisions of SOP 98-9 are effective for
transactions entered into in fiscal years beginning after March 15, 1999.
Earlier adoption is permitted, however, retroactive application is prohibited.
The Company believes SOP 98-9 will not materially impact its financial
statements.
14
<PAGE>
FACTORS THAT MAY AFFECT FUTURE RESULTS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY'S ACTUAL RESULTS MAY DIFFER
MATERIALLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS.
FACTORS THAT MIGHT CAUSE SUCH A DIFFERENCE INCLUDE, BUT ARE NOT LIMITED TO,
THOSE DISCUSSED BELOW.
Significant Fluctuations in Quarterly Results of Operations
Although the Company experienced a profit in 1998, the Company generated a net
loss of $863,000 in the nine months ended September 30, 1999 and has experienced
significant fluctuations in its quarterly results. The Company's operating
results may continue to fluctuate as a result of many factors, including the
length of the sales cycles for new or existing customers, the size, timing or
duration of significant customer contracts, fluctuations in number of subscriber
records under management, timing or duration of service offerings, rate of
adoption of wireless services by Public Safety Answering Points, efforts
expended to accelerate the introduction of certain new products, ability of the
Company to hire, train and retain qualified personnel, increased competition,
changes in operating expenses, changes in Company strategy, the financial
performance of the Company's customers, changes in telecommunications
legislation and regulations that may affect the competitive environment for the
Company's services, and general economic factors. The Company's contracts for
data management services generally include a non-recurring initial fee, and
therefore, the Company may recognize significantly increased revenue for a short
period of time upon commencing services for a new customer.
The Company's expense levels are based in significant part on its expectations
regarding future revenue. The Company's revenue is difficult to forecast because
the market for the Company's services is evolving rapidly and the length of the
Company's sales cycle, the size and timing of significant customer contracts and
license fees and the timing of recognition of non-recurring initial fees vary
substantially among customers. Accordingly, the Company may be unable to adjust
spending in a timely manner to compensate for any unexpected shortfall in
revenue. Any significant shortfall could therefore have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, the Company hired a significant number of employees in 1998 and
expects to continue hiring additional employees during 1999. The Company expects
that this increase will affect the Company's operating margins for the short
term. There can be no assurance that the Company can continue to report
operating profits, and failure to do so could have a material adverse effect on
the Company's business, financial condition and results of operations.
Based on all of the foregoing, the Company believes that future revenue,
expenses and operating results are likely to vary significantly from quarter to
quarter. As a result, quarter-to-quarter comparisons of operating results are
not necessarily meaningful or indicative of future performance. Furthermore, it
is possible that in some future quarter the Company's operating results will be
below the expectations of public market analysts or investors. In such event, or
in the event that adverse conditions prevail, or are perceived to prevail, with
respect to the Company's business or generally, the market price of the
Company's Common Stock would likely be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Lengthy Sales Cycle
Potential customers of the Company typically commit significant resources to
the technical evaluation of the Company's services and products and the Company
typically spends substantial time, effort and money providing education
regarding the Company's 9-1-1 OSS solution. The evaluation process often results
in an extensive and lengthy sales cycle, typically ranging between six months
and two years, making it difficult for the Company to forecast the timing and
magnitude of sales contracts. Delays associated with customers' internal
approval and contracting procedures, procurement practices, and testing and
acceptance processes are common. For example, customers' budgetary constraints
and internal acceptance reviews may cause potential customers to delay or forego
a purchase. The delay or failure to complete one or more large contracts could
have a material adverse effect on the Company's business, financial condition
and results of operations and cause the Company's operating results to vary
significantly from quarter to quarter. See "-- Significant Fluctuations in
Quarterly Results of Operations".
Reliance on Significant Customers
The Company historically has depended on, and expects to continue to depend
on, large contracts from a limited number of significant customers. During the
nine months ended September 30, 1999, the Company recognized
15
<PAGE>
approximately 78% of total revenue from Ameritech, BellSouth Inc. and U.S. WEST,
each of which accounted for greater than 10% of the Company's total revenue in
such period. During the nine months ended September 30, 1998, the Company
recognized approximately 84% of total revenue from Ameritech, AT&T, BellSouth
Inc. and U.S. WEST, each of which accounted for greater than 10% of the
Company's total revenue in such period. The Company believes that these
customers will continue to represent a substantial portion of the Company's
total revenue in the future. Certain of the Company's contracts with these
customers allow them to cancel their contracts with the Company in the event of
changes in regulatory, legal, labor or business conditions. The Company's
contracts with these customers expire between 2002 and 2005. The loss of any of
these customers would have a material adverse effect on the Company's business,
financial condition and results of operations. Two of the Company's significant
customers, Ameritech and US West, have entered into merger agreements with
companies that are not customers of the Company. The Company cannot predict what
effect, if any, these acquisitions will have on the Company and there can be no
assurance that these acquisitions or any future consolidation in the
telecommunications industry will not have a material adverse effect on the
Company's business, financial condition and results of operation. None of the
Company's major customers has any obligation to purchase additional products or
additional services beyond those currently contemplated by their existing
contracts. Consequently, the failure by the Company to develop relationships
with significant new customers could have a material adverse effect on the rate
of growth in the Company's revenue, if any. If the Company fails to monitor and
maintain adequately the quality and expand the breadth of its services and
products, advance its technology or continue to price its services and products
competitively, one or more of its major customers may select alternative
providers or seek to develop services and products internally.
Dependence on Key Personnel
The Company's future success depends in large part on the continued service of
its key management, sales, product development and operational personnel,
including George Heinrichs, President, and on the Company's ability to continue
to attract, motivate and retain highly qualified employees, including technical,
managerial and sales and marketing personnel. However, competition in the
recruitment of highly qualified personnel in the software and telecommunications
services industry is intense and has become particularly significant in the
Denver metropolitan area. The inability to hire and retain qualified personnel
or the loss of the services of key personnel could have a material adverse
effect upon the Company's current business, development efforts and future
business prospects. If such personnel do not remain active in the Company's
business, the Company's operations could be materially adversely affected. The
Company currently maintains a key person life insurance policy with respect to
Mr. Heinrichs. The Company is the named beneficiary of this policy, which is for
$3,000,000.
Rate of Adoption by Public Safety Answering Points
The Company expects the percentage of the Company's revenue derived from the
management of 9-1-1 data records for wireless carriers to increase. Recognizing
the public safety need for improved wireless 9-1-1 service, the Federal
Communications Commission (the "FCC") issued Report & Order 94-102 (the "Order")
on June 12, 1996, a directive that mandated the adoption of 9-1-1 technology by
wireless carriers in two phases. Phase I requires wireless carriers to provide
to requesting PSAPs at the time of a 9-1-1 call, the caller's telephone number
and location of the receiving cell site. However, under the FCC rules, wireless
carriers are not required to provide Phase I and Phase II service without
adequate cost recovery. Wireless carriers are required to provide Phase I
services within six months of an adequate PSAP request. The Wireless
Communications and Public Safety Act of 1999 was signed into law in October
1999. This legislation provides liability protection to wireless carriers that
is in parity with wireline carriers' liability protection and is intended to
accelerate deployment of wireless 9-1-1 services. However, there is no
assurance that the legislation will have the desired effect of accelerating
wireless 9-1-1 deployment. The Federal Communications Commission ("FCC")
continues to work with the wireless industry to facilitate wireless 9-1-1
implementation. However, due to cost recovery, liability and operational issues,
the number of live Phase I markets is not significant. Phase II requires
wireless carriers to locate a 9-1-1 caller to within certain parameters, subject
to FCC guidelines. The FCC has outlined a phased implementation schedule for
Phase II. The Company believes that the technological challenges confronting
wireless carriers attempting to comply with the Order will encourage them to
outsource their 9-1-1 services. If many wireless carriers decide not to
outsource such services, the Company's business, financial condition and results
of operations could be materially and adversely affected. The number of PSAPs
demanding services complying with the Order from wireless carriers has been less
than anticipated by the Company. If the rate of adoption by PSAPs continues to
be slow because of cost recovery, liability or operational issues, extensions
granted by the FCC or other reasons, the Company will experience a delay in
receiving revenue under its current wireless contracts that, because the Company
has already incurred costs in expectation of such revenue, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
16
<PAGE>
Dependence on New Products and Services; Rapid Technological Change
The market for the Company's services is characterized by rapid technological
change, frequent new product or service introductions, evolving industry
standards and changing customer needs. The Company is implementing its Emergency
Warning and Evacuation System, which will allow PSAPs to call all numbers in a
given area and warn of imminent danger. The Company intends to offer other new
products in the future. The introduction of products and services embodying new
technologies and the emergence of new industry and technology standards can
render existing products and services obsolete and unmarketable in short periods
of time. The Company expects other vendors regularly to introduce new products
and services, as well as enhancements to their existing products and services,
that will compete with the services and products offered by the Company. As a
result, the life cycles of the Company's services and products are difficult to
estimate. The Company believes that its future success will depend in large part
on its ability to maintain and enhance its current service and product
offerings, to develop and introduce regularly new services and products that
will keep pace with technological advances and satisfy evolving customer
requirements, and to achieve acceptable levels of sales of its new services and
products through its current customers that resell the Company's solutions to
their subscribers. However, there can be no assurance that the Company will not
experience difficulties that could delay or prevent the successful development,
introduction or marketing of such new services and products or that its new
services and products will adequately meet the requirements of the marketplace
and achieve market acceptance. Announcements of currently planned or other new
service and product offerings by the Company or its competitors may cause
customers to defer the purchase of existing Company services and products. The
Company's inability to develop on a timely basis new services or products, or
the failure of such new services or products to achieve market acceptance, could
have a material adverse effect on the Company's business, financial condition
and results of operations. The development of new, technologically advanced
products and services is a complex and uncertain process requiring high levels
of innovation, as well as the accurate anticipation of technological and market
trends. There can be no assurance that the Company will successfully develop,
introduce or manage the transition to new services and products. Furthermore,
services and products such as those offered by the Company may contain
undetected or unresolved errors when they are first introduced or as new
versions are released. There can be no assurance that, despite extensive testing
by the Company, errors will not be found in new services and products after
commencement of commercial availability, resulting in delay in or loss of market
acceptance and sales, diversion of development resources, injury to the
Company's reputation or increased service and warranty costs, any of which could
have a material adverse effect on the Company's business, financial condition
and results of operations. Significant delays in meeting deadlines for announced
service or product introductions or performance problems with such products or
upgrades could result in an undermining of customer confidence in the Company's
services and products, which would materially adversely affect its customer
relationships as well.
In addition, the Company plans to introduce transaction-based services and
software products to industries different from those the Company has
traditionally supported. There can be no assurance that the Company will be
successful in developing and marketing these new services and products or that
its current or new services and products will adequately meet the demands of its
new markets. Because it is generally not possible to predict the time required
and costs involved in reaching certain research, development and engineering
objectives related to entering new markets, actual development costs could
exceed budgeted amounts and estimated development schedules could require
extensions. Furthermore, there can be no assurance that the Company will not
experience difficulties that could delay or prevent the successful development,
introduction and marketing of these services and products. If the Company is
unable to develop and introduce new services and products to these new markets
in a timely manner, or if a new release of a product or service to such new
markets does not achieve market acceptance, the Company's business, financial
condition and results of operations could be materially adversely affected.
Dependence on a Single Service Offering; Sustainability of Growth
The Company currently derives substantially all of its revenue from the
provision of its 9-1-1 OSS solution to ILECs, CLECs and wireless carriers.
Accordingly, the Company is susceptible to adverse trends affecting this market
segment, such as government regulation, technological obsolescence and the entry
of new competition. The Company expects that this market will continue to
account for substantially all of its revenue in the near future. As a result,
the Company's future success will depend on its ability to continue to sell its
9-1-1 OSS solution to ILECs, CLECs and wireless carriers, maintain and increase
its market share by providing other value-added services to the market, and
successfully adapt its technology and services to other related markets. There
can be no assurance that markets for the Company's existing services and
products will continue to expand or that the Company will be successful in its
efforts to penetrate new markets.
Fixed Price Contracts and Other Project Risks
17
<PAGE>
During the nine months ended September 30, 1999 and the year ended December
31, 1998, approximately 87% and 80%, respectively, of the Company's revenue was
generated on a fixed price per subscriber basis. The Company generally enters
into contracts with a ten-year term for wireline data management services and
with a two- to five-year term for wireless base services and clearinghouse
services. In addition, the Company has a five-year contract with a state agency.
The Company generally receives a fixed monthly fee based upon the number of
subscribers and upon the services selected by the customer. Therefore, the
Company's failure to estimate accurately the resources required for a fixed
price per subscriber contract could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview."
The Company provides 9-1-1 OSS services that are critical to the public's
perception of its customers. The Company's failure to meet a customer's
expectations in the performance of its services could damage the Company's
reputation and adversely affect its ability to attract new business, and may
have a material adverse effect upon its business, financial condition and
results of operations. The Company has undertaken, and in the future may
undertake, projects in which the Company guarantees performance based upon
defined operating specifications. Unsatisfactory performance may result in
client dissatisfaction and a reduction in payment to, or payment of damages by,
SCC, any of which could have a material adverse effect on the Company's
business, financial condition and results of operations.
Because the Company's services and products are utilized by its customers to
provide critical 9-1-1 services, the provision of services and licensing of
software by the Company may entail the risk of product liability and related
claims. The Company's agreements with its customers typically require the
Company to indemnify its customers for the Company's own acts of negligence. The
Company currently has product liability insurance that, subject to liability
limitations and customary exclusions, covers claims resulting from the failure
of the Company's services or products to perform the function or serve the
purpose intended. To the extent that any claims are not covered by such
insurance, the Company's business, financial condition and results of operations
may be materially and adversely affected by a successful product liability
claim.
Emerging Telecommunications Market and New Carriers; Regulatory Uncertainty
The Company provides its 9-1-1 OSS solution to telecommunications carriers in
the wireline and wireless markets. Although these markets have experienced
significant growth and have been characterized by increased deregulation and
competition in recent years, there can be no assurance that such trends will
continue at similar rates or that the Company will be able to market and sell
effectively its products and services in such markets. In addition, many of the
new entrants in the telecommunications market are companies that lack
significant financial and other resources. To cultivate relationships with such
new market entrants, the Company may be required to offer alternative pricing
arrangements, which may provide for deferred payments. However, there can be no
assurance that the Company will be able to develop such relationships or that
new carriers that become customers of the Company will gain market acceptance
for their telecommunications services. If the Company permits customers that do
not have adequate financial resources to pay the Company for its services on a
deferred basis, the Company ultimately may be unable to collect payments for
such services. Because the Company historically has depended on a limited number
of long-term customer relationships, the failure of the Company to develop
relationships with, make sales to, or collect payments from new
telecommunications carriers, or the failure of the Company's customers to
compete effectively in the telecommunications market, could have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, the telecommunications industry is experiencing
substantial consolidations and changes that are unpredictable, and any such
consolidation or change could have a material adverse effect on the Company's
business, financial condition and results of operations.
9-1-1 services generally are funded by a locally imposed fee per subscriber
per month. A portion of this tax is paid to the local carrier providing the 9-1-
1 services. The Company generally receives a monthly fee per subscriber from its
customers for management of 9-1-1 data records, allowing the carrier to match
its fixed revenue stream for 9-1-1 services with a fixed cost for record
management. Changes by local governments in the funding mechanism for 9-1-1
services or the parties responsible for the provision of such services could
have a material adverse effect on the Company's business, financial condition
and results of operations.
The market for the Company's services and products has been influenced by the
adoption of regulations under the Telecommunications Act of 1996 (the "1996
Act"), the new duties imposed on ILECs by the 1996 Act to open the local
telephone markets to competition, and the requirements imposed on wireless
carriers by the Order. Therefore, any changes to such legal requirements, the
adoption of new regulations by federal or state regulatory authorities under the
1996 Act or any legal challenges to the 1996 Act could have a material adverse
effect upon the market for the Company's services and products. Although the
1996 Act was designed to expand competition in the
18
<PAGE>
telecommunications industry, the realization of the objectives of the 1996 Act
is subject to many uncertainties, including judicial and administrative
proceedings designed to define rights and obligations pursuant to the 1996 Act,
actions or inactions by ILECs and other carriers that affect the pace at which
changes contemplated by the 1996 Act occur, resolution of questions concerning
which parties will finance such changes, and other regulatory, economic and
political factors.
The Company is aware of certain litigation challenging the validity of the
1996 Act and the local telephone competition rules adopted by the FCC to
implement the 1996 Act. The U.S. Supreme Court in AT&T v. Iowa invalidated the
unbundling requirements adopted by the FCC while upholding a portion of the
FCC's local competition rules. However, the Regional Bell Operating Companies
("RBOCs") have agreed to comply with the invalidated unbundling requirements
pending application of the FCC's new rules, which have now been promulgated, to
comply with the decision of the Supreme Court. The final impact of the
application of these rules is not yet known. Such litigation may serve to delay
full implementation of the 1996 Act, which could adversely affect demand for the
Company's services and products. Any delays in the deadlines imposed by the 1996
Act, the FCC, or any invalidation, repeal or modification in the requirements
imposed by the Act or the FCC could have a material adverse effect on the
Company's business, financial condition and results of operations. Moreover,
customers may require, or the Company otherwise may deem it necessary or
advisable, that the Company modify its services and products to address actual
or anticipated changes in the regulatory environment. Any other delays in
implementation of the 1996 Act, or other regulatory changes, could materially
adversely affect the Company's business, financial condition and results of
operations.
The Company signed a contract to provide 9-1-1 data management services to the
General Services Commission ("GSC") which contract was assigned by GSC to the
Commission for State Emergency Communications ("CSEC") for the State of Texas.
As this is the first time that a state entity has endeavored to centralize 9-1-1
OSS and data management services with a neutral third party, federal and state
regulations governing 9-1-1 service provisioning, which have typically applied
to certified telecommunications providers, are being challenged and clarified
for the first time. The Company successfully completed the field trial required
under the contract in July 1999 and is in the process of marketing the Company's
services to the state's public safety agencies and implementing services to
those who opt into the contract. Prior to commencement of the field trial, SBC
Communications, Inc. ("SBC"), which has historically been responsible for the
provisioning of 9-1-1 OSS, data transport and data management services in the
State of Texas, challenged whether the Company has a right to access SBC's
source systems and 9-1-1 database, whether they must allow other parties to
interconnect to their selective routing switches and whether they are obligated
by law to unbundle components of their network functionality. However, an
interim agreement among the involved parties was reached in March 1999 that
allowed the Company to perform the field trial to test the interfacing
technology solutions in the Houston area. As part of the interim agreement, the
legal challenges and all related proceedings were placed in abeyance pending the
outcome of the field trial. Those matters are still in abeyance.
As required by the agreement, SBC filed wireline and wireless tariffs
regarding its portion of the unbundled services. They failed to unbundle their
tariffs in a manner that allowed the cost of the Company's solution to be
competitively neutral to the grandfathered SBC's solution, and the tariffs were
contested by CSEC, the Company and various other parties. The outcome of the
tariff filing is uncertain although the parties to the tariff matters have
finalized the execution of a second interim agreement for both wireline and
wireless, which sets the rates to be charged to public safety agencies who wish
to procure the Company's solution until a final tariff is determined. The
Company believes that these legal and technological issues and their associated
cost implications are likely to be readdressed by the Public Utilities
Commission of the State of Texas ("PUC"), which is expected to decide on these
matters by the end of 1999. Until such resolution, this interim tariff
agreement will govern those rates and charges. The Company believes that the
services that it will provide under its contract with the General Services
Commission are permitted within the scope of the existing regulations and that
the outcome of the matter before the PUC will be favorable to the Company and
the CSEC. However, there can be no assurance that the PUC will decide in favor
of the Company and the CSEC or that SBC will not resume its desire to pursue
this legal challenge on a longer term basis, thus causing further delay of the
commencement of the services by exercising its right to appeal a PUC decision
that favors the Company or the CSEC. If the PUC does not decide in the
Company's favor or places contingencies on the manner in which the services are
provided, the Company may be prohibited from delivering its services to the
State of Texas, may expend significant resources to appeal the PUC's decision or
may expend additional costs in redesigning the methodology by which the services
are provided. In addition, if SBC exercises its right to appeal, the Company
may be required to spend significant resources in defending its right to provide
its services in the State of Texas.
Risk of System Failures
19
<PAGE>
The Company's operations are dependent upon its ability to maintain its
computer and telecommunications equipment and systems in effective working
order, and to protect its systems against damage from fire, natural disaster,
power loss, telecommunications failure or similar events. Although all of the
Company's mission-critical systems and equipment are designed with built-in
redundancy and security, there can be no assurance that a fire, natural
disaster, power loss, telecommunications failure or similar event would not
result in an interruption of the Company's services. Any damage, failure or
delay that causes interruptions in the Company's operations could have a
material adverse effect on the Company's business, financial condition and
results of operations. Furthermore, any future addition or expansion of the
Company's facilities to increase capacity could increase the Company's exposure
to damage from fire, natural disaster, power loss, telecommunications failure or
similar events. There can be no assurance that the Company's property and
business interruption insurance will be adequate to compensate the Company for
any losses that may occur in the event of a system failure or that such
insurance will continue to be available to the Company at all or, if available,
that it will be available on commercially reasonable terms.
Management of Change
The Company has expanded its operations rapidly over the past several years,
placing significant demands on its administrative, operational and financial
personnel and systems. Additional expansion by the Company or additional demands
placed on the Company as a result of becoming a public company may further
strain its management, operational, financial reporting, and other systems and
resources. There can be no assurance that the Company's systems, resources,
procedures, controls and existing space will be adequate to support such
expansion of the Company's operations. The Company's future operating results
will depend substantially on the ability of its officers and key employees to
manage changing business conditions and to implement and improve its management,
operational, financial control and other reporting systems. In addition, the
Company's future operating results depend on its ability to attract, train and
retain qualified consulting, technical, sales, financial, marketing and
management personnel. Failure to hire, train or retain qualified personnel
necessary to keep pace with the Company's development of products and services
could have a material adverse effect on the Company's business, financial
condition and results of operations. Continued expansion will require the
Company's management to: enhance management information and reporting systems;
standardize implementation methodologies of SCC's NDSC; further develop its
infrastructure; and continue to maintain customer satisfaction. If the Company
is unable to respond to and manage changing business conditions, the quality of
the Company's products and services, its ability to retain key personnel and its
business, financial condition and results of operation could be materially
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Highly Competitive Market; Competition
The market for 9-1-1 OSS solutions is intensely competitive and the Company
expects competition to increase in the future. The Company believes that the
principal competitive factors affecting the market for 9-1-1 OSS services
include flexibility, reliability, manageability, technical features, wireless
support, performance, ease of use, price, scope of product offerings, and
customer service and support. Although the Company believes that its solution
competes favorably with respect to such factors, there can be no assurance that
the Company can maintain its competitive position against current and potential
competitors, especially those with significantly greater financial, marketing,
support service, technical and other competitive resources.
The Company's principal competitors generally fall within one of three
categories: internal development departments of major carriers or consulting
firms that support such departments; relatively smaller companies that offer
applications with limited scope; and larger companies that are either in the
process of entering the Company's market or have the potential to develop
products and services that compete with the Company's service offerings.
A number of companies currently market or have under development software
products and services to provide 9-1-1 administration. The Company competes with
a few smaller companies, including XYPoint Corporation, for the provision of
9-1-1 data management services to wireless carriers, although the Company
expects more significant competition in the future. Mergers or consolidations
among these competitors or acquisitions of these companies by larger competitors
would make them more formidable competitors to the Company. There can be no
assurance that the Company's current and potential competitors will not develop
products and services that may be more effective than the Company's current or
future 9-1-1 solutions or that the Company's technologies and offerings will not
be rendered obsolete by such developments.
Finally, there are a number of companies that market and sell various products
and services to telecommunications carriers, such as billing software and
advanced telecommunications equipment, that have been broadly adopted by the
Company's customers and potential customers. In addition, vendors of
telecommunications software and hardware in the future may enhance their
products to include functionality that is currently provided by
20
<PAGE>
the Company's solutions. The widespread inclusion of the functionality of the
Company's service offerings as standard features of other telecommunications
software or hardware could render the Company's services obsolete and
unmarketable, particularly if the quality of such functionality were comparable
to that of the Company's services. Furthermore, even if the 9-1-1 functionality
provided as standard features by telecommunications software or networking
hardware is more limited than that of the Company's services, there can be no
assurance that a significant number of customers would not elect to accept more
limited functionality in lieu of purchasing additional products or services. For
example, Lucent Technologies offers carriers software systems with functionality
similar to the Company's services. Many of these larger companies have longer
operating histories, greater name recognition, access to larger customer bases
and significantly greater financial, technical and marketing resources than the
Company. As a result, they may be able to adapt more quickly to new or emerging
technologies and changes in customer requirements, or to devote greater
resources to the promotion and sale of their products and services, than the
Company. If these companies were to introduce products or services that
effectively compete with the Company's service offerings, they could be in a
position to substantially lower the price of their 9-1-1 products and services
or to bundle such products and services with their other product and service
offerings.
For the foregoing reasons, there can be no assurance that the Company will be
able to compete successfully against its current and future competitors.
Increased competition may result in price reductions, reduced gross margins and
loss of market share, any of which could materially and adversely affect the
Company's business, financial condition and results of operations.
Dependence on Proprietary Rights
The Company's success and its ability to compete depends significantly upon
its proprietary rights. The Company relies primarily on a combination of
copyright, trademark and trade secret laws, as well as confidentiality
procedures and contractual restrictions to establish and protect its proprietary
rights. There can be no assurance that such measures will be adequate to protect
the Company's proprietary rights. Further, the Company may be subject to
additional risks as it enters into transactions in foreign countries where
intellectual property laws are not well developed or are difficult to enforce.
Legal protections of the Company's proprietary rights may be ineffective in such
countries. Litigation to defend and enforce the Company's intellectual property
rights could result in substantial costs and diversion of resources, and could
have a material adverse effect on the Company's business, financial condition
and results of operations, regardless of the final outcome of such litigation.
Despite the Company's efforts to safeguard and maintain its proprietary rights,
there can be no assurance that the Company will be successful in doing so or
that the steps taken by the Company in this regard will be adequate to deter
misappropriation or independent third-party development of the Company's
technology, or to prevent an unauthorized third party from copying or otherwise
obtaining and using the Company's technology. There also can be no assurance
that others will not independently develop similar technologies or duplicate any
technology developed by the Company. Any such events could have a material
adverse effect on the Company's business, financial condition and results of
operations.
As the number of entrants to the Company's markets increases and the
functionality of the Company's services and products increases and overlaps with
the products and services of other companies, the Company may become subject to
claims of infringement or misappropriation of the intellectual property rights
of others. In certain of its customer agreements, the Company agrees to
indemnify its customers for any expenses or liabilities resulting from claimed
infringements of patents, trademarks or copyrights of third parties. In certain
limited instances, the amount of such indemnities may be greater than the
revenue the Company may have received from the customer. There can be no
assurance that third parties will not assert infringement or misappropriation
claims against the Company in the future with respect to current or future
product or service offerings. Any claims or litigation, with or without merit,
could be time consuming, result in costly litigation or require the Company to
enter into royalty or licensing arrangements. Such royalty or licensing
arrangements, if required, may not be available on terms acceptable to the
Company, if at all, and could have a material adverse effect on the Company's
business, financial condition and results of operations.
Risks Associated with International Sales
Although substantially all of the Company's revenue is generated from sales to
customers in the United States, the Company has generated revenue in Canada and
intends to enter additional international markets, which will require
significant management attention and financial resources. International sales
are subject to a variety of risks, including difficulties in establishing and
managing international distribution channels, and in translating products and
related materials into foreign languages. International operations are also
subject to difficulties in collecting accounts receivable, staffing, managing
personnel and enforcing intellectual property rights. Other factors that can
adversely affect international operations include fluctuations in the value of
foreign currencies and currency exchange rates, changes in import/export duties
and quotas, introduction of tariff or non-tariff barriers and economic or
political
21
<PAGE>
changes in international markets. There can be no assurance that these factors
will not have a material adverse effect on the Company's future international
sales and, consequently, on the Company's business, financial condition and
results of operations. Furthermore, any inability to obtain foreign regulatory
approvals on a timely basis could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview".
Risks Relating to Potential Acquisitions
As part of its overall strategy, the Company regularly evaluates opportunities
to enter into strategic acquisitions, including potential business combinations
and significant investments in complementary companies, assets, products and
technologies, although the Company has no present arrangements, commitments or
agreements with respect to any acquisition. Acquisitions involve a number of
operating risks that could materially adversely affect the Company's business,
financial condition and results of operations, including the diversion of
management's attention to assimilate the operations, products and personnel of
the acquired companies, the amortization of acquired intangible assets, and the
potential loss of key employees of the acquired companies. Furthermore,
acquisitions may involve businesses in which the Company lacks experience.
Because management has limited experience in acquisitions and the Company has no
experience in integrating acquired companies or technologies into its
operations, there can be no assurance that the Company will be able to manage
one or more acquisitions successfully, or that the Company will be able to
integrate the operations, products or personnel gained through any such
acquisitions without a material adverse effect on the Company's business,
financial condition and results of operations.
Year 2000 Capability
Many currently installed computer and software products are coded to accept
only two digit entries in the date code field. These date code fields will need
to accept four digit entries to distinguish twenty-first century dates from
twentieth century dates. As a result, by the end of 1999, computer systems
and/or software used by many companies may need to be upgraded to comply with
such "Year 2000" requirements. Significant uncertainty exists in the software
industry concerning the potential effects associated with such compliance.
The Company uses off-the-shelf and custom software developed internally and by
third parties for its production systems. The Company has completed its
assessment of and has implemented a plan for the programming and testing of its
internally developed software to make it Year 2000 compliant. In addition, the
Company has identified which of its third party production systems it believes
have date-sensitive applications to determine where Year 2000 issues may exist.
The Company has contacted the third-party suppliers and has received responses
from most of those suppliers, including the suppliers that the Company considers
critical. The Company has received and installed patches for the systems that
are not Year 2000 compliant.
The Company estimates that its total costs to convert its production systems
to be Year 2000 compliant, including primarily internal labor, third party
hardware and internal and third party software costs, was approximately
$400,000. The Company completed the conversion of its production systems in the
third quarter of 1999 and continues to evaluate any changes to the systems.
However, there can be no assurance that unidentified Year 2000 problems will not
cause the Company to incur material expenses in responding to such problems or
otherwise have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, to the extent that such
software and systems do not become Year 2000 compliant, there can be no
assurance that potential systems interruptions, the Company's potential
inability to meet its contractual obligations or the cost necessary to update
such software will not have a material adverse effect on the Company's business,
financial condition and results of operations. Certain of the Company's current
contracts with its customers require that the Company warrant Year 2000
capability by a certain date. Any failure to achieve Year 2000 compliance by
such date could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company has completed the necessary upgrades of its information technology
("IT") and non-IT systems to be Year 2000 compliant. Non-IT systems include fax
machines, photocopiers, telephone switches, security systems and other common
office devices. The Company also contacted third party suppliers to confirm
their Year 2000 compliance. Failure of one or more of these internal systems to
become Year 2000 compliant could impair the Company's ability to communicate
with its customers and perform critical business operations and could cause the
Company to process information manually or limit access to data.
The Company is developing contingency plans with respect to Year 2000 issues
for certain of its systems and is continually monitoring the risks involved.
Some of these contingency plans include manual processing until such time that
the system becomes compliant. The Company will freeze all software changes in
the fourth quarter of 1999
22
<PAGE>
and perform recontamination testing of its production systems to ensure that any
changes made to the systems since the last Year 2000 testing have not impaired
the Year 2000 compliance of the systems. To supplement the Company's normal on-
call procedures, key employees of the Company will be on site where critical
systems are located through the Year 2000 changeover. The Company is also making
support arrangements with its critical third party suppliers to ensure that
support is available if unanticipated problems arise.
Although the Company expects to identify and resolve all Year 2000 issues that
could materially affect its business operations, the Company believes it is not
possible to determine with complete certainty that all Year 2000 issues will be
identified or corrected in time. If the costs to convert the Company's systems
to be Year 2000 compliant are greater than anticipated or if the Company's
systems do not contain all necessary date code changes in time, there is no
assurance that system interruptions or an inability to meet contractual
obligations would not occur or that such occurrences would not have a material
adverse effect on the Company's business, financial condition and results of
operations. See " Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Year 2000 Capability."
Potential Volatility of Stock Price
Prior to the Company's initial public offering in June 1998, there was no
public market for the Company's Common Stock. Since completion of the Company's
initial public offering, average daily trading volume has been relatively low.
There can be no assurance that an active public market for the Company's Common
Stock will develop or be sustained. The trading price of the Company's Common
Stock could be subject to wide fluctuations in response to variations in
operating results, announcements of technological innovations or new products by
the Company or its competitors, changes in financial estimates by securities
analysts, and other events or factors. In addition, the stock market has
experienced volatility that has particularly affected the market prices of
equity securities of many high technology companies and that often has been
unrelated to the operating performance of such companies. These broad market
fluctuations may materially adversely affect the market price of the Company's
Common Stock.
Control by Existing Stockholders; Effects of Certain Anti-Takeover Provisions
Members of the Board of Directors and the executive officers of the Company,
together with members of their families and entities that may be deemed
affiliates of or related to such persons or entities, beneficially own
approximately 36.4% of the outstanding shares of Common Stock of the Company as
of September 30, 1999. Accordingly, these stockholders are able to influence
election of all members of the Company's Board of Directors and influence the
outcome of corporate actions requiring stockholder approval, such as mergers and
acquisitions. This level of ownership by such persons and entities may have a
significant effect in delaying, deferring or preventing a change in control of
the Company and may adversely affect the voting and other rights of other
holders of Common Stock. Certain provisions of the Company's Amended and
Restated Certificate of Incorporation, Amended and Restated Bylaws, Delaware law
and equity incentive plans also may discourage certain transactions involving a
change in control of the Company. This level of ownership by such persons and
entities, when combined with the ability of the Board of Directors to issue
"blank check" preferred stock without further stockholder approval, may have the
effect of delaying, deferring or preventing a change in control of the Company.
No Dividends
The Company has not paid any cash or other dividends on its Common Stock, nor
does it expect to pay dividends in the foreseeable future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact the financial
position, results of operations or cash flows of the Company due to adverse
changes in financial and commodity market prices and rates. The Company is
exposed to market risk in the areas of changes in United States interest rates.
These exposures are directly related to its normal operating and funding
activities. Historically, the Company has not used derivative instruments or
engaged in hedging activities.
Interest Rate Risk
The Company renewed its line of credit in the second quarter of 1999. The
related interest rate is variable based on the lender's prime rate or the Libor
rate, and, therefore, is affected by changes in market interest rates. At
September 30, 1999, no amounts were outstanding under the Company's line of
credit. In addition, the Company
23
<PAGE>
invests excess funds in high-grade bonds and commercial paper on which the
Company monitors interest rates frequently and as the investments mature. The
Company does not believe that reasonably possible near-term changes in interest
rates will result in a material effect on future earnings, fair values or cash
flows of the Company.
24
<PAGE>
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings.
None.
Item 2 - Changes in Securities and Use of Proceeds.
On June 29, 1998, the Company consummated its initial public offering (the
"Offering") of its common stock, par value $.001 per share (the "Common Stock").
The estimated net offering proceeds to the Company after deducting the foregoing
discounts, commissions, fees and expenses were $25,988,400, of which $3,510,400
relates to the exercise of the underwriters' over-allotment option on July 22,
1998. Through September 30, 1999, the proceeds of the offering have been applied
as follows:
<TABLE>
<CAPTION>
<S> <C>
Aggregate offering price $28,980,000
Direct and indirect payment to others for:
Underwriting discounts and commissions 2,028,600
Other offering expenses 963,000
Construction of building and facilities 300,000
Capital lease payment to receive discount 2,878,500
Repayment of indebtedness 4,610,000
</TABLE>
None of such payments were direct or indirect payments to directors, officers,
general partners of the Company or their associates or to persons owning 10% or
more of any class of equity securities of the Company or to affiliates of the
Company. The Company expects to use its remaining net proceeds for product
development and general corporate purposes, including working capital. A
portion of the net proceeds also may be used for the acquisition of businesses,
products and technologies that are complementary to those of the Company. The
Company invested approximately $15 million of the offering proceeds in an
investment portfolio consisting mostly of high-grade bonds and commercial paper.
Item 3 - Defaults on Senior Securities.
None.
Item 4 - Submission of Matters to a Vote of Security Holders.
None.
Item 5 - Other Information.
None.
Item 6 - Exhibits and Reports on Form 8-K.
(a) Exhibits.
27 Financial Data Schedule
(b) Reports on Form 8-K.
None.
25
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCC Communications Corp.
(Registrant)
November 9, 1999 /s/ George K. Heinrichs
- ---------------- -----------------------
Date George K. Heinrichs, President
and Chief Executive Officer
November 9, 1999 /s/ Carol Nelson
- ---------------- ----------------
Date Carol Nelson, Chief
Financial Officer
26
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 8,200,000
<SECURITIES> 11,672,000
<RECEIVABLES> 2,872,000
<ALLOWANCES> 100,000
<INVENTORY> 0
<CURRENT-ASSETS> 25,446,000
<PP&E> 26,847,000
<DEPRECIATION> 14,553,000
<TOTAL-ASSETS> 41,721,000
<CURRENT-LIABILITIES> 6,552,000
<BONDS> 0
0
0
<COMMON> 11,000
<OTHER-SE> 33,084,000
<TOTAL-LIABILITY-AND-EQUITY> 41,721,000
<SALES> 0
<TOTAL-REVENUES> 24,102,000
<CGS> 0
<TOTAL-COSTS> 18,118,000
<OTHER-EXPENSES> 7,794,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 386,000
<INCOME-PRETAX> (1,392,000)
<INCOME-TAX> (529,000)
<INCOME-CONTINUING> (863,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (863,000)
<EPS-BASIC> (.08)
<EPS-DILUTED> (.08)
</TABLE>
