<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 31 March 1998
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
--- ----
12,240,359 shares of the registrant's Common stock, $0.01 par value, were
outstanding as of May 13, 1998.
THIS DOCUMENT CONTAINS 23 PAGES.
THE EXHIBIT INDEX IS ON PAGE 21.
1
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ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
FORM 10-Q, March 31, 1998
CONTENTS
Item Number Page
- ----------- ----
PART I: FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Balance sheets:
March 31, 1998 and December 31, 1997 3
Statements of operations:
Three months ended March 31, 1998 and 1997 4
Statements of cash flows:
Three months ended March 31, 1998 and 1997 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 19
SIGNATURES 20
EXHIBIT INDEX 21
2
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
--------- -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $12,293 $ 6,679
Accounts receivable, net of allowance for doubtful accounts and
sales returns of $1,800 and $2,975, respectively 2,630 2,970
Inventories 149 267
Prepaid expenses and other current assets 1,813 2,508
Assets held for sale --- 1,755
-------- --------
Total current assets 16,885 14,179
-------- --------
Property and equipment, at cost:
Computers and equipment 2,863 2,892
Equipment acquired under capital leases 2,441 2,443
Furniture and fixtures 240 292
-------- --------
Less - Accumulated depreciation 3,668 3,477
-------- --------
1,876 2,150
-------- --------
Other assets and deposits 81 81
Purchased intangibles, net of $1,197 and $1,106 of accumulated
amortization, respectively 848 972
-------- --------
19,690 17,382
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of capital lease obligations 216 356
Accounts payable 3,530 5,072
Accrued expenses 3,135 3,719
Reserve for distributor inventories 238 216
Deferred revenue 1,200 1,013
-------- --------
Total current liabilities 8,319 10,376
-------- --------
Capital lease obligations, net of current portion --- 10
-------- --------
Stockholders' Equity:
Common stock, $.01 par value Authorized - 20,000,000 shares
Issued and outstanding 12,241,920, shares and 12,223,213
shares, respectively 122 122
Additional paid in capital 62,685 62,665
Deferred compensation (131) (229)
Accumulated deficit (51,140) (55,480)
Cumulative translation adjustment (118) (35)
Treasury stock (15,000 and 257,867 shares at cost, respectively) (47) (47)
-------- --------
Total stockholders' equity 11,371 6,996
-------- --------
$ 19,690 $ 17,382
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements
3
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
------------------
1998 1997
-------- --------
<S> <C> <C>
Revenue:
- --------
Net product revenue $ 3,123 $ 11,460
Other revenue 1,052 1,033
----------- ----------
Total revenue 4,175 12,493
----------- ----------
Operating expenses:
- -------------------
Cost of product revenue 873 2,076
Sales and marketing 2,411 6,306
Research and development 2,328 3,138
General and administrative 784 1,088
Charge for purchased research
and development --- 15,898
Gain on sale of assets (6,518) ---
----------- ----------
Income ( loss) from operations 4,297 (16,013)
----------- ----------
Interest income, net 40 122
----------- ----------
Income (loss) before provision
For income taxes 4,337 (15,891)
----------- ----------
Provision for income taxes --- ---
----------- ----------
Net income ( loss) $ 4,337 $ (15,891)
=========== ==========
Basic earnings per share $ 0.35 $ (1.35)
=========== ==========
Diluted earnings per share $ 0.35 $ (1.35)
=========== ==========
Basic shares used in per share calculation 12,220,178 11,725,000
=========== ==========
Diluted shares used in per share calculation 12,400,303 11,725,000
=========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
--------------------------
1998 1997
-------- --------
<S> <C> <C>
Cash Flows from Operating Activities
Net income (loss) $ 4,337 $(15,891)
Adjustments to reconcile net loss
to net cash used in operating activities
Charge for purchased research and development --- 15,898
Gain on sale of assets (6,518) ---
Amortization of deferred compensation 98 ---
Depreciation and amortization 289 1,078
Change in direct marketing costs --- (26)
Changes in assets and liabilities:
Accounts receivable 309 318
Inventories 116 (185)
Prepaid expenses and other current assets 696 (46)
Accounts payable (1,528) 1,852
Accrued expenses (582) (2,096)
Reserve for distributor inventory 22 (104)
Deferred revenue 193 (757)
------- --------
Net cash provided by (used in) operating activities (2,569) 41
------- --------
Cash Flows From Investing Activities
Change in other assets and deposits --- (1)
Purchase of property and equipment, net 64 (540)
Purchase of Purview Technologies, Inc., net of
cash acquired --- (1,228)
Purchase of csd Software GmbH, net of cash acquired --- (5,770)
Net proceeds from assets held for sale, net of deal costs 8,273 ---
------- --------
Net cash provided by (used in) investing activities 8,337 (7,539)
------- --------
Cash Flows From Financing Activities
Exercise of stock options 2 38
Stock purchase through ESPP 20 4
Principal repayments on obligation under capital lease (148) (277)
------- --------
Net cash used in financing activities (126) (235)
------- --------
Net effect of exchange rates on cash & cash equivalents (28) (34)
Net decrease in cash and cash equivalents 5,614 (7,767)
Cash and cash equivalents, beginning of period 6,679 20,774
------- --------
Cash and cash equivalents, end of period $12,293 $ 13,007
======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for -
Interest paid $ 23 $ 40
======= ========
Income taxes paid $ 0 $ 326
======= ========
</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, March 31, 1998
(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. Earnings (loss) per Share
-------------------------
The Company calculates earnings (loss) per share in accordance with
Statement of Financial Accounting Standards No. 128 "SFAS 128" "Earnings Per
Share." Basic earnings per share in calculated by dividing net income (loss) by
the weighted average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution of stock options that could
share in the earnings of the Company.
Basic and diluted EPS as required by SFAS 128, are as follows:
<TABLE>
<CAPTION>
Three Months
Ended March 31,
-----------------------------------
1998 1997
--------------- ---------------
<S> <C> <C>
Net Income (loss) $ 4,337 $ (15,891)
Basic weighted average shares outstanding 12,220,178 11,725,000
Weighted average common equivalent shares 180,125 ---
Diluted weighted average shares outstanding 12,400,303 11,725,000
=============== ===============
Basic earnings per share $ 0.35 $ (1.35)
=============== ===============
Diluted earnings per share $ 0.35 $ (1.35)
=============== ===============
</TABLE>
3. New Accounting Pronouncements
------------------------
The Company adopted SFAS 130 "Reporting Comprehensive Income", effective
January 1, 1998. SFAS 130 establishes standards for reporting and display of
comprehensive income and its financial statements. The Company's only item of
other comprehensive income relates to foreign currency translation adjustments,
and is presented separately on the balance sheet as required. If presented on
the statement of operations for the three months ended March 31, 1998 and March
31, 1997, comprehensive income would be $83 and $29 lower, respectively, than
reported net income (loss), due to foreign currency translation adjustments.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position 98-1, "Accounting for Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1
requires computer software costs associated with internal use software to be
expensed as incurred until certain capitalization criteria are met. The Company
will adopt SOP 98-1 prospectively beginning January 1, 1999. Adoption of this
Statement will not have a material impact on the Company's consolidated
financial position or results of operations.
In April 1998, the AICPA issued Statement of Position 98-5, "Reporting on
the Costs of Start-Up Activities" ("SOP 98-5"). SOP 98-5 requires all costs
associated with pre-opening, pre-operating and organization activities to be
expensed as incurred. The Company will adopt SOP 98-5 beginning January 1,
1999. Adoption of this Statement will not have a material impact on the
Company's consolidated financial position or results of operations.
6
<PAGE>
4. Gain On Sale of Assets
----------------------
In connection with the Sale of Assets to Elron Software Inc., the
Company received net proceeds of $8,823 and incurred $550 of deal costs. As a
result of the Sale of Assets that had a carrying value of $1,755 the Company
recorded again of $6,518.
7
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
Management Discussion and Analysis of Financial Condition and Results of
Operations
FORM 10-Q, March 31, 1998
(unaudited)
OVERVIEW
ON Technology Corporation and Subsidiaries (the "Company") is engaged in the
development, marketing, sales support, and distribution of Groupware and Client
Management 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
------------------------------
MARCH 31, MARCH 31,
1998 1997
--------- ---------
<S> <C> <C>
Revenue:
Net product revenue 74.8 % 91.7 %
Other revenue 25.3 % 8.3 %
-----------------------------
Total revenue 100.0 % 100.0 %
-----------------------------
Operating expenses:
Cost of product revenue 20.9 % 16.6 %
Sales and marketing 57.7 % 50.5 %
Research and development 55.8 % 25.1 %
General and administrative 18.8 % 8.7 %
Charge for purchased R&D --- 127.3 %
Gain on sale of assets (156.1)% ---
Income (loss) from operations 102.9 % (128.2)%
-----------------------------
Interest income, net 1.0 % 1.0 %
-----------------------------
Net income (loss) before
Provision for income taxes 103.9 % (127.2)%
-----------------------------
Provision for income taxes --- ---
-----------------------------
Net income (loss) 103.9 % (127.2)%
=============================
</TABLE>
NET PRODUCT REVENUE. The Company's net product revenue is derived primarily
from the licensing of software products. Net product revenue, for the three
months ended March 31, 1997, also includes revenue from catalog sales of third
party products and catalog advertising space of $179 thousand. For the three
months ended March 31, net product revenue decreased $8.4 million (72.7%) from
1997 to 1998, due primarily to products de-emphasized as part of the strategic
reorganization and restructurings undertaken in 1997 and the Company's sale of
its Network Management and Network Security Business along with the related
marketing systems and organization to Elron Software Inc.
8
<PAGE>
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 March 31, other revenue increased $19 thousand (1.8%) from 1997 to 1998.
This increase is primarily attributed to an increase in revenue from maintenance
contracts for existing customers. Other revenue decreased in absolute dollars
due to the Eltron Transaction.
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
March 31, cost of product revenue decreased $1.2 million (57.9%) from 1997 to
1998. 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 businesses. The cost of product revenue decreased in absolute dollars
due to the Elron Transaction.
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 March 31, sales
and marketing expenses decreased $3.9 million (61.8%) from 1997 to 1998. The
decrease in absolute dollars is due to the Elron Transaction.
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 March 31, research and development expense decreased $810 thousand (25.8%)
from 1997 to 1998. The decrease in absolute dollars is due to the Elron
Transaction. 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 March
31, general and administrative expense decreased $304 thousand (27.9%) from 1997
to 1998. The percentage of general and administrative expense to total revenue
increased due to reduced sales resulting from the Elron Transaction.
9
<PAGE>
CHARGE FOR PURCHASED RESEARCH AND DEVELOPMENT. In connection with the
acquisitions of Purview Technologies, Inc. and csd Software GmbH during the
three months ended March 31, 1997, the Company allocated an aggregate of
$15.9 million 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.
GAIN ON SALE OF ASSETS. In connection with the Sale of Assets to Elron
Software, Inc., the Company received net proceeds of $8.8 million and incurred
$550 thousand of deal costs. As a result of the Sale of Assets that had a
carrying value of $1.8 million the Company recorded a gain of $6.5 million.
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 March 31, interest income decreased
$82 thousand (67.2%) from 1997 to 1998. The decrease is a result of the change
in cash available for investment during these two periods.
INCOME TAXES. The Company recorded a book gain on the Sale of Assets to
Elron, however for tax purposes the Company recognized an ordinary loss on this
transaction. As a result, no tax provision is required for the three months
ended March 31, 1998. There were no tax provision recorded for the three
months ended March 31, 1997.
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 March 31,
1997 and March 31, 1998, the Company had available cash and cash equivalents of
$13.0 million and $12.3 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 March 31,
1998, the Company did not have an outstanding balance under the line of credit
agreement.
Net cash provided by (used in) operating activities for the three months ended
March 31, 1997 and March 31, 1998, was $41 thousand and ($2.7) million,
respectively. For the three months ended March 31, 1997, net cash provided by
operating activities consisted primarily of a net loss of $15.9 million offset
by a charge for purchased research and development of $15.9 million. Additional
factors contributing to net cash provided by operating activities included
depreciation and amortization of $1.1 million, a decrease in accounts receivable
of $318 thousand and accrued expenses of $2.0 million and an increase in
accounts payable of $1.9 million. These charges are primarily the result of the
acquisitions of Purview Technologies and csd Software GmbH. For the three months
ended March 31, 1998, net cash used in operating activities consisted primarily
of net income of $4.3 million which is offset by a $6.5 million gain on sale
of assets, and net change in operating assets and liabilities of $387 thousand.
Net cash provided by (used in) investing activities for the three months ended
March 31, 1997 and March 31, 1998 was ($7.5) million and $8.3 million,
respectively. For the three months ended March 31, 1997, net cash used in
investing activities primarily reflects purchases of property and equipment of
$540 thousand, and direct costs of the acquisitions of Purview Technologies,
Inc. and csd Software GmbH of $1.2 million and $5.8 million, respectively. For
the three months ended March 31, 1998 cash provided by investing activities was
primarily a result of net proceeds from assets held for sale of $8.3 million.
Net cash used in financing activities for the three months ended March 31,
1997 and March 31, 1998 was $235 thousand and $126 thousand, respectively. For
the three months ended March 31, 1997, net cash used in financing activities
consisted of principal repayment on obligations under capital lease of $277
thousand which was partially offset by the exercises of stock options and stock
purchases through the Company's Employee Stock Purchase Plan ("ESPP") of $42
thousand. For the three months ended March 31, 1998, net cash used in financing
activities consisted of principal repayment on obligations under capital lease
of $148 thousand, partially offset by the exercises of stock options and stock
purchases through the ESPP of $22 thousand.
10
<PAGE>
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
SOME 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 HARBOUR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
THE FOLLOWING RISK FACTORS, AMONG OTHER FACTORS (INCLUDING THE ACCURACY OF THE
COMPANY'S INTERNAL ESTIMATES OF REVENUE AND OPERATING EXPENSE LEVEL AND OTHER
RISKS DETAILED FROM TIME TO TIME IN THE COMPANY'S FILINGS WITH THE SECURITIES
AND EXCHANGE COMMISSION), MAY CAUSE THE COMPANY'S ACTUAL RESULTS TO DIFFER
MATERIALLY FROM THE RESULTS STATED IN SUCH FORWARD LOOKING STATEMENTS.
CHANGE IN MARKETING STRATEGY
Historically, the Company has marketed all of its products other than the
Comprehensive Client Management ("CCM") products through its Free Trial
Marketing system. Pursuant to the Elron Transaction, the Company sold, 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 extensions of such products, to existing customers
and identified potential customers, for a period of three years from the closing
date of the Elron 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 retains limited rights to the Free Trial Marketing
system, the Company's ability to implement a marketing strategy based on the
Free Trail Marketing system has been be severely curtailed because the Company
no longer has the personnel and infrastructure necessary to support 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 on the its CCM products.
CCM PRODUCT MARKETING STRATEGY
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 CCM products consists primarily of
large corporations such as Deutsche Telekom and Munich Reinsurance (both
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 Groupware products of approximately $2,500. 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.
As a result of the Elron Transaction, the Company relies on fewer large
customers for its revenue since the target market for CCM products is primarily
large corporations. Currently, only one customer accounts for more than 10% of
the Company's net revenue. For the twelve months ended December 31, 1997,
Deutsche Telekom accounted for $4.5 million, or 52% of net revenue from the
Company's current products. For the three months ended March 31, 1998, Deutsche
Telecom accounted for $767 thousand, or 18% of net revenue. It is possible that
the Company's change in marketing strategy will result in other customers
accounting for more than 10% of the Company's net revenues.
11
<PAGE>
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 were 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.
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, to
attract and retain the required development personnel in Cambridge,
Massachusetts and Starnberg, Germany and to coordinate and manage geographically
remote development efforts.
FINANCIAL RESOURCES REQUIRED BY THE CCM PRODUCTS
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 it has sufficient financial resources to fund these costs
through at least December 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.
RAPID TECHNOLOGICAL CHANGE
The Groupware and Enterprise Desktop 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, unpon its
ability 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 limit its Groupware marketing efforts
to exclusively selling new seats to its existing customer base. The Company has
identified a number of enhancements to CCM which it believes are important to
its continued success in the Enterprise Desktop 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 and
otherwise), prospects and results of operations. In addition, from time to time
the Company or its competitors may announce new products with capabilities or
technology 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 customer users would have a
material adverse effect on the Company's business, condition (financial or
otherwise), prospects and results of operations.
12
<PAGE>
COMPETITION
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 or 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 software compete includes 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
repect to each of these factors; howver, 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 cometitors 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 have a material
adverse effect on the Company's business, condition (financial or otherwise),
prospects and results of operations. There can be no assurance that the Company
will continue to compete effectively against existing and potential competitors
in these markets, many of whom have substantially greater financial, technical,
marketing and support resources and name recognition than the Company.
The Groupware, and Enterprise Desktop 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.
In the Enterprise Desktop Management market, the Company faces competition
from large and established companies, such as Microsoft, Intel and IBM/Tivoli,
which offer client management capabilities as part of their systems, network
and/or desktop management systems. Moreover, Microsoft has announced the Zero
Administration Initiative for Windows ("ZAW"), which includes a set of
technologies that address some of the same client management issues as CCM.
Microsoft has described components of ZAW as being available for future versions
of the Windows NT and Windows 95 operating systems, as well as the Microsoft
Systems Management Server product. There can be no assurance that the Company
can continue to compete effectively against Client Management software which is
included free with operating system software.
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
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 and
results of operations.
13
<PAGE>
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. 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 and results of
operations. 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.
INCLUSION OF CCM AND GROUPWARE IN SYSTEM SOFTWARE AND APPLICATION SUITES
In the future, vendors of operating system software and 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 CCM and Groupware 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 and Groupware software
functions provided as standard features by operating systems are more limited
than those 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 CCM
and Groupware 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.
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.
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.
INDIRECT CHANNELS OF DISTRIBUTION
The Company markets its products (other than ON Command CCM) through
distributors and resellers in addition to its direct sales force. 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 distributors is subject to a reserve for
returns. Although management believes that the current reserve balance is
14
<PAGE>
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.
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
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, condition (financial or otherwise), prospects and results of
operations.
The Company has signed license agreements from users of its CCM products
to protect its copyrights and trade secrets in those products. The licenses may
not be enforceable under some 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 signed license agreements prove to be
unenforceable, this may have a material adverse effect on the Company's
business, condition (financial or otherwise), prospects 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 filed
for the trademark "ON Command CCM" in the United States, the European Community,
Canada and Australia. The Company has obtained only four foreign registrations
of its Notework mark and two foreign registrations of its Meeting Maker mark,
due to 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.
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, financial condition 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
15
<PAGE>
compensation for a breach of such representations. In the future, litigation may
be necessary to enforce and protect trade secrets and 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,
financial condition 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 and results of
operations. Furthermore, there can be no assurance that any necessary licenses
will be available on reasonable terms, or at all.
The Company could be subjected to lawsuits by customers, past, present or
future, and others due to possible errors in the Company's software. The
Company is not aware of any material errors in its software or any pending or
threatened litigation. The Company maintains insurance covering such
liabilities in the amounts of $12 million domestically and $4 million
internationally. The Company believes that its insurance coverages are
sufficient to cover any such losses.
INTERNATIONAL REVENUE
For the years ended December 31, 1996 and 1997 and the three months ended
March 31, 1998, total revenue from international licenses (license revenue from
outside the United States) represented approximately 17%, 37% and 52%,
respectively, of the Company's total revenue. The Company expects that
international revenue will constitute a significantly greater portion of the
Company's total revenue in 1998. 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.
LOSS OF KEY MANAGEMENT PERSONNEL
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, Loren
Platzman, John Bogdan and Edward 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 could have a material adverse effect on the
Company's business, condition (financial or otherwise), prospects and 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
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 on
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.
16
<PAGE>
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. Any loss of revenue
from the Groupware products may have a material adverse effect on the Company's
business, condition (financial or otherwise), prospects and results of
operation.
STRATEGIC REORGANIZATION
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, the
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 business, discontinuing sales of the Company's
virus protection software, closing or reducing the Company's offices in Sydney,
Australia; Paris, France; London, United Kingdom; and Munich, Germany while
building up the Company's office in Starnberg, Germany and laying off
approximately 118 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.
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 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 and
results of operations. Because of the nature of its distribution methods for
its Groupware, 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 roll-out cycle for CCM, the
Company will be better able to assess 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, in light of
the de-emphasis in marketing efforts for the Groupware 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 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.
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, March 31, 1998
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
On February 11, 1998, the Company held a special meeting of its
stockholders (the "Special Meeting"). At the Special Meeting, the Company
submitted a proposal to approve the Elron Transaction.
The number of shares issued, outstanding and eligible to vote as of
the record date of January 5, 1998 was 12,270,820. The votes cast at the Special
Meeting were as follows:
Delivered
Votes For Votes Against Abstain Not Voted
- --------- ------------- ------- ---------
8,614,526 33,026 14,251 0
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.
(b) Reports on Form 8-K
The Company filed a current report on Form 8-K dated January 9, 1998
in relation to the Special Meeting and the definitive Proxy Statement for the
Special Meeting.
19
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
FORM 10-Q, March 31, 1998
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: May 15, 1998 Name: Herman De Latte
Title: Chief Executive Officer
/s/ John M. Bogdan
-------------------------------
Date: May 15, 1998 Name: John M. Bogdan
Title: Vice President of Finance
and Chief Financial Officer
20
<PAGE>
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
FORM 10-Q, March 31, 1998
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
27.0 Financial Data Schedule
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> MAR-31-1998 MAR-31-1997
<CASH> 12,293 13,007
<SECURITIES> 0 0
<RECEIVABLES> 2,630 12,346
<ALLOWANCES> 1,800 1,509
<INVENTORY> 149 2,553
<CURRENT-ASSETS> 16,885 30,091
<PP&E> 5,544 11,342
<DEPRECIATION> 3,668 5,344
<TOTAL-ASSETS> 19,690 40,456
<CURRENT-LIABILITIES> 8,319 13,999
<BONDS> 0 0
0 0
0 0
<COMMON> 122 121
<OTHER-SE> 11,249 26,142
<TOTAL-LIABILITY-AND-EQUITY> 19,690 40,456
<SALES> 3,123 11,460
<TOTAL-REVENUES> 4,175 12,493
<CGS> 873 2,068
<TOTAL-COSTS> 5,523 12,619
<OTHER-EXPENSES> (6,518) 15,898
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 40 133
<INCOME-PRETAX> 4,337 (15,891)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 4,337 (15,891)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 4,337 (15,891)
<EPS-PRIMARY><F1> 0.35<F1> (1.35)<F1>
<EPS-DILUTED><F1> 0.35<F1> (1.35)<F1>
<FN>
<F1>BASIC AND DILUTED EPS INFORMATION HAS BEEN PREPARED IN ACCORDANCE WITH
SFAS NO 128, AND BASIC AND DILUTED HAVE BEEN ENTERED IN PLACE OF PRIMARY AND
DILUTED EPS, RESPECTIVELY.
</FN>
</TABLE>
