<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended 30 September 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ to ________
Commission file number 0-26376
ON TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 04-3162846
(State of incorporation) (IRS Employer Identification Number)
One Cambridge Center
Cambridge Massachusetts 02142
(617) 374-1400
(Address and telephone of principal executive offices)
___________
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
YES X NO
------- -------
12,268,870 shares of the registrant's Common stock, $0.01 par value, were
outstanding as of October 31, 1997.
THIS DOCUMENT CONTAINS 24 PAGES.
------
THE EXHIBIT INDEX IS ON PAGE 22.
1
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ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
FORM 10-Q, September 30, 1997
CONTENTS
<TABLE>
<CAPTION>
Item Number Page
- ----------- ----
<S> <C>
PART I: FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Balance sheets:
September 30, 1997 and December 31, 1996 3
Statements of operations:
Three and nine months ended September 30, 1997 and 1996 4
Statements of cash flows:
Nine months ended September 30, 1997 and 1996 5
Notes to condensed consolidated financial statements 6-7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-18
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities 19
Item 3. Defaults Upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
EXHIBIT INDEX 22
</TABLE>
2
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ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 8,394 $ 20,774
Accounts receivable, net of allowance for doubtful accounts and
sales returns of $2,062 and $1,191, respectively 9,512 9,852
Inventories, net 1,409 2,323
Prepaid expenses and other current assets 3,600 2,537
---------- ----------
Total current assets 22,915 35,486
---------- ----------
Property and equipment, at cost:
Computers and equipment 8,063 6,226
Equipment acquired under capital leases 3,895 3,895
Furniture and fixtures 275 247
---------- ----------
Less - Accumulated depreciation 7,079 4,527
---------- ----------
5,154 5,841
---------- ----------
Direct marketing costs 81 1,067
Other assets and deposits 71 86
Purchased intangibles, net of $2,074 and $1,261 of accumulated
amortization, respectively 2,545 1,662
---------- ----------
$ 30,766 $ 44,142
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of capital lease obligations $ 684 $ 1,063
Accounts payable 6,250 5,619
Accrued expenses 3,679 2,252
Reserve for distributor inventories 100 204
Deferred revenue 1,580 1,001
---------- ----------
Total current liabilities 12,293 10,139
---------- ----------
Capital lease obligations, net of current portion 71 510
---------- ----------
Stockholders' Equity:
Common stock, $.01 par value - Authorized - 20,000,000 shares
Issued and outstanding -12,281,502 shares and 11,008,243
shares, respectively 123 110
Additional paid in capital 63,037 55,637
Deferred compensation (347) 0
Accumulated deficit (44,135) (20,354)
Accumulated deficit of S corporation (354) (354)
Cumulative translation adjustment 125 88
Treasury stock (15,000 and 257,867 shares at cost, respectively) (47) (1,634)
---------- ----------
Total stockholders' equity 18,402 33,493
---------- ----------
$ 30,766 $ 44,142
========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements
3
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ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenue:
- --------
Net product revenue $ 9,051 $ 12,248 $ 33,648 $ 36,619
Other revenue 1,363 389 3,474 1,153
----------- ----------- ----------- -----------
Total revenue 10,414 12,637 37,122 37,772
----------- ----------- ----------- -----------
Operating expenses:
- -------------------
Cost of product revenue 3,214 4,423 7,650 9,713
Sales and marketing 5,502 6,172 18,995 18,222
Research and development 3,275 2,493 9,956 6,775
General and administrative 1,716 1,102 3,975 3,190
Charge for purchased incomplete
research and development --- --- 15,898 13,285
Charge for restructuring 4,530 5,415 4,530 5,415
----------- ----------- ----------- -----------
Loss from operations (7,823) (6,968) (23,882) (18,828)
----------- ----------- ----------- -----------
Interest income, net 59 259 234 884
----------- ----------- ----------- -----------
Loss before provision
for income taxes (7,764) (6,709) (23,648) (17,944)
----------- ----------- ----------- -----------
Provision (benefit) for income
taxes (642) (483) (133) (44)
=========== =========== =========== ===========
Net loss $ (7,122) $ (6,226) $ (23,781) $ (17,900)
=========== =========== =========== ===========
Net Loss per common share $ (0.58) $ (0.57) $ (1.97) $ (1.65)
=========== =========== =========== ===========
Weighted average number of
common shares outstanding 12,223,309 10,980,103 12,091,960 10,875,798
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
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ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------------------
1997 1996
-------------- --------------
<S> <C> <C>
Cash Flows from Operating Activities
Net Loss $ (23,781) $ (17,900)
Adjustments to reconcile net loss
to net cash used in operating activities
Charge for purchased research and development 15,898 13,285
Asset write-down related to restructure charge 1,328 2,829
Amortization of deferred compensation 69 0
Depreciation and amortization 3,438 2,489
Change in direct marketing costs (50) (970)
Change in net deferred income taxes 1,062 0
Changes in assets and liabilities:
Accounts receivable 1,363 (482)
Inventories 959 1,279
Prepaid expenses and other current assets (912) (582)
Accounts payable 197 72
Accrued expenses 17 434
Reserve for distributor inventory (104) (534)
Deferred revenue (2,692) 64
---------- ----------
Net cash used in operating activities (3,208) (16)
---------- ----------
Cash Flows From Investing Activities
Change in other assets and deposits 15 30
Purchase of property and equipment, net (1,549) (3,660)
Purchase of neTrend Corporation, net 0 (2,260)
Purchase of Leprechaun Software International, Ltd.,
net of cash acquired 0 (786)
Purchase of Technocom plc, net 0 (1,963)
Purchase of Purview Technologies, Inc., net of cash acquired (1,121) 0
Purchase of csd Software GmbH, net of cash acquired (5,791) 0
---------- ----------
Net cash used in investing activities (8,446) (8,639)
---------- ----------
Cash Flows From Financing Activities
Exercise of stock options 29 138
Stock purchase through ESPP 73 93
Purchase of treasury stock (47) (1,030)
Principal repayments on obligation under capital lease (818) (882)
---------- ----------
Net cash used in financing activities (763) (1,681)
---------- ----------
Net effect of exchange rates on cash & cash equivalents 37 2
Net decrease in cash and cash equivalents (12,380) (10,334)
Cash and cash equivalents, beginning of period 20,774 33,338
---------- ----------
Cash and cash equivalents, end of period $ 8,394 $ 23,004
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for -
Interest paid $ 131 $ 179
========== ==========
Income taxes paid $ 487 $ 1,270
========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements
5
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FORM 10-Q, September 30, 1997
(dollars in thousands, except per share amount)
(unaudited)
1. Interim Financial Statements
----------------------------
The accompanying consolidated financial statements have been presented
by ON Technology Corporation (together with its consolidated subsidiaries, the
"Company") without audit (except for the balance sheet information as of
December 31, 1996) in accordance with generally accepted accounting principles
for interim financial statements and with the instructions to Form-10Q and
Regulation S-X pertaining to interim financial statements. Accordingly, these
interim financial statements do not include all information and footnotes
required by generally accepted accounting principles for complete financial
statements. The financial statements reflect all adjustments and accruals which
management considers necessary for a fair presentation of financial position as
of September 30, 1997 and December 31, 1996, and results of operations for the
three and nine months ended September 30, 1997 and September 30, 1996. The
results for the interim periods presented are not necessarily indicative of
results to be expected for any future period. The financial statements should
be read in conjunction with the audited financial statements and the notes
thereto included in the Company's Registration Statement on Form 10-K.
2. Net Loss Per Common Share
-------------------------
Net loss per common share is computed using the weighted average
number of common shares outstanding during each period.
3. Direct Marketing Costs
----------------------
The Company sells its products through various channels, including
free trial direct marketing. The Company incurs substantial costs in advance of
a free trial campaign, including the rental of mailing lists, postage and
printing. In 1994, the Company began capitalizing such costs in accordance with
the American Institute of Certified Public Accountants' (AICPA) Statement of
Position 93-7, Reporting on Advertising Costs. The Company amortizes such costs
over a three month period, which approximates the period of expected revenues.
The Company has recorded approximately $81 and $1,067 of capitalized direct
marketing costs in the accompanying condensed consolidated balance sheets at
September 30, 1997 and December 31, 1996, respectively.
4. New Accounting Standards
------------------------
In February 1997, the Financial Standards Board (FASB) issued SFAS No.
128, Earnings Per Share which is effective for the fiscal year ending December
31, 1997 and early adoption is not permitted. The Company does not expect the
adoption of these standards to have a material effect on its financial position
or results of operations.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 requires disclosure of all components of comprehensive
income on an annual and interim basis. Comprehensive income is defined as the
change in equity of a business enterprise during a period from transactions and
other events and circumstances from nonowner sources. SFAS No. 130 is effective
for fiscal years beginning after December 15, 1997.
In July 1997, the FASB issued SFAS No. 131, Disclosure About Segments
of an Enterprise and Related Information. SFAS No. 131 requires certain
financial and supplementary information to be disclosed on an annual and interim
basis for each reportable segment of an enterprise. SFAS No. 131 is effective
for fiscal years beginning after December 15, 1997. Unless impracticable,
companies would be required to restate prior period information upon adoption.
5. Charge for Restructuring
------------------------
On July 29, 1997, the company announced that it had implemented a
reorganization of its operations and a restructuring plan (the "Plan"). The
Plan included write-offs and write-downs of certain assets, including
6
<PAGE>
accruing the costs related to a significant reduction in the workforce,
primarily in the technical support and sales and marketing departments. In
addition, the Company has exited from the anti-virus business and de-emphasized
its investment in new customer acquisitions for the Company's groupware, network
management and security businesses. As a result of the Plan the Company recorded
a restructuring charge of $4,530. Included in the Plan was an additional
inventory write-down of $849 which is included in cost of product revenue in
accordance with Emerging Issues Task Force (EITF) 96-9, Classification of
Inventory Markdowns and Other Costs Associated with a restructuring.
The following are the significant components of the $4,530 charge to
restructuring:
<TABLE>
<CAPTION>
<S> <C>
Employee severance, benefits and related costs $1,980
Write-off and write-down of assets to net realizable value excluding inventory 1,346
Provision for costs in closing facilities 1,204
------
$4,530
</TABLE>
6. Subsequent Events
-----------------
On October 29, 1997, the Company announced that it would seek
shareholder approval (the "Proposed Transaction") to sell to Elron Software
Inc., a wholly owned subsidiary of Elron Electronics Industries, for an
aggregate price of $12 million, with the possibility of an additional
performance bonus of up to $1.5 million, (a) all of the Company's right, title
and interest as owner of the computer software programs known as OnGuard
Internet Manager, OnGuard Firewall, and the Odyssey Application Software and
Database, and as licensee of SofTrack (collectively, the "Software"), (b) all of
the Company's right, title and interest in its catalog business, including
management information systems, sales and marketing databases and customer
lists; (c) all of the Company's right, title and interest in and to the
methodology, procedures, techniques and documentation utilized by the Company
for the sale and distribution of computer software, hardware and peripherals,
(collectively, the "Free Trial Marketing System"); (d) all of the Company's
right title and interest in certain contracts, agreements, real and personal
property leases, licenses and other instruments; (e) certain accounts
receivable, notes and notes receivable, with a Company-guaranteed value of
$3,000,000; (f) certain equipment, furniture, leasehold improvements; (g)
certain inventory; (h) certain trade names and trademarks; and (i) the goodwill
associated with the foregoing assets (collectively, the "Proposed Assets"). As
part of the Proposed Transaction, Elron will hire from the Company,
approximately 100 employees including Ivan O'Sullivan, the Company's Vice
President - World Wide Marketing, and Chadwick Roll, the Company's Vice
President of Inside Sales.
As a result of the sale of assets to Elron Software Inc., the Company
expects to record a pre-tax reorganization and restructuring charge totaling
$6.2 million to $6.6 million in the fourth quarter ended December 31, 1997. The
restructuring charge includes reorganization costs related to the Company's sale
of its Network Management and Network Security Business to Elron Software Inc,
the closing of its international sales offices in the United Kingdom, France and
Australia, and the Company's severance costs related to the reduction of the
related workforce.
7
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
Management Discussion and Analysis of Financial Condition and Results of
Operations
FORM 10-Q, September 30, 1997
(unaudited)
OVERVIEW
The Company develops, markets and supports communication and network
management software, including client/server tools for group scheduling,
software metering, firewall technology and enterprise client software.
The Company does not provide forecasts of the future financial performance
of the Company. From time to time, however, the information provided by the
Company or statements made by its employees may contain forward-looking
statements. In particular, statements contained in this Form 10-Q that are not
historical statements (including, but not limited to, statements concerning
estimates of future revenues, operating expense levels and such operating
expense levels relative to the Company's total revenues) constitute forward-
looking statements under the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. See "Special Note Regarding Forward-Looking
Statements" and "Certain Factors That May Affect Future Results."
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
financial data as percentages of the Company's total revenue:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------ ------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1997 1996
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Revenue:
Net product revenue 86.9 % 96.9 % 90.6 % 96.9 %
Other revenue 13.1 % 3.1 % 9.4 % 3.1 %
--------------------------------------------------------------------
Total revenue 100.0 % 100.0 % 100.0 % 100.0 %
--------------------------------------------------------------------
Operating expenses:
Cost of product revenue 30.9 % 35.0 % 20.6 % 25.7 %
Sales and marketing 52.8 % 48.8 % 51.2 % 48.2 %
Research and development 31.4 % 19.7 % 26.8 % 17.9 %
General and administrative 16.5 % 8.7 % 10.7 % 8.5 %
Charge for purchased R&D 0.0 % 0.0 % 42.8 % 35.2 %
Charge for restructuring 43.5 % 42.9 % 12.2 % 14.3 %
--------------------------------------------------------------------
Loss from operations (75.1)% (55.1)% (64.3)% (49.8)%
--------------------------------------------------------------------
Interest income, net 0.5 % 2.0 % 0.6 % 2.3 %
--------------------------------------------------------------------
Net loss before
provision for income taxes (74.6)% (53.1)% (63.7)% (47.5)%
--------------------------------------------------------------------
Provision for income taxes (6.2)% (3.8)% 0.4 % (0.1)%
--------------------------------------------------------------------
Net loss (68.4)% (49.3)% (64.1)% (47.4)%
====================================================================
</TABLE>
NET PRODUCT REVENUE. The Company's net product revenue is derived primarily
from the licensing of software products. Net product revenue also includes
revenue from catalog sales of third party products and catalog advertising
space. For the three months ended September 30, net product revenue decreased
$3,197,000 (26.1%) from 1996 to 1997. For the nine months ended September 30,
net product revenue decreased $2,971,000 (8.1%) from 1996 to 1997. The decrease
was primarily attributable to products de-emphasized as part of the strategic
reorganization and restructuring of the third quarter of 1997. The Company
anticipates that net product revenue will continue to decrease in absolute
dollars due to the Company's Proposed Transaction to sell its Network Management
and Network Security Business along with the related marketing systems and
organization to Elron Software Inc. See Note 6 (Subsequent Events) to the
Condensed Consolidated Financial Statements.
OTHER REVENUE. The Company's other revenue consists of rentals of portions
of the Company's customer lists, royalties received in connection with licensing
ON's software to third parties and maintenance revenue. For the three months
ended September 30, other revenue increased $974,000 (250.4%) from 1996 to 1997.
For the nine months ended September 30, other revenue increases $2,321,000
(201.3%) from 1996 to 1997. This increase is
8
<PAGE>
primarily attributed to an increase in revenue from maintenance contracts for
existing customers as well as those obtained as part of the csd Software GmbH
("csd") acquisition. The Company anticipates that other revenue may decrease in
absolute dollars due to the Company's Proposed Transaction. See Note 6
(Subsequent Events) to the Condensed Consolidated Financial Statements.
COST OF PRODUCT REVENUE. Cost of product revenue primarily consists of
expenses associated with product documentation, production and fulfillment costs
and royalty fees associated with products that are licensed from third party
developers. In addition, cost of product revenue includes the cost of third
party products resold through the Company's catalog, the cost of producing the
catalog and amortization of purchased intangibles. For the three months ended
September 30, cost of product revenue decreased $1,209,000 (27.3%) from 1996 to
1997. For the nine months ended September 30, cost of product revenue decreased
$2,063,000 (21.2%) from 1996 to 1997. This decrease was primarily the result of
decreased product revenue. As part of the Company's announced reorganization of
its operations, the Company has ceased to market, sell, develop and support the
anti-virus business and decreased its emphasis on the investment in new customer
acquisitions for its groupware, network management and security businesses. As
a result, the product inventory related to the ceased product lines and de-
emphasized products were subsequently identified and written-off, all of which
is included in cost of product revenue in the amount of $849,000. For the nine
months ended September 30, 1996, the Company recorded a similar restructuring
charge of $2,026,000. The Company anticipates that cost of product will continue
to decrease in absolute dollars due to the Company's Proposed Transaction. See
Note 6 (Subsequent Events) to the Condensed Consolidated Financial Statements.
SALES AND MARKETING EXPENSE. Sales and marketing expense primarily consists
of compensation and benefits paid to sales and marketing personnel and the costs
of direct mail and telemarketing campaigns including the costs of product trials
requested by potential customers. Sales and marketing expense also includes the
costs of administering the catalog operation, the costs of public relations,
trade shows and conferences, and the telephone and information technology costs
associated with sales activities. For the three months ended September 30, sales
and marketing expenses decreased $670,000 (10.9%) from 1996 to 1997. For the
nine months ended September 30, sales and marketing expenses increased $773,000
(4.2%) from 1996 to 1997. The increase in absolute dollars was primarily the
result of the csd acquisition and the costs associated with marketing a larger
portfolio of products. The Company anticipates that sales and marketing expense
may decrease in absolute dollars due to the Company's Proposed Transaction. See
Note 6 (Subsequent Events) to the Condensed Consolidated Financial Statements.
RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense includes
costs associated with the development of new products, the enhancement of
existing products, and the provision of technical support. For the three months
ended September 30, research and development expense increased by $782,000
(31.4%) from 1996 to 1997. For the nine months ended September 30, research and
development expenses increased by $3,181,000 (47.0%) from 1996 to 1997. The
increase was primarily related to the increase in the size of the product
portfolio, and the associated costs of product development, enhancements and
maintenance relating to products acquired in the acquisition of csd Software
GmbH and Purview Technologies, Inc. The Company plans to continue to make
significant investments in research and development related to the Company's
enterprise client software business.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense
includes executive compensation, executive support costs, accounting operations,
planning, and business development operations. For the three months ended
September 30, general and administrative expense increased $614,000 (55.7%) from
1996 to 1997. For the nine months ended September 30, general and
administrative expenses increased by $785,000 (24.6%) from 1996 to 1997. The
increase in absolute dollars reflects personnel growth and associated costs in
general support areas, offset by continued efficiency in core administrative
operations. This increase, however, was approximately the same as a percentage
of total revenue from 1996 to 1997. The growth is a direct result of the
acquisitions of the LAN Software business from Technocom plc and csd Software
GmbH. The percentage of general and administrative expense to total revenue is
expected to increase due to reduced sales resulting from the Company's Proposed
Transaction. See Note 6 (Subsequent Events) to the Condensed Consolidated
Financial Statements.
9
<PAGE>
CHARGE FOR PURCHASED RESEARCH AND DEVELOPMENT. In connection with the
acquisitions of Purview Technologies, Inc. and csd Software GmbH during the nine
months ended September 30, 1997, and the acquisitions of neTrend Corporation,
Leprechaun Software International, Ltd. and the LAN software business of
Technocom plc during the nine months ended September 30, 1996, the Company
allocated an aggregate of $15.9 million and $13.3 million, respectively, of the
aggregate purchase price for such acquisitions to purchased incomplete research
and development projects. Accordingly, these costs were expensed as of the
acquisition dates. These allocated costs represent the estimated fair market
value related to the incomplete projects as determined by an appraisal. The
development of these projects had not reached technological feasibility and the
technology had no alternative future use. The technology acquired in these
acquisitions has required, and will require, substantial additional development
by the Company.
CHARGE FOR RESTRUCTURING AND REORGANIZATION. On July 29, 1997, the Company
announced that it had implemented a reorganization of its operations and a
restructuring plan (the "Plan"). The Plan included write-offs and write-downs
of certain assets, including accruing the costs related to a significant
reduction in the workforce, primarily in the technical support and sales and
marketing departments. In addition, the Company has exited from the anti-virus
business and de-emphasized its investment in new customer acquisitions for the
Company's groupware, network management and security businesses. As a result of
the Plan the Company recorded a charge of $4,530,000. Included in the Plan was
an additional inventory write-down of $849,000 which is included in cost of
product revenue in accordance with Emerging Issues Task Force (EITF) 96-9,
Classification of Inventory Markdowns and Other Costs Associated with a
restructuring. On August 6, 1996 the Company had a similar charge for
restructuring and reorganization of $5,450,000.
As a result of the sale of Proposed Assets to Elron Software Inc., the Company
expects to record a pre-tax reorganization and restructuring charge totaling
$6.2 million to $6.6 million in the fourth quarter ended December 31, 1997. The
restructuring charge includes reorganization costs related to the Company's sale
of the Proposed Assets to Elron Software Inc, the closing of international sales
offices in the United Kingdom, France and Australia, and the Company's severance
costs related to the reduction of the related workforce.
INTEREST INCOME, NET. Interest income consists primarily of interest
expense associated with equipment leases and interest income earned on cash and
cash equivalents. For the three months ended September 30, interest income
decreased $200,000 (77.2%) from 1996 to 1997. For the nine months ended
September 30, interest income decreased $650,000 (73.5%) from 1996 to 1997. The
decrease is the result of the change in the Company's cash position, primarily
effected by cash used in acquisitions.
INCOME TAXES. The tax provision for the three and nine months ended
September 30, 1996 was calculated based upon the Company's expected 1996
effective tax rate of 10.7% in 1996, giving benefit to available net operating
loss carryforwards and research and development credits. The tax provision for
the three and nine months ended September 30, 1997 represents a tax provision on
income in Germany with no provision or benefit required in the Company's
remaining foreign or domestic operating results.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash flow
from operations and public and private placements of capital stock. At September
30, 1996 and September 30, 1997, the Company had available cash and cash
equivalents of $23.0 million and $8.4 million, respectively. The Company has an
unused and available line of credit of $10.0 million with a commercial bank. The
Company can borrow under this line of credit up to the greater of $10.0 million
or the sum of 80% of qualified domestic accounts receivable and 40% of qualified
foreign accounts receivable. Advances pursuant to the line of credit are secured
by liens granted on the Company's accounts receivable. At September 30, 1997,
the Company did not have an outstanding balance under the line of credit
agreement.
Net cash used in operating activities for the nine months ended September
30, 1996 and September 30, 1997, was $16 thousand and $3.2 million,
respectively. For the nine months ended September 30, 1996, cash used in
operating activities consisted primarily of a $13.3 million charge for purchased
research and development, a $2.5 million increase in depreciation and
amortization, and an $2.8 million charge for asset write-down related to a
restructure charge, off-set by a net loss of $(17.9) million. For the nine
months ended September 30, 1997, net cash
10
<PAGE>
used in operating activities consisted primarily of a net loss of ($23.8
million) offset by a charge for purchased research and development of $15.9
million. Additional factors contributing to net cash used in operating
activities included depreciation and amortization of $3.4 million, and an asset
write-down related to restructuring charge of $1.3 million. These changes
primarily are the result of the acquisitions of Purview Technologies, Inc., and
csd Software GmbH.
Net cash used in investing activities for the nine months ended September
30, 1996 and September 30, 1997 was $8.6 million and $8.4 million, respectively.
For the nine months ended September 30, 1996, net cash used in investing
activities consisted of acquisition related direct costs and the cash portion of
the purchase price associated with the acquisitions of neTrend Corporation,
Leprechaun Software International, Ltd. and the LAN Software business of
Technocom plc of $2.2 million, $0.8 million and $2.0 million, respectively. In
addition there were property and equipment purchases of $3.7 million. For the
nine months ended September 30, 1997, net cash used in investing activities
primarily reflects purchases of property and equipment of $1.6 million, and
direct costs of the acquisitions of Purview Technologies, Inc. and csd Software
GmbH of $1.2 million and $5.8 million, respectively.
Net cash used in financing activities for the nine months ended September
30, 1996 and September 30, 1997 was $1.7 million and $763 thousand,
respectively. For the nine months ended September 30, 1996, net cash used in
financing activities consisted of principal repayment on obligations under
capital lease of $882 thousand and stock repurchase of $1.0 million, partially
offset by exercises of stock options and stock purchases through the Company's
Employee Stock Purchase Plan ("ESPP") of $93 thousand. For the nine months ended
September 30, 1997, net cash used in financing activities consisted of principal
repayment on obligations under capital lease of $818 thousand, partially offset
by exercises of stock options and stock purchases through the ESPP of $73
thousand.
The Company has estimated that the product development, marketing and sales
costs of the CCM products are approximately $1.0 to $1.5 million per month. The
Company believes that its existing cash balances, funds generated from
operations and borrowing under its line of credit will be sufficient to fund
these costs through March 1998, whether or not the Proposed Transaction is
consummated. If the Proposed Transaction is consummated, the Company believes
that it will have sufficient financial resources to fund these costs through at
least December 1998. If the Proposed Transaction is not consummated, the
Company will have to seek additional sources of capital to fund CCM product
costs beyond March 1998. There can be no assurance that the Company's estimate
of the marketing, sales and product development costs of the CCM products will
prove correct, that such costs will not increase beyond the Company's available
financial resources, or that additional sources of capital, if and when needed,
will be sufficient or available.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
SOME STATEMENTS CONTAINED IN THIS FORM 10Q THAT ARE NOT HISTORICAL
STATEMENTS (INCLUDING BUT NOT LIMITED TO, STATEMENTS CONCERNING ESTIMATES OF
FUTURE REVENUES, OPERATING EXPENSE LEVELS AND SUCH OPERATING LEVELS RELATIVE TO
THE COMPANY'S TOTAL REVENUES) CONSTITUTE FORWARD-LOOKING STATEMENTS UNDER THE
SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
THE RISK FACTORS DISCUSSED BELOW, AMONG OTHER FACTORS (INCLUDING THE ACCURACY OF
THE COMPANY'S INTERNAL ESTIMATES OF REVENUE AND OPERATING EXPENSE LEVEL AND THE
OTHER RISK FACTORS DISCLOSED FROM TIME TO TIME IN THE COMPANY'S FILINGS WITH THE
SECURITIES AND EXCHANGE COMMISSIONS), MAY CAUSE THE COMPANY'S ACTUAL RESULTS TO
DIFFER MATERIALLY FROM THE ESTIMATED RESULTS STATED IN SUCH FORWARD-LOOKING
STATEMENTS.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
The risk factors discussed below, among other factors (including the
accuracy of the Company's internal estimates of revenue and operating expense
levels), may cause the Company's actual results to differ materially from the
results stated in the forward-looking statements contained in this Form 10-Q.
The following discussion of the Company's risk factors should be read in
conjunction with the Company's financial statements and related notes thereto
contained in the Company's Annual Report on Form 10-K for the year ended
December 31, 1996.
The following risk factors concern the Proposed Transaction and the
business of the Company to be conducted if the Proposed Transaction is
consummated, or if the Proposed Transaction is not consummated:
CHANGE IN MARKETING STRATEGY
Historically, the Company has marketed all of its products other than its
Comprehensive Client Management ("CCM") Products through its Free Trial
Marketing system. See "--Free Trial Marketing." Pursuant to the Proposed
Transaction, the Company is selling, among other things, its Free Trial
Marketing system, subject to a limited license-back to the Company. This
license will allow the Company to continue to use the Free Trial Marketing
system to market its current Groupware products, including future versions and
feature extension of such products, to existing customers and identified leads,
for a period of three years from the closing date of the Proposed Transaction
(the "Closing Date"), subject to termination in the event of a sale of the
Groupware products or a sale of all or substantially all of the Company's
business or assets.
Although the Company will retain limited rights to the Free Trial Marketing
system after the consummation of the Proposed Transaction, the Company's ability
to implement a marketing strategy based on the Free Trial Marketing system will
be severely curtailed because the Company will no longer have the personnel and
infrastructure necessary to support to such a strategy. Moreover, the Company
has made the strategic decision to limit its Groupware marketing efforts to
exclusively selling new seats to its existing customer base, while focusing the
majority of its management, financial and technical resources to the CCM
products. The Company has made a strategic decision to cease marketing the
Groupware products to new customers. Inasmuch as the Company's historical
marketing strategy has been based primarily on the Free Trial Marketing system,
the Company's decision to sell substantially all of its rights to the Free Trial
Marketing system will significantly limit the marketing strategies available to
the Company.
CCM PRODUCT MARKETING STRATEGY
After the consummation of the Proposed Transaction, the Company will be
focused primarily on its CCM products. The target market for the CCM products
is entirely different from the target market for the products the Company has
marketed and sold through its Free Trial Marketing system. The target market
for the CCM products consists primarily of large corporations such as Deutsche
Telekom, BASF and Munich Reinsurance (all existing CCM customers). In addition,
CCM product sales per customer are generally in the range of $20,000 to
$500,000, as opposed to an average sale per customer for the Company's other
products of approximately $2,000. Sales of CCM products pose significantly
greater financial risks, and require greater up-front investments in marketing,
technical and financial resources, than sales of the Company's historical
products. As a result, the Company is adopting a new and untested marketing
strategy using a direct sales force and in-field service organization. This
marketing strategy requires significant investments in additional marketing and
technical personnel, retraining of existing personnel, ongoing product
development and creation of an in-field service organization. To date,
substantially all of the Company's marketing of CCM products has been in Europe.
While the Company has developed valuable experience and expertise in Europe,
there can be no assurance that the Company will be able to transfer such
experience and expertise to the North American market.
TECHNOLOGICAL REQUIREMENTS OF THE CCM PRODUCTS; PRODUCT DEVELOPMENT
The technological demands of the CCM products require a commitment of
significant ongoing financial, technical and personnel resources to product
development, training of service technicians and customer training. Because the
Company's historical products are not as technologically demanding as the CCM
products, the Company has not to date made the required investment and has not
proven that it can develop and maintain the organization required to support
such products. The Company believes that its experience with the CCM products
in Europe will provide a valuable base on which to build the necessary
financial, technical and personnel resources to sell, market, develop and
support the CCM products in North America; however, there can be no assurance
that the Company will be able to expand and develop its resources to support CCM
products in North America.
After the consummation of the Proposed Transaction, the Company will be
focused primarily on its CCM product. The CCM product is typically larger and
more complex than the products that the Company has previously developed. The
Company's ability to continue to enhance the CCM product to meet customer and
market requirements will depend substantially on its ability to effectively
manage its development effort and to attract and retain the required development
personnel in Cambridge, Massachusetts and Starnberg, Germany.
MANAGEMENT AGREEMENT; TRANSFERRED EMPLOYEES
Contemporaneously with the execution and delivery of the Purchase
Agreement, the Company and Elron Software, Inc. entered into a Management
Agreement (the "Management Agreement") pursuant to which Elron Software, Inc.
will manage the assets being acquired by Elron pursuant to the Purchase
Agreement (the "Proposed Assets") for its benefit and at its risk and expense.
Pursuant to the Management Agreement, Elron, has, subject to certain covenants
regarding extraordinary transactions, complete discretion to operate the
business of the Company with regard to the Proposed Assets. In the event that
the Proposed Transaction is not consummated, Elron will be obligated to return
the Proposed Assets to the Company, subject to the terms and conditions of the
Management Agreement. There can be no assurance that the Proposed Assets would
upon return by Elron have at least the same value as such assets had at the time
the Management Agreement was executed. Any diminution in value of the Proposed
Assets could have a material adverse effect on the Company's business, condition
(financial and otherwise), prospects and results of operations.
Pursuant to the Purchase Agreement, certain employees of the Company will
be employed by the Company, but will from the date of the Purchase Agreement
until the Closing Date, to the extent allowed by law, be subject to the complete
supervision, direction and control of Elron Software, Inc. (the "Transferred
Employees"). The Company has been advised that the Transferred Employees have
been offered various benefits and incentives by Elron Software, Inc. after the
consummation of the Proposed Transaction. In the event that the Proposed
Transaction is not consummated, and as a result such benefits and incentives are
not provided, the performance of the Transferred Employees could be materially
adversely affected and a significant portion of such employees may seek
employment elsewhere.
FAILURE OF THE COMPANY TO OBTAIN CERTAIN THIRD-PARTY CONTRACTS
Although the only condition to closing the Proposed Transaction (the
"Closing") is that the Purchase Agreement and Proposed Transaction be approved
by the stockholders of the Company, the Company is obligated to obtain certain
third-party consents on or prior to the Closing. In the event that the Company
does not obtain such consents, it will be obligated to pay certain specified
financial damages. The payment of such financial penalties may have a material
adverse effect on the Company's business, condition (financial and otherwise),
prospects and results of operations.
INTERNATIONAL REVENUE
In fiscal 1996 and the nine-month period ending September 30, 1997, total
revenue from international licenses (license revenue from outside the United
States) represented approximately 17% and 35%, respectively, of the Company's
total revenue. For the fourth quarter of 1997 and thereafter (assuming the
Proposed Transaction is consummated), the Company expects that international
revenue will constitute a significantly greater portion of the Company's total
revenue. Accordingly, a greater percentage of the Company's total revenue will
be subject to the risks inherent in international sales, including the impact of
fluctuating exchange rates on demand for its products, longer payment cycles,
greater difficulty in protecting intellectual property, greater difficulty in
accounts receivable collection, unexpected changes in legal and regulatory
requirements, seasonality due to the slowdown of European business activity in
the third quarter and tariffs and other trade barriers. There can be no
assurance that these factors will not have a material adverse effect on the
Company's future international license revenue. Further, in countries with a
high incidence of software piracy, the Company may experience a higher rate of
piracy of its products.
LOSS OF KEY MANAGEMENT PERSONNEL
Ivan O'Sullivan and Chadwick Roll, Vice President - Worldwide Marketing and
Vice President of Inside Sales of the Company, respectively, are among the
Transferred Employees. Messrs. O'Sullivan and Roll are key employees of the
Company. The loss of their services may have a material adverse effect on the
Company's business, condition (financial or otherwise), prospects or results of
operations.
The Company's success depends to a significant extent upon a number of key
technical and management employees. While the Company's employees are required
to sign standard agreements concerning confidentiality and ownership of
inventions, the employees, with the exception of Messrs. Herman DeLatte,
Platzman and Bogdan are generally not otherwise subject to employment agreements
or noncompetition covenants. The loss of the services of any of the Company's
key employees could have a material adverse effect on the Company's business,
financial condition or results of operation. The Company does not maintain life
insurance policies on key employees. The Company's success also depends in large
part upon its ability to attract and retain highly skilled technical,
managerial, sales and marketing personnel.
Competition in the software industry for such personnel is intense. There
can be no assurance that the Company will be successful in retaining its
existing key personnel and in attracting and retaining the personnel it
requires.
GROUPWARE BUSINESS
After the consummation of the Proposed Transaction, the Company's products
will consist of the CCM and the Groupware products. The Company has made the
strategic decision to limit its Groupware marketing efforts to exclusively
selling new seats to its existing customer base, while focusing the majority of
its management, financial and technical resources to the CCM products. The
Company believes that in the short-term the Company can significantly reduce the
costs associated with the Groupware products while continuing to generate cash
flow from the sale of these products. However, there can be no assurance that
cash flow from the sale of the Groupware products will not decrease faster than
expected. In addition, over the longer term, the Company's strategic decision
to cease marketing the Groupware products to new customers will lead to an
erosion of the customer base and a reduction of revenue from such products.
Furthermore, the Company is considering the possibility of selling or licensing
one or more of the Groupware products in order to provide additional cash for
the CCM Business. The possibility of these dispositions may further adversely
the impact of the Groupware business.
The Company's ability to attract and retain the employees needed to service
the Groupware products may be materially adversely affected by the Company's
strategic decision to de-emphasize the Groupware products and possibly sell or
license one or more of these products. Any loss of revenue from the Groupware
products may have a materially adverse affect on the Company's business
condition (financial and otherwise), prospects and results of operation.
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RISKS ASSOCIATED WITH STRATEGIC RESTRUCTURING
On July 29, 1997, the Company reorganized and restructured its operations.
On October 29, 1997, additional restructuring actions were implemented. These
actions were designed to focus the Company on the CCM Business. To date,
implementation of this new corporate strategy has included hiring a new Chief
Executive Officer, electing a new Chairman of the Board of Directors, de-
emphasizing the acquisition of new customers in the Company's Groupware and
Network Management and Security businesses, discontinuing sales of the Company's
virus protection software, closing or reducing the Company's offices in Sydney,
Paris, London and Munich, while building up the Company's office in Starnberg,
Germany and laying off approximately 160 employees. There can be no assurance
that the Company's new corporate strategy will be successfully implemented.
Furthermore, there can be no assurance that the Company will not engage in
further reorganizations or restructurings in the future.
Moreover, there can be no assurance that the Company will be successful in
developing and expanding its new enterprise client management software business.
The Company's decision to de-emphasize customer acquisition investment in its
groupware, network management and security businesses is expected to result in a
significant sales decline for those businesses. There can be no assurance that
the growth, if any, in the Company's new enterprise client management software
business will offset, either in whole or in part, the decline in revenues from
the Company's other businesses. The elimination of the Company's anti-virus
business will adversely impact total sales. There can be no assurance that the
Company will not engage in further reorganizations and restructuring in the
future.
VARIABILITY OF QUARTERLY OPERATING RESULTS
The Company's licensing activity and results of operations can fluctuate
significantly on a quarterly basis. Causes of such fluctuations may include,
among other factors the volume and timing of new and repeat orders, the
introduction or announcement of new products or product enhancements by ON or
third parties, failure to ship trials, changes in response rates to the
Company's mailings and telemarketing programs, interruption in the Company's
overnight delivery, telephone or internal networks and databases, work
stoppages, changes in product prices, changes in operating expenses, changes in
product mix, increase in international sales as a percentage of total revenue,
seasonality, trends in the computer industry, unavailability of product,
potential software viruses and perceived threats thereof, customer order
deferrals, general economic conditions, extraordinary events such as
acquisitions or litigation and the occurrence of unexpected events. While to
date, the Company has not experienced any significant failure to ship trials,
work stoppages or unavailability of products, there can be no assurance any of
such events will not occur in the future. The occurrence of any such event could
have a material adverse effect on the Company's business, condition (financial
or otherwise), prospects or results of operations. Because of the nature of its
distribution methods for its Groupware and Network Management and Security
products, the Company has virtually no backlog with respect to such products and
generally cannot predict when users will license such products. As a result of
the longer enterprise sales and product rollout cycle for CCM, the Company will
have improved visibility of anticipated customer orders for CCM. Historically,
repeat orders have accounted for a significant portion of the Company's total
revenue; however, there can be no assurance that the Company will be able to
sustain current repeat order rates in the future, especially after consummation
of the Proposed Acquisition and in light of the deemphasis in marketing efforts
for the Groupware and Network Management and Security products. Furthermore,
since the Company's cost of total revenue is relatively low and its operating
expenses are relatively fixed, any revenue shortfall in a quarter will result in
a substantially similar shortfall in net income. In addition, significant
quarterly fluctuations in licensing activity will cause significant fluctuations
in the Company's cash flows and the cash and cash equivalents, accounts
receivable and deferred revenue accounts on the Company's balance sheet.
The Company's business has experienced and is expected to continue to
experience seasonality, due in part to customer buying patterns. In recent
years, the Company generally has had greater demand for its products in the
fourth quarter and has had weaker demand for its products during the first
quarter. These fluctuations are caused primarily by customer budgeting and
purchasing patterns. The Company believes this pattern will continue.
The Company believes that period-to-period comparisons of its financial
results should not be relied upon as an indication of future performance.
RISKS ASSOCIATED WITH RAPID TECHNOLOGICAL CHANGE
The Groupware, Network Management and Security and Client Management
software markets are characterized by rapid technological developments, changes
in customer requirements, evolving industry standards and frequent new product
introductions. The Company's future success will depend, in part, upon its
ability
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to enhance its existing applications, develop and introduce new products that
take advantage of technological advances, and respond promptly to new customer
requirements and evolving industry standards. As discussed above, the Company
has made a strategic decision to discontinue further new customer development of
its Groupware products and has agreed to sell, subject to shareholder approval,
its Network Management and Security products. The Company has identified a
number of enhancements to CCM which it believes are important to its continued
success in the Client Management software market. There can be no assurance that
the Company will be successful in developing and marketing, on a timely basis,
enhancements to its existing products or new products, or that its new products
will adequately address the changing needs of the marketplace. Failure by the
Company in any of these areas could materially and adversely affect the
Company's business, condition (financial or otherwise), prospects or results of
operations. In addition, from time to time the Company or its competitors may
announce new products with capabilities or technologies that could have a
potential to replace or shorten the life cycles of the Company's existing
products or render such products obsolete. There can be no assurance that
announcements by the Company or its competitors of new products will not cause
customers to defer purchasing the Company's existing products. In addition,
there can be no assurance that future changes in DOS, Windows, Windows NT, UNIX,
NetWare or other popular operating systems would not result in incompatibility
with the Company's products. The Company's failure to introduce new products on
a timely basis that are compatible with operating systems and environments
preferred by desktop computer users would have a material adverse effect on the
Company's business, condition (financial or otherwise), prospects and results of
operations.
COMPETITIVE RISKS
The market for the Company's products is highly competitive, and the
Company expects competition to increase in the future. The Company believes that
the principal competitive factors affecting the market for its products include
performance, functionality, ease of use, ease of installation, quality, customer
support, breadth of product line, speed of product delivery, frequency of
upgrades and updates, brand name recognition, company reputation, adherence to
industry standards, integration with third-party solutions and price. Certain of
the criteria upon which the performance and quality of the Company's Groupware
and Network Management and Security software compete include speed of response,
ease of use, ease of installation, interoperability with other messaging systems
and simplicity of administration. The Company believes that it generally
competes favorably with respect to each of these factors; however, there can be
no assurance that the Company will be able to continue to compete successfully
against current and future competitors. Certain of the Company's competitors
have been in the market longer than the Company, and other competitors are
larger and may have greater name recognition that the Company. As is the case in
many segments of the software industry, the Company may encounter increasing
price competition in the future. This could reduce average selling prices and,
therefore, profit margins. Competitive pressures could result not only in
sustained price reductions but also in a decline in sales volume, which could
adversely affect the Company's business, financial condition or results of
operations. There can be no assurance that the Company will continue to compete
effectively against existing and potential competitors in the communications and
network management software markets, many of whom have substantially greater
financial, technical, marketing and support resources and name recognition than
the Company.
The Groupware, Network Management and Security and Client Management
software markets are highly fragmented, with products offered by many vendors.
In the e-mail market, the Company competes with offerings from software,
shareware and freeware developers. Shareware is software that is made available
electronically on bulletin boards systems. Shareware users are encouraged to
evaluate the software for a short period of time and then either cease using it
or pay a license fee. In the group scheduling market, the Company also competes
with personal information manager products ("PIMs") that have been enhanced to
include some group scheduling features. In addition, the trend toward
enterprise-wide communications software solutions may result in a consolidation
of the communications software market around a smaller number of vendors who are
able to provide all of the necessary software and support capabilities.
RISKS ASSOCIATED WITH PRODUCT DEVELOPMENT
The Company has in the past experienced delays in software development, and
there can be no assurance that it will not experience further delays in
connection with its current or future product development activities. The
Company puts all of its products through alpha and beta test cycles and makes
significant efforts to debug all products before commercial release. The Company
makes well-marked alpha and beta versions of its software available for
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evaluation and testing and solicits and responds to input from evaluators.
However, there can be no assurance that the Company's products will not contain
undetected errors or version compatibility issues, particularly when first
introduced or when new versions are released, resulting in loss of or delay in
market acceptance. Delays and difficulties associated with new product
introductions or product enhancements could have a material adverse effect on
the Company's business, condition (financial or otherwise), prospects or results
of operations.
In addition to developing new products, the Company's internal development
staff is focused on developing upgrades and updates to existing products and
modifying, enhancing and completing any acquired products and incomplete
projects. Future enhancements may, among other things, include additional
functionality, respond to user problems or address issues of compatibility with
changing operating systems and environments. The Company believes that the
ability to provide these enhancements to users frequently and at a low cost is
key to its success. Failure to release such enhancements on a timely basis could
have a material adverse effect on the Company's business, condition (financial
or otherwise), prospects or results of operation. There can be no assurance that
the Company will be successful in these efforts.
If the Company believes that a licensed product continues to be valuable
after the expiration of the initial license term, it will seek to extend the
term of the license. There can be no assurance that the Company will be able to
extend the term of expiring licenses, or that the economic arrangements for such
extensions would be comparable to the arrangements in effect during the initial
license term.
RISKS OF INCLUSION OF CCM, GROUPWARE, NETWORK MANAGEMENT, AND SECURITY SOFTWARE
AND APPLICATION SUITES
In the future, vendors of operating system software and group of
applications sold for a single price (generally referred to as application
suites) may continue to enhance their products to include certain functions that
are currently provided most often by Groupware and Network Management software
or may bundle these products in their application suites at no additional
charge. The widespread inclusion of the functions provided by the Company's
products as standard features of operating system software could, particularly
if the quality of such functions were comparable to that of the Company's
products, render the Company's products obsolete and unmarketable. Furthermore,
even if the CCM, Groupware, Network Management and Security software functions
provided as standard features by operating systems are more limited than that of
the Company's products, there is no assurance that a significant number of
customers would not elect to accept such functions in lieu of purchasing
additional software. If the Company were unable to develop new Groupware,
Network Management and Security software products to further enhance operating
systems and to replace successfully any obsolete products, the Company's
business, condition (financial or otherwise), prospects and results of
operations would be materially and adversely affected.
DEPENDENCE ON EMERGENCE OF NETWORK MANAGEMENT SOFTWARE
The market for the Company's network management software is new and
evolving, and its growth depends upon the broader market acceptance of network
management software. In addition, there are a number of potential approaches to
the market, including incorporating network management software into network
operating systems. Therefore, even if network management software products gain
broader market acceptance, there can be no assurance that the Company's products
will be chosen by organizations which acquire network management software.
Moreover, a change in the licensing policies of Microsoft or other software
vendors which changes the basis on which concurrent users are measured or priced
could adversely effect the Company's network management software products.
Furthermore, to the extent that the network management software market does
develop, the Company expects that competition will increase. See "- Competitive
Risks," and "-- Risks of Inclusion of Communications Software and Network
Management Software in System Software and Application Suites."
RISKS ASSOCIATED WITH FREE TRIAL MARKETING
If the Proposed Transaction is not consummated and the rights to the Free
Trial Marketing system revert to the Company and, in any event, to the extent
the Company retains certain limited rights to the Free Trial Marketing system
pursuant to the Purchase Agreement, the Company would be exposed to the risks
associated with the Free Trial Marketing System set forth below.
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As part of the Free Trial Marketing system, customers are provided with 30-
day free trials of certain of the Company's principal products. The trials are
full featured versions of the product that are internally designed to cease
operation in 30 days. The Company depends on direct mail, trade shows and
telemarketing to find prospects and install trials. There can be no assurance
that this strategy will continue to be effective in the future for either
current or new products. The failure of this strategy to continue to effectively
generate license revenue would have a material adverse effect on the Company's
business, condition (financial or otherwise), prospects and results of
operations. In addition, as mailings are mailed repeatedly to the same
customers, customers' responsiveness to particular offers and products declines.
There can be no assurance that the Company will be able to sustain current
response rates to its mailings in the future. The Company's growth with respect
to products sold and marketed through the Free Trial Marketing system depends
both on its ability to select names from rented lists and to grow its "house
list." The availability and relevance of rentable names to the Company's
products are not certain. In addition, since the ability of the Company to grow
its house list is dependent on the supply of rentable names, house list growth
cannot be assured. In both the domestic and international markets, increases in
postal rates (including modifications in the classification of mail) or
telephone rates, or changes in postage or telephone regulations which prohibit
unsolicited direct mail or unsolicited telephone calls, could significantly
impact the economics of the Company's Free Trial Marketing strategy. In
addition, it is possible that other software vendors could adopt all or parts of
the Company's strategy and compete more directly or effectively with the
Company.
If some of the Company's Free Trial Marketing disks were to become infected
with a computer virus, they would cause difficulties for prospects and could
damage the Company's reputation. The Company does extensive testing for viruses.
The Company's use of outside fulfillment contractors increases the risk that a
virus could be shipped undetected on disks bearing the Company's label. There
can be no assurance that ON would be able to collect adequate compensation from
such fulfillment contractors if such a virus infected disks bearing the
Company's label.
The Company fulfills orders received directly from customers through a
third-party fulfillment contractor, which warehouses the Company's products and
ships them directly to ON's customers. The Company also maintains a private use
prospects list at a bonded third-party database firm. In the event that either
the customer fulfillment contractor or the private use database firm experience
a substantial business interruption, whether through business failure or
interruption or some natural calamity, or the Company's relationship with either
of such parties is terminated for any reason, the Company's ability to continue
to mail free trial offers to prospective customers and to fulfill orders placed
by customers would be adversely affected.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS
The Company may in the future undertake additional acquisitions that could
present challenges to the Company's management, such as integrating and
incorporating new operations, product lines, technologies and personnel. If the
Company's management is unable to manage these challenges, the Company's
business, financial condition or results of operations could be materially
adversely affected. Any acquisition, depending on its size, could result in
significant dilution to the Company's stockholders. Furthermore, there can be no
assurance that any acquired products will gain acceptance in the Company's
markets.
RISKS ASSOCIATED WITH PAST ACQUISITIONS
The Company has in the past made a number of acquisitions that have been
and are being integrated and incorporated into the Company's operations, along
with the acquired product lines, technologies and personnel. If the Company's
management is unable to continue to manage these challenges, the Company's
business, financial condition or results of operations could be materially
adversely affected. There can be no assurance that any acquired products will
gain acceptance in the Company's markets.
RISKS OF INDIRECT CHANNELS OF DISTRIBUTION
The Company markets its products through distributors and resellers in
addition to its direct sales force and its Free Trial Marketing system. These
distributors and resellers also sell other products that are complementary to,
or compete with, those of ON. There can be no assurance that these distributors
and resellers will not give greater priority to products of other suppliers.
They have no long-term obligation to purchase products from the Company. Since
the Company's agreements with its distributors provide for a right of return,
revenue recognized upon sales to
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distributors is subject to a reserve for returns. Although management believes
that the current reserve balance is adequate to cover this exposure, there can
be no assurance that any future period reserves for returns will be adequate. In
addition, the Company may be unaware of the nature and scope of the
representations made to customers by these distributors and resellers. For
example, they could make representations to customers about the Company's
current and future products which are inaccurate or incomplete. This could
result in the products not meeting the customers' expectations or requirements.
Although the Company's agreements with its distributors generally provide the
Company with recourse against unauthorized action taken by the distributors,
there can be no assurance that the Company could recover adequate compensation
to cover the damage caused by an inaccurate representation. See "--Risks
Associated with International Revenue."
RISKS ASSOCIATED WITH PROTECTION OF PROPRIETARY TECHNOLOGY
The Company's success is heavily dependent upon its proprietary software
technology. The Company relies on a combination of contractual rights,
trademarks, trade secrets and copyrights to establish and protect its
proprietary rights in its software.
The Company uses a printed "shrink-wrap" license for users of its
Groupware, Network Management and Security products distributed through
traditional distribution channels in order to protect its copyrights and trade
secrets in those products. Since these shrink-wrap licenses are not signed by
the licensee, many authorities believe that they may not be enforceable under
many state laws and the laws of many foreign jurisdictions. If such licenses are
not enforceable, the user would not be bound by the terms thereof, including the
terms which seek to protect the Company's proprietary technology. If the printed
shrink-wrap licenses prove to be unenforceable, this may have a material adverse
effect on the Company's business, financial condition and results of operations.
The laws of some foreign countries either do not protect the Company's
proprietary rights or offer only limited protection for those rights.
Furthermore, in countries with a high incidence of software piracy, the Company
may experience a higher rate of piracy of its products.
The Company has obtained registrations in the United States for the
following trademarks: ON Technology, Notework, Meeting Maker, ON Technology &
Design, ON Location, Instant Update and DaVinci Systems. The Company has
obtained only four foreign registrations of its Notework mark and two foreign
registrations of its MeetingMaker mark, due to the significant costs involved in
obtaining foreign registrations. As a result, the Company may not be able to
prevent a third party from using its trademarks in many foreign jurisdictions.
The Company has not to date registered any of its copyrights.
There can be no assurance that the steps taken by the Company to protect
its proprietary software technology will be adequate to deter misappropriation
of this technology. Lesser sensitivity by corporate, government or institutional
users to avoiding copyright infringement could have a material adverse effect on
the Company's business, condition (financial or otherwise), prospects and
results of operation. While the Company to date has not taken any legal action
to enforce its intellectual property rights against infringing users, it
believes, based upon current interpretations of law, that its use of Free Trial
Marketing and the widespread availability of its trials do not significantly
impact its ability to enforce its intellectual property rights against
infringing users, including corporate, institutional and government entities.
However, there is no assurance that a court or other authority may not rule
otherwise in the future. Such a ruling would have a material adverse effect on
the Company's business, condition (financial or otherwise), prospects and
results of operations.
There has been substantial litigation in the software industry involving
intellectual property rights of technology companies, although, to date, the
Company has not been subject to any such litigation. Although the Company does
not believe that it is infringing the intellectual property rights of others,
there can be no assurance that such claims, if asserted, would not have a
material adverse effect on the Company's business, condition (financial or
otherwise), prospects and results of operations. In addition, as the Company may
acquire or license a portion of the software included in its future products
from third parties, its exposure to infringement actions may increase because
the Company must rely upon such third parties for information as to the origin
and ownership of any software being acquired. The Company generally obtains
representations as to the origin and ownership of such acquired or licensed
software and generally obtains indemnification to cover any breach of such
representations. However, there can be no assurance that such representations
are accurate or that such indemnification will provide adequate compensation for
a breach of such representations. In the future, litigation may be necessary to
enforce and protect trade secrets and
16
<PAGE>
other intellectual property rights owned by the Company. The Company may also be
subject to litigation to defend against claimed infringement of the rights of
others or to determine the scope and validity of the proprietary rights of
others. Any such litigation could be costly and cause diversion of management's
attention, either of which could have a material adverse effect on the Company's
business, condition (financial or otherwise), prospects or results of
operations. Adverse determinations in such litigation could result in the loss
of the Company's proprietary rights, subject the Company to significant
liabilities, require the Company to seek licenses from third parties or prevent
the Company from manufacturing or selling its products, any one of which could
have a material adverse effect on the Company's business, condition (financial
or otherwise), prospects or results of operations. Furthermore, there can be no
assurance that any necessary licenses will be available on reasonable terms, or
at all.
DEPENDENCE UPON KEY PERSONNEL
The Company's success depends to a significant extent upon a number of key
technical and management employees. Messrs. Christopher Risley and John Rizzi,
President and Vice President of Worldwide Sales, respectively, have terminated
their employment relationships with the Company effective as of September 1,
1997. While the Company's employees are required to sign standard agreements
concerning confidentiality and ownership of inventions, the employees, with the
exception of Messrs. Risley, Platzman, Bogdan, Rizzi, O'Sullivan and Green, are
generally not otherwise subject to employment agreements or noncompetition
covenants. The loss of the services of any of the Company's key employees,
including the departures of Messrs. Risley and Rizzi as part of the Company's
strategic restructuring, could have a material adverse effect on the Company's
business, financial condition or results of operation. The Company does not
maintain life insurance policies on key employees. The Company's success also
depends in large part upon its ability to attract and retain highly skilled
technical, managerial, sales and marketing personnel. Competition in the
software industry for such personnel is intense. There can be no assurance that
the Company will be successful in retaining its existing key personnel and in
attracting and retaining the personnel it requires. See also "Risks Associated
with Strategic Restructuring".
17
<PAGE>
VOLATILITY OF STOCK PRICE
The trading price of the Company's Common Stock has been, and in the future
may be, subject to wide fluctuations in response to actual or anticipated
quarterly operating results of the Company, announcements of technological
innovations or new applications by the Company or its competitors and general
market conditions in the software industry, as well as other events or factors.
In addition, stock markets have experienced extreme price and volume trading
volatility in recent years. This volatility has had a substantial effect on the
market price of many technology companies and has often been unrelated to the
operating performance of those companies. This volatility may adversely effect
the market price of the Company's Common Stock.
18
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
FORM 10-Q, September 30, 1997
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
Not Applicable
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The exhibits listed in the accompanying Exhibit Index on page 22 are
filed or incorporated by reference as part of this Report.
19
<PAGE>
(b) Reports on Form 8-K
The Company filed a current report on form 8-K dated November 12,
1997 in connection with the Company's announcement of (a) the Company seeking
shareholder approval to sell assets (b) the Company's recording of a charge for
the reorganization of its international organization and (c) the reduction of
its restructuring charge previously reported by the Company.
20
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
FORM 10-Q, September 30, 1997
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ON TECHNOLOGY CORPORATION
/s/ Herman De Latte
----------------------------------
Date: November 14, 1997 Name: Herman De Latte
Title: Chief Executive Officer
/s/ John M. Bogdan
----------------------------------
Date: November 14, 1997 Name: John M. Bogdan
Title: Vice President of Finance
and Chief Financial Officer
21
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
FORM 10-Q, September 30, 1997
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
11.0 Computation of Net loss per share
27.0 Financial Data Schedule
<PAGE>
EXHIBIT 11.0
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
Computation of Net Loss Per Share (1)
FORM 10-Q, September 30, 1997
(dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------------ ------------------------------
1997 1996 1997 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net Loss $ (7,122) $ (6,226) $ (23,781) $ (17,900)
Weighted Average Common Shares
Outstanding During Period............... 12,223,309 10,980,103 12,091,960 10,875,798
---------- ---------- ---------- ----------
12,223,309 10,980,103 12,091,960 10,875,798
========== ========== ========== ==========
Net Loss Per Share......................... $ (0.58) $ (0.57) $ (1.97) $ (1.65)
========== ========== ========== ==========
</TABLE>
- ---------------
(1) Primary and fully diluted net loss per share has not been separately
presented, as the amounts would not be meaningful.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<EXCHANGE-RATE> 1
<CASH> 8,394
<SECURITIES> 0
<RECEIVABLES> 9,512
<ALLOWANCES> 2,062
<INVENTORY> 1,409
<CURRENT-ASSETS> 22,915
<PP&E> 12,233
<DEPRECIATION> 7,079
<TOTAL-ASSETS> 30,766
<CURRENT-LIABILITIES> 12,293
<BONDS> 0
0
0
<COMMON> 123
<OTHER-SE> 18,279
<TOTAL-LIABILITY-AND-EQUITY> 30,766
<SALES> 33,648
<TOTAL-REVENUES> 37,122
<CGS> 7,650
<TOTAL-COSTS> 32,926
<OTHER-EXPENSES> 20,428
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 234
<INCOME-PRETAX> (23,648)
<INCOME-TAX> (133)
<INCOME-CONTINUING> (23,781)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (23,781)
<EPS-PRIMARY> (1.97)
<EPS-DILUTED> (1.97)
</TABLE>
