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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
---------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
---------------
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
COMMISSION FILE NUMBER 0-27538
RAPTOR SYSTEMS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 7372 51-0337926
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation Classification Code Number) Identification No.)
or organization)
---------------
RAPTOR SYSTEMS, INC.
69 HICKORY DRIVE
WALTHAM, MASSACHUSETTS 02154
(Address of Principal Executive Offices)
(781) 487-7700
(Registrant's Telephone Number, Including Area Code)
---------------
Indicate by check whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes X No
--- ---
As of October 31, 1997 there were 13,549,344 outstanding shares of the
issuer's Common Stock, par value $.01 per share.
- Page 1 of 18
- Exhibit Index is on Page 16
Raptor Systems, Inc. 1
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RAPTOR SYSTEMS, INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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PART I - CONSOLIDATED FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS:
CONSOLIDATED BALANCE SHEETS AT SEPTEMBER 30, 1997
AND DECEMBER 31, 1996 3
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 4
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE
MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 8
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 14
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 14
</TABLE>
Raptor Systems, Inc. 2
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PART I. CONSOLIDATED FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
RAPTOR SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................... $27,710,786 $37,567,372
Marketable securities ................................... 23,601,144 15,396,866
Accounts receivable, less allowances of $752,010 and
$431,000, at September 30, 1997 and December 31, 1996,
respectively ......................................... 5,222,584 4,048,456
Other current assets .................................... 2,429,046 733,507
----------- -----------
Total current assets ............................ 58,963,560 57,746,201
----------- -----------
Net property and equipment .............................. 1,898,879 1,401,447
Equity investments ...................................... 4,039,954 4,036,001
=========== ===========
Total assets .................................... $64,902,393 $63,183,649
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................ 210,880 481,266
Accrued liabilities ..................................... 2,022,642 1,994,329
Accrued non-recurring costs ............................. 1,319,182 --
Deferred revenue ........................................ 2,190,496 1,580,289
----------- -----------
Total current liabilities ....................... 5,743,200 4,055,884
----------- -----------
Stockholders' equity:
Preferred stock, $.01 par value;
3,004,161 and 5,000,000 shares authorized at
December 31, 1996 and September 30, 1997,
respectively; none issued and outstanding .............. -- --
Common stock, $.01 par value; 30,000,000 shares
authorized; 13,537,108 and 13,102,528 shares
issued and outstanding at September 30, 1997 and
December 31, 1996, respectively ...................... 135,371 131,025
Additional paid-in capital .............................. 63,631,262 60,989,463
Accumulated deficit ..................................... (2,051,519) (1,177,620)
Cumulative translation adjustment ....................... (18,254) (1,746)
Unearned compensation ................................... (2,537,667) (813,357)
----------- -----------
Total stockholders' equity ...................... 59,159,193 59,127,765
----------- -----------
Total liabilities and stockholders' equity $64,902,393 $63,183,649
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Raptor Systems, Inc. 3
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RAPTOR SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ----------------------------------
1997 1996 1997 1996
------------------------------ ----------------------------------
<S> <C> <C> <C> <C>
Revenue ....................................... $ 7,332 $ 4,141 $ 19,621 $ 9,116
Cost of revenue ............................... 663 223 1,566 584
----------- ----------- ----------- -----------
Gross margin .................................. 6,669 3,918 18,055 8,532
Operating expenses:
Selling and marketing ....................... 3,270 2,458 9,235 5,999
Research and development .................... 1,116 827 2,998 2,278
General and administrative .................. 899 584 2,777 1,555
Non-recurring charge for purchased technology -- -- 6,522 --
----------- ----------- ----------- -----------
Total operating expenses ............ 5,285 3,869 21,532 9,832
----------- ----------- ----------- -----------
Operating income (loss) ....................... 1,384 49 (3,477) (1,300)
Interest income, net .......................... 697 656 2,132 1,726
----------- ----------- ----------- -----------
Income (loss) before income taxes ............. 2,081 705 (1,345) 426
(Provision) benefit for income taxes .......... (728) -- 471 --
----------- ----------- ----------- -----------
Net income (loss) ............................. $ 1,353 $ 705 $ (874) $ 426
=========== =========== =========== ===========
Net income (loss) per common and common
equivalent share ........................... $ .09 $ .05 $ (.07) $ .03
=========== =========== =========== ===========
Weighted average common and common equivalent
shares outstanding ......................... 15,156,375 14,797,988 13,330,385 13,402,751
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Raptor Systems, Inc. 4
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RAPTOR SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED- IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
1997 1996
-------- --------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)............................... $ (874) $ 426
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS)
TO NET CASH USED IN OPERATING ACTIVITIES:
Depreciation.................................... 623 280
Provision for sales allowances.................. 321 234
Compensation stock option expense............... 251 225
Deferred income tax benefit..................... (471) --
Changes in operating assets and liabilities:
Accounts receivable............................ (1,495) (2,040)
Other assets................................... (1,226) (421)
Accounts payable............................... (269) 150
Accrued liabilities............................ 30 111
Accrued non-recurring charges.................. 1,319 --
Deferred revenue............................... 610 789
------- -------
Cash used in operating activities.............. (1,181) (246)
------- -------
INVESTING ACTIVITIES:
Purchases of property and equipment........... (1,121) (962)
Purchase of marketable securities............. (8,205) (6,530)
Equity investment in common stock............. (4)
------- -------
Cash used in investing activities............. (9,330) (7,492)
------- -------
FINANCING ACTIVITIES:
Proceeds from issuance of common stock......... 671 45,705
Net proceeds from issuance of preferred stock.. -- 5,000
Issuance of warrants........................... -- 1,000
Payment of bank debt........................... -- (933)
------- -------
Cash provided by financing activities............ 671 50,772
------- -------
Effects of exchange rate changes on cash......... (16) --
------- -------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS (9,856) 43,034
------- -------
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 37,567 1,890
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $27,711 $44,924
======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
Raptor Systems, Inc. 5
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RAPTOR SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION:
The consolidated financial statements of Raptor Systems, Inc. (the "Company" or
"Raptor") for the three and nine months ended September 30, 1997 and 1996 are
unaudited and reflect all adjustments, consisting of normal recurring
adjustments, which are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods. These consolidated
financial statements should be read in conjunction with the financial statements
and notes thereto included in the Company's Annual Report on Form 10-K for the
year ended December 31, 1996 filed with the Securities and Exchange Commission.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets, liabilities and accrued litigation at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates and would
impact future results of operations and cash flows.
The results of operations for the three and nine months ended September 30, 1997
are not necessarily indicative of the results expected for the full year ending
December 31, 1997.
2. RISKS AND UNCERTAINTIES:
The Company invests its cash and marketable securities in deposits with
commercial banks, and in money market funds, commercial paper and government
securities. The Company has not experienced any losses to date on its invested
cash. The values at September 30, 1997 and December 31, 1996 approximate fair
value.
The Company sells its products to a wide variety of customers in a variety of
industries. The Company performs ongoing credit evaluations of its customers but
does not require collateral or other security to support customer receivables.
The Company maintains allowances for credit losses and sales returns based on
management's estimates.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets, liabilities and accrued litigation at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates and
would impact future results of operations and cash flows.
3. COMPUTATION OF NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE:
Net income (loss) per common share is computed based upon the weighted average
number of common shares and common equivalent shares outstanding. Common
equivalent shares are included in the per share calculations where the effect of
their inclusion would be dilutive.
In February 1997, The Financial Accounting Standards Board issued Statement on
Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128), which
specifies the computation, presentation, and disclosure requirements for
earnings per share by replacing the presentation of primary earnings per share
with a presentation of basic earnings per share. Basic earnings per share
includes no dilution and is computed by dividing income available to common
shareholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution of securities
that could share in the earnings of an entity, similar to fully diluted earnings
per share. SFAS 128 is effective for periods ending after December 15, 1997,
including interim periods. SFAS 128 requires restatement of all prior period
earnings per share data.
Had the Company computed earnings per share consistent with the provisions of
SFAS 128, basic and diluted earnings per share would have been $.10 and $.09,
respectively, for the three month period ended September 30, 1997 and both basic
and diluted earnings per share would have been $(.07) for the nine month period
ended September 30, 1997. Basic and diluted earnings per share would have been
$.06 and $.05, respectively, for the three month period ended September 30, 1996
and .04 and .03, respectively, for the nine month period ended September 30,
1996.
Raptor Systems, Inc. 6
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4. LITIGATION:
On February 27, 1995, Lightburn and Associates, Inc. ("LAI"), a former reseller
of Raptor products, commenced an action against Raptor in the United States
District Court for the District of Maryland. This action is based on allegations
that Raptor engaged in unfair competition, fraud, intentional and/or negligent
misrepresentation, tortious interference with business relationships and breach
of contract by entering into direct contractual arrangements with two customers.
On December 9, 1996, the Court granted Raptor's motion for summary judgment on
all claims that had been asserted against Raptor. The Court similarly entered an
order dismissing the counterclaims made by Raptor. As set forth in the Court's
order, the case is now closed, subject to any appeal rights the parties may
have. LAI has filed an appeal of the Court's decision. The Company has filed its
response to the appeal by LAI and a cross-appeal of the dismissal of its claims.
Appellate argument is expected during the fourth quarter of 1997. Raptor
believes that the ultimate outcome of this litigation will not have a material
adverse effect on its financial position. Litigation costs are included in
general and administrative expenses.
5. NON RECURRING CHARGE:
The non-recurring charge for purchased in-process technology was $6,522,000 and
is related to the May 9, 1997 acquisition of a perpetual license, including the
underlying products, to the Axcess technology, which will be used in future
product offerings currently under development.
6. RECENTLY ISSUED ACCOUNTING STANDARDS:
In June 1997, the FASB issued two pronouncements, Statement of Financial
Accounting Standard No. 130, "Reporting Comprehensive Income," (SFAS No. 130)
and No. 131, "Disclosure about Segments of an Enterprise and Related
Information" (SFAS No. 131). SFAS No. 130 establishes standards for reporting
and display of comprehensive income, which is defined as the equity of a
business enterprise during a period from nonowner sources. SFAS No. 130 is
effective for years beginning after December 15, 1997 and requires restatement
of financial statements for all prior years presented. The adoption of SFAS No.
130 is expected to only impact the presentation of financial information.
SFAS No. 131 requires public companies to report all financial and descriptive
information about operating segments in their financial statements and requires
selected information about operating segments to be reported in interim
financial reports issued to shareholders. Operating segment financial
information is required to be reported on the basis that is used internally for
evaluating segment performance and allocation of resources. SFAS No. 131 is
effective for financial statement for periods beginning after December 15, 1997
and requires presentation of comparative information for prior periods
presented. The adoption of SFAS No. 131 is expected to impact the way the
Company reports information about its operating segments.
Raptor Systems, Inc. 7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following information should be read in conjunction with the consolidated
financial statements and the notes thereto and the Risk Factors outlined in the
Company's Annual Report on Form 10-K filed with the Securities and Exchange
Commission for the year ended December 31, 1996.
This Form 10-Q contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, and Section 21E of the Securities Exchange
Act of 1934. The Company's actual results could differ materially from those set
forth in the forward-looking statements. Factors that might cause such a
difference are set forth below. The words "believe," "expect," "anticipate,"
"intend," "estimate," and other expressions which are predictions of or indicate
future events and trends and which do not relate to historical matters identify
forward-looking statements. Reliance should not be placed on forward-looking
statements because they involve known and unknown risks, uncertainties and other
factors, which may cause the actual results, performance or achievements of the
Company to differ materially from anticipated future results, performance or
achievements expressed or implied by such forward looking statements. The
Company undertakes no obligation to publicly update or revise any
forward-looking statement, whether as a result of new information, future events
or otherwise. Factors that might cause such a difference are discussed in the
section entitled "Certain Factors that may Affect Future Results" below.
INTRODUCTION:
Raptor Systems, Inc. (the "Company" or "Raptor") develops, markets, licenses and
supports a family of integrated network security software products that provide
comprehensive, enterprise-wide security for organizational networks, including
networks that are connected to the Internet. The Company's application-level
Eagle firewall and EagleMobile virtual private network technology form the basis
of a network security solution that enables an organization to protect its
network from unauthorized access by internal and external users and to secure
organizational communications over the Internet and internal networks, including
"Intranets." The Company's integrated enterprise-wide network security solution
consists of individual product modules that secure organizational networks,
including networks connected to the Internet, LANs (local area networks) and
Intranets, mobile PC users and remote sites. The Company's product modules
interact seamlessly, are easy-to-use and are supported by a common management
and monitoring capability that enables a network administrator to manage the
security of a large, geographically dispersed organizational network from a
single location. Raptor's network security solutions are designed to enable
organizations to protect valuable data, extend the boundaries of organizational
networks without compromising network integrity and capitalize on the emergence
of the Internet as a medium of communications and commerce.
RESULTS OF OPERATIONS:
NET (LOSS) INCOME AND EARNINGS PER SHARE:
Net income for the third quarter of 1997 was $1,353,000 ($.09 per share), an
increase of $648,000 over net income of $705,000 ($.05 per share) for the same
period in 1996. Year to date 1997 net loss was $874,000 ($.07 per share),
compared to net income of $426,000 ($.03 per share) for the same period in 1996.
The Company incurred a non-recurring charge for the acquisition costs in the
second quarter of 1997 as an in-process research and development expense. The
net loss, year to date, is precipally the result of the $6,522,000 (equal to
$4,239,000 or $.23 per share after tax) non-recurring charge related to the
second quarter acquisition of in-process technology.
Net income and earnings per share, calculated without the non-recurring
charge, for the nine month period ended September 30, 1997 would have
been $3,365,000 ($.22 per share). Weighted average common and common share
equivalent shares outstanding would have been 15,084,567 for the nine month
period ended September 30, 1997.
Raptor Systems, Inc. 8
<PAGE> 9
REVENUES:
Total revenues increased 77% in the third quarter of 1997 over the third quarter
of 1996. Ninety percent of the third quarter revenue resulted from the reseller
channel and 10% resulted from direct sales efforts. Revenue by geographical
region as a percentage of total third quarter revenue is as follows: US and
North America 80%, Europe and Asia 20%. Support revenue of $895,000 for the
third quarter increased 286% over the third quarter of 1996 and 25% sequentially
from the second quarter of 1997. Training revenues increased 19% sequentially
from the second quarter of 1997 to 4% of total revenue. As a result of the
growth of these other lines of business, software license sales in the third
quarter of 1997 were 84% of revenue compared to 86% in the second quarter and
88% of revenue in the first quarter of 1997.
Windows NT-based firewall products accounted for 62% of the third quarter's
revenue from software sales while Unix-based firewall products accounted for 24%
and non-firewall products accounted for 14%. The average selling price for the
third quarter of 1997 was $4,147, which decreased $359 from $4,506 in the second
quarter of 1997. The reduction in the average selling price of its products is
largely due to the change in the mix of the products sold and the channels
through which the products are sold, non-firewall products, like Eagle NetWatch
and WebNOT, have lower selling prices than the firewall products. The average
selling price of high-end firewalls for the third quarter was $4,667, a decrease
of $565 from $5,232 in the second quarter of 1997. During the three month period
ended September 30, 1997 the Company sold 1,744 units, an increase in total
units of 87 over the second quarter of 1997. Of these third quarter unit sales,
217 were Eagle Unix firewalls, compared to 235 Eagle Unix firewalls in the
second quarter of 1997, 965 Eagle NT firewalls, compared to 694 Eagle NT
firewalls in the second quarter, 241 were The WALL firewalls, compared to 464
The WALL firewalls in the second quarter, in addition the company sold 321
non-firewall products such as NetWatch, Telemate.net, Raptor Axcess, and WebNot,
an increase of 22% from 264 non-firewall units in the second quarter of 1997 and
an increase of 149% from the first quarter of 1997. As the Company sells more
non-firewall products the average selling price on all of the Company's products
will decrease. Another reason for the decline in the average firewall selling
price is due to the fact that during the second quarter the company introduced
new versions of its firewalls, priced to meet certain market requirements. In
the first quarter of 1997 the Company offered Eagle firewalls which ranged in
price from $6,500 to $25,000. During the second quarter the company introduced a
version of the Eagle NT firewall that does not have the virtual private
networking (VPN) tunneling capability, priced at $3,995. The Company did not
change its list prices in 1996 and there has been no change in its list prices
in 1997. The analysis above does not take into account the effects of THE
WALL(TM), a low end firewall product, on the average firewall selling price. The
average selling price for THE WALL(TM) product in the third quarter of 1997 was
$717, up 40% from the secoNd quarter average selling price of $512.
To date, the Company has sold over 8,100 server units; excluding mobile and
desktop client products. During the third quarter the Company sold over 3,800
copies of the EagleMobile client software, an increase of 19% compared to 3,200
units in the second quarter and 245% compared to 1,100 units in the first
quarter of 1997. To date the Company has sold approximately 13,000 mobile units.
Revenues from Master Distributors (Ingram Micro, MicroAge, Tech Data and Access
Graphics) were approximately 13%, collectively, compared to 7% in the second
quarter, when shipments to the Master Distributors began. Revenues and unit
information from these Master Distributors are reported on a sell-through basis.
Company revenues are derived from a diverse customer base and over 319 VARs. As
a result, no customers accounted for more than 4% of revenues during the three
and nine month periods ended September 30, 1997. In addition, the Master
Distributors redistributed the Company's products to over 200 of their reseller
customers during the second and third quarters of 1997.
Revenue from customer support contracts was $895,000, an increase of 25% from
the second quarter of 1997. Deferred revenue related to support contracts
increased $190,000 during the third quarter to $2,190,496. The deferred revenue
number includes a prepayment from Compaq Computer Corporation ("Compaq") which
was originally recorded in the second quarter of 1996. The Company recognizes
revenue related to the Compaq prepayment as software license revenue, which is
based on royalty reports received from Compaq.
Raptor Systems, Inc. 9
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COST OF REVENUES:
Cost of revenues includes the cost of training customers, providing telephone
support, manuals, packaging, diskettes and fulfillment costs. In addition, cost
of revenues includes royalties paid to third-party developers, inventory
obsolescence reserves and the costs associated with product upgrades. Gross
margin as a percentage of revenues for the third quarter of 1997 decreased 2%
compared to the third quarter of 1996 and decreased 1% from the second quarter
of 1997. Costs associated with training customers as well as the royalties paid
to third-party developers were the primary reasons for the decline in the gross
margin. The increase in training costs was offset with training revenues during
the quarter.
OPERATING EXPENSES:
The Company's operating expenses and the respective percentage of revenues for
the Third quarter of 1997 as compared to Third quarter of 1996 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
(DOLLARS IN THOUSANDS)
----------------------------------------------
% of % of
1997 Revenues 1996 Revenues
------ -------- ------- --------
<S> <C> <C> <C> <C>
Sales and Marketing $3,270 45% $2,458 59%
Research and Development 1,116 15% 827 20%
General and Administrative 899 12% 584 14%
------ --- ------ ---
$5,285 72% $3,869 93%
====== === ====== ===
</TABLE>
The Company's operating expenses and the respective percentage of revenues for
the nine month period ended September 30, 1997 as compared to the nine month
period ended September 30,1996 are as follows, excluding the non-recurring
charge for purchased in process technology:
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
(DOLLARS IN THOUSANDS)
----------------------------------------------
% of % of
1997 Revenues 1996 Revenues
------- -------- ------ --------
<S> <C> <C> <C> <C>
Sales and Marketing $ 9,235 47% $5,999 66%
Research and Development 2,998 15% 2,278 25%
General and Administrative 2,777 14% 1,555 17%
------- --- ------ ----
$15,010 76% $9,832 108%
======= === ====== ====
</TABLE>
In connection with the acquisition of the Axcess technology, the Company had a
non-recurring operating cost of $6,522,000 in the second quarter of 1997. With
this non-recurring charge, the Company's operating expenses for the nine month
period were $21,532,000. Total operating expenses decreased as a percentage of
revenues to 72% in the third quarter of 1997 compared to 93% in the third
quarter of 1996 and 76% in the second quarter of 1997. This decrease is
primarily the result of increased revenues without a comparable corresponding
increase in operating expenses.
Sales and marketing expenses, which include salary, commissions, advertising,
travel and other selling-related expenses, decreased to 45% of revenues in the
third quarter of 1997 compared to 59% of revenues in the third quarter of 1996
and 47% in the second quarter of 1997. The absolute dollar increase is
attributable to compensation costs as well as increased travel and remote office
costs.
Research and development expenses, which include salary, payments to independent
contractors and other costs associated with the development of new products and
the enhancement of existing products, decreased to 15% of revenues in the third
quarter of 1997 compared to 20% of revenues in the third quarter of 1996, and
increased 1% compared to 14% of revenues in the second quarter of 1997. As the
Company adds features and functionality to its products, makes its products
available on additional platforms and continues to develop new products the cost
of development should continue to increase. Additionally, costs associated with
development and enhancement of the Axcess technology acquired by the Company
from
Raptor Systems, Inc. 10
<PAGE> 11
Open Market in the second quarter of this year will require the Company to
invest in additional resources in the fourth quarter of 1997.
General and administrative expenses decreased to 12% of revenues in the third
quarter of 1997 compared to 14% in the third quarter of 1996 and decreased 3%
from 15% in the second quarter of 1997. General and administrative expenses
include salary, rent, and other expenses associated with the general management
and administration of the Company. Litigation costs are included in general and
administrative expenses. During the second quarter of 1997, the Company incurred
legal costs of approximately $105,000 in connection with two legal matters,
which have been ongoing since February 1995 and June 1996, respectively. During
July 1997, the parties agreed to the terms of a settlement related to one of the
cases, which has been dismissed by the Court (See "Litigation" in the Notes to
the Consolidated Financial Statements (unaudited)). As a result legal costs in
the third quarter of 1997 were lower than those in the second quarter of 1997.
The number of employees increased 17% to 129 at September 30, 1997 compared with
110 at December 31, 1996. Employment will continue to increase in support of
higher revenues, with a majority of this growth occurring in the sales and
marketing and research and development departments. The Company has periodically
granted stock options to employees at a discount to fair market value as an
integral part of its compensation programs since 1995. The general and
administrative expenses for the quarter and nine month periods ended September
30, 1997 include $75,000 and $225,000, respectively, charged to operations
related to unearned compensation for discounted employee stock options granted
prior to the third quarter. During the third quarter of 1997, the Company
recorded $1,976,000 of additional unearned compensation on the balance sheet
related to employee stock options, of which $26,000 was charged to operations in
the third quarter. Unearned compensation expense in the fourth quarter of 1997
is expected to be $198,000.
The Company estimates that the tax rate for 1997 will be 35% and has used that
rate to calculate the income tax benefit from the second quarter non-recurring
charge for in-process technology.
LIQUIDITY AND CAPITAL RESOURCES:
The Company considers all short-term investments, which consist of money market
accounts and Government securities, with original maturities of less than 90
days, to be cash equivalents. In addition, securities held with maturities
greater than 90 days but less than a year are classified as marketable
securities.
Cash, cash equivalents and marketable securities decreased from $52,964,000 at
December 31, 1996 to $51,312,000 at September 30, 1997 but increased from
$50,435,000 at June 30, 1997. This decrease of $1,652,000 is attributable to
$5,050,000 paid to Open Market, Inc., during the second and third quarter,
partially offset by the proceeds from employees exercising stock options,
$2,132,000 in interest income year to date and cash generated from operations
through the nine-months ended September 30, 1997. Although the Company agreed to
pay Open Market $6,200,000 for the Axcess technology, that sum is payable during
the year based on certain milestones in the acquisition agreement. During the
third quarter the Company paid $850,000 to Open Market. The final payment of
$1,150,000 is expected to be made in the fourth quarter of 1997.
The Company believes that its existing cash and marketable securities balances
together with cash generated from operations will be sufficient to meet the
Company's working capital, financing and capital expenditure needs through at
least the next twelve months. The Company continues to investigate the
acquisition of key technology, complementary product lines and other companies,
all of which may be financed by a variety of sources.
Raptor Systems, Inc. 11
<PAGE> 12
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS:
This Form 10-Q contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, and Section 21E of the Securities Exchange
Act of 1934. The Company's actual results could differ materially from those set
forth in the forward-looking statements. Factors that might cause such a
difference are set forth below. The words "believe," "expect," "anticipate,"
"intend," "estimate," and other expressions which are predictions of or indicate
future events and trends and which do not relate to historical matters identify
forward-looking statements. Reliance should not be placed on forward-looking
statements because they involve known and unknown risks, uncertainties and other
factors, which may cause the actual results, performance or achievements of the
Company to differ materially from anticipated future results, performance or
achievements expressed or implied by such forward looking statements. The
Company undertakes no obligation to publicly update or revise any
forward-looking statement, whether as a result of new information, future events
or otherwise.
A number of uncertainties exist that could affect the Company's future operating
results, including, without limitation, changes in the market for network
security products, advances in technology, competition from larger, more
established competitors, general economic conditions, the Company's continued
ability to develop and introduce innovative products, potential delays in
product releases, new product announcements from other companies, pricing
practices of competitors, the Company's ability to control costs and its ability
to attract and retain key employees.
Market prices for securities of software companies have generally been volatile.
In particular, the market price of the Company's common stock has been and may
continue to be subject to significant fluctuations. These fluctuations may be
due to factors specific to the Company or to factors affecting the computer
industry or securities markets in general. Prior to 1996, there was no public
market for the Company's Common Stock. In addition, in recent years the stock
market in general, and the market for shares of small capitalization companies
in particular, have experienced extreme price fluctuations, which have often
been unrelated to the operating performance of affected companies. There can be
no assurance that the market price of the Company's Common Stock will not
experience significant fluctuations in the future, including fluctuations that
are unrelated to the Company's performance. General market price declines or
market volatility in the future could have a material adverse effect on the
market price of the Common Stock.
The Company derives approximately 90% of its revenue from its Eagle family of
network security products, all of which are dependent upon the Company's Eagle
application-level firewall. As a result, any factor adversely affecting sales of
this product could have a material adverse effect on the Company.
The market for network security products and services is relatively new,
intensely competitive, rapidly evolving and subject to rapid technological
change. The Company expects competition to intensify in the future. Due to the
rapid expansion of the network security market, the Company may face competition
from new entrants in the network security industry, possibly including the
Company's resellers. There can be no assurance that the Company's current and
potential competitors will not develop network security products that may be
more effective than the Company's current or future products or that the
Company's technologies and products would not be rendered obsolete by such
developments. An increase in competition could result in price reductions and
loss of market share. Such competition and any resulting reduction in gross
margins could have a material adverse effect on the Company's business,
financial condition and results of operations. While the Company believes that
it does not compete against manufacturers of other classes of security products
(such as encryption and authentication), there can be no assurance that the
Company's customers will not perceive the products of such other companies as
substitutes for the Company's products.
The Company recently has experienced significant growth in both revenue and in
employees. This growth has resulted in an increase in responsibilities placed
upon the Company's management and has placed added pressures on the Company's
operating and financial systems. In 1995, the Company hired 50 new employees,
including a Chief Executive Officer and other key members of management, to help
it manage this growth. In 1996, the Company hired 42 additional employees
including its Chief Financial Officer and
Raptor Systems, Inc. 12
<PAGE> 13
through the nine months ended September 30, 1997 experienced a net increase of
19 employees. The Company's ability to assimilate new personnel will be critical
to the Company's performance, and there can be no assurance that the management
and systems currently in place will be adequate if the Company continues to grow
or that the Company will be able to implement additional systems successfully
and in a timely manner as required.
The Company's future success depends to a significant extent on its senior
management and other key employees, including key development personnel. The
Company has no employment agreements with any of its employees, and it relies
significantly on issuance of stock options and the market value of its common
stock to attract, retain, and motivate employees. The Company also believes that
its future success will depend in large part on its ability to attract and
retain additional key employees. Any inability on the part of the Company to
attract and retain additional key employees or the loss of one or more of its
current key employees could have a material adverse effect on the Company's
business, financial condition and results of operations. Stock options are
granted at a discount to fair market value when necessary to attract and retain
key employees, which results in unearned compensation expense over the vesting
period of such options.
The Company distributes its products primarily through strategic VARs, regional
VARs, international VARs and master distributors (Ingram Micro, Tech Data,
Micro-Age and Access Graphics). The success of the Company is therefore
dependent in large part upon the performance of its resellers. The Company's
relationships with most of its resellers have been established within the past
two years, and the Company is unable to predict with accuracy the extent to
which its resellers will be successful in marketing and selling the Company's
products.
In addition, as the network security industry continues to evolve, the Company
plans to develop and introduce new products to address the changing needs of the
evolving network security market. There can be no assurance that the Company
will be able to develop new products or that such products will achieve market
acceptance or, if market acceptance is achieved, that the Company will be able
to maintain such acceptance for a significant period of time. Any inability of
the Company to develop products on a timely basis that address changing customer
requirements may require the Company to substantially increase development
expenditures or may result in a loss of market share to a competitor. Moreover,
products as complex as those offered by the Company may contain undetected
errors when first introduced or when new versions are released. The Company has
in the past discovered software errors in certain of its product offerings after
their introduction and has experienced delays and lost revenue during the period
required to correct these errors. In particular, the personal computer hardware
environment is characterized by a wide variety of non-standard configurations
that make pre-release testing for programming or compatibility errors very
difficult and time-consuming. There can be no assurance that, despite testing by
the Company, errors will not occur in new products or releases after
commencement of commercial shipments, resulting in adverse publicity, in loss of
or delay in market acceptance, or in claims by customers against the Company,
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
A high percentage of the Company's revenues are expected to be realized in the
third month of each quarter and tend to be concentrated in the latter half of
that month. The Company's orders early in a quarter will not generally be large
enough to assure that it will meet its revenue targets for any particular
quarter. Accordingly, the Company's quarterly results may be difficult to
predict until the end of the quarter, and a shortfall in shipments or contract
orders at the end of any particular quarter may cause the results for that
quarter to fall short of anticipated levels.
Raptor Systems, Inc. 13
<PAGE> 14
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS:
No reportable events have occurred which would require modification of the
discussion under Item 3 - Legal Proceedings contained in the Company's Report on
Form 10-K for the year ended December 31, 1996 and the Company's report on Form
10-Q for the quarter ended June 30, 1997. See Note 4 to the Consolidated
Financial Statements contained in this Form 10-Q for the period ended September
30, 1997 for additional information related to previously disclosed litigation
proceedings.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a.) Exhibit 11 - Statement re: Computation of Earnings per Share
Exhibit 27 - Financial Data Schedule
b.) Reports on Form 8-K - None filed for the Quarter ended September 30, 1997
Raptor Systems, Inc. 14
<PAGE> 15
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.
RAPTOR SYSTEMS, INC.
November 10, 1997 /s/ John S. Ingalls
-----------------------------------------------------
John S. Ingalls
Vice President of Finance and Chief Financial Officer
(Principal Financial Officer)
November 10, 1997 /s/ John W. Peacock
-----------------------------------------------------
John W. Peacock
Director of Finance and Controller
(Principal Accounting Officer)
Raptor Systems, Inc. 15
<PAGE> 16
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION PAGE
- --------------- ----------- ----
<S> <C> <C>
EXHIBIT 11 STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE 17
EXHIBIT 27 FINANCIAL DATA SCHEDULE 18
</TABLE>
Raptor Systems, Inc. 16
<PAGE> 1
COMPUTATION OF EARNINGS PER SHARE:
EXHIBIT 11
RAPTOR SYSTEMS, INC.
STATEMENT RE: COMPUTATION OF EARNINGS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1997 1996 1997 1996
------- ------- ------- -------
<S> <C> <C> <C> <C>
Common stock outstanding, beginning of period 13,376 12,560 13,102 2,450
Weighted average number of shares issued 79 46 228 8,495
Weighted average number of common and common 2,664 2,706
stock equivalents 2,421 --
Less: Assumed purchase of treasury shares (720) (472) -- (248)
------- ------- ------- -------
Weighted average number of common and common
equivalent shares outstanding 15,156 14,798 13,330 13,403
======= ======= ======= =======
Net income (loss) $ 1,353 $ 705 $ (874) $ 426
======= ======= ======= =======
Net income (loss) per common and common
equivalent share $ .09 $ .05 $ (.07) $ .03
======= ======= ======= =======
</TABLE>
- -----------
(1) Fully diluted net income per share is the same as primary net income per
share.
Raptor Systems, Inc. 17
<TABLE> <S> <C>
<ARTICLE> 5
<CURRENCY> US$
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<EXCHANGE-RATE> 1.0
<CASH> 27,710,786
<SECURITIES> 23,601,144
<RECEIVABLES> 5,222,584
<ALLOWANCES> 752,010
<INVENTORY> 0
<CURRENT-ASSETS> 58,963,560
<PP&E> 3,108,903
<DEPRECIATION> 1,210,024
<TOTAL-ASSETS> 64,902,393
<CURRENT-LIABILITIES> 5,743,200
<BONDS> 0
0
0
<COMMON> 135,371
<OTHER-SE> 59,023,822
<TOTAL-LIABILITY-AND-EQUITY> 64,902,393
<SALES> 7,332,477
<TOTAL-REVENUES> 7,332,477
<CGS> 493,896
<TOTAL-COSTS> 5,285,580
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,081,760
<INCOME-TAX> 728,000
<INCOME-CONTINUING> 1,353,116
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,353,116
<EPS-PRIMARY> .09
<EPS-DILUTED> .09
</TABLE>
