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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended 30 September 2002
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)
Waltham Woods
880 Winter Street, Building 4
Waltham, Massachusetts 02451-1449
(781) 487 - 3300
(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____
---
23,480,412 shares of the registrant's Common Stock, $0.01 par value, were
outstanding as of November 11, 2002.
THIS DOCUMENT CONTAINS 34 PAGES.
ON TECHNOLOGY CORPORATION
FORM 10-Q, September 30, 2002
CONTENTS
Item Number Page
- ----------- ----
PART I: FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Balance sheet:
September 30, 2002 and December 31, 2001 3
Statement of operations:
Three and nine months ended September 30, 2002 and 2001 4
Statement of cash flows:
Nine months ended September 30, 2002 and 2001 5
Notes to consolidated financial statements 6-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-28
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
Item 4 Controls and Procedures 29
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 2. Changes in Securities and Use of Proceeds 30
Item 3. Defaults Upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits and Reports on Form 8-K 30
SIGNATURES 31
CERTIFICATIONS 32-33
EXHIBIT INDEX 34
2
PART I: FINANCIAL INFORMATION
Item 1: ON TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEET
(in thousands, except share data)
(unaudited)
September 30, December 31,
2002 2001
---- ----
Assets
Current Assets:
Cash and cash equivalents $ 12,472 $ 9,767
Restricted cash 1,069 1,069
Accounts receivable, net of allowances
of $881 and $1,070 respectively 4,726 5,964
Prepaid expenses and other current assets 1,217 1,016
Deferred tax asset - current 482 433
---------------- ----------------
Total current assets 19,966 18,249
Property and equipment, net 1,063 1,006
Deferred tax asset - long term 482 433
Other assets and deposits, net 238 428
---------------- ----------------
Total assets $ 21,749 $ 20,116
================ ================
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 2,773 $ 2,435
Accrued expenses 4,355 4,345
Deferred revenue - short term 4,840 4,754
---------------- ----------------
Total current liabilities 11,968 11,534
Stockholders' Equity:
Preferred stock, $0.01 par value - 2,000,000 shares authorized -
No shares issued and outstanding --- ---
Common stock, $0.01 par value -50,000,000 shares authorized -
23,373,599 and 22,581,533 shares issued,
and 23,358,599 and 22,566,533 shares
outstanding, respectively 234 226
Additional paid-in capital 81,060 80,768
Deferred stock-based compensation (87) (126)
Accumulated deficit (72,166) (72,775)
Accumulated other comprehensive income 787 536
Treasury stock, 15,000 shares at cost (47) (47)
---------------- ----------------
Total stockholders' equity 9,781 8,582
---------------- ----------------
Total liabilities and stockholders' equity $ 21,749 $ 20,116
================ ================
The accompanying notes are an integral part of these consolidated financial
statements.
3
ON TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
2002 2001 2002 2001
---- ---- ---- ----
Revenue:
- -------
Net CCM and related products $ 5,028 $ 3,545 $ 16,503 $ 10,129
Service and maintenance 3,435 2,194 9,041 6,099
Other --- --- --- 568
----------- ----------- ----------- ------------
Total revenue 8,463 5,739 25,544 16,796
----------- ----------- ----------- ------------
Cost of Revenue:
- ---------------
Cost of CCM and related products revenue 723 655 3,090 1,998
Cost of service and maintenance revenue 773 295 2,095 927
----------- ----------- ----------- ------------
Total cost of revenue 1,496 950 5,185 2,925
----------- ----------- ----------- ------------
Gross Profit 6,967 4,789 20,359 13,871
----------- ----------- ----------- ------------
Operating expenses:
- ------------------
Sales and marketing 3,520 3,068 9,672 9,174
Research and development 2,071 1,963 6,075 6,103
General and administrative 1,178 1,728 3,741 3,817
----------- ----------- ----------- ------------
Total operating expenses 6,769 6,759 19,488 19,094
----------- ----------- ----------- ------------
Income (loss) from operations 198 (1,970) 871 (5,223)
Interest income, net 54 33 89 130
Other income (expense), net (6) 276 309 (1,608)
----------- ----------- ----------- ------------
Income (loss) before provision for
income taxes 246 (1,661) 1,269 (6,701)
Provision for income taxes 230 33 660 66
----------- ----------- ----------- ------------
Net income (loss) $ 16 $ (1,694) $ 609 $ (6,767)
=========== =========== =========== ============
Basic net income (loss) per share $ 0.00 $ (0.11) $ 0.03 $ (0.44)
Diluted net income (loss) per share $ 0.00 $ (0.11) $ 0.03 $ (0.44)
Weighted average common
shares outstanding - basic 23,228,839 15,375,783 23,064,869 15,340,782
Weighted average common
shares outstanding - diluted 24,063,989 15,375,783 24,115,051 15,340,782
The accompanying notes are an integral part of these consolidated financial
statements
4
ON TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months
Ended September 30,
-------------------
2002 2001
---- ----
Cash Flows from Operating Activities:
Net income (loss) $ 609 $ (6,767)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities
Depreciation and amortization 756 792
Non-cash charges associated with the revaluation of
intercompany loans to foreign subsidiaries (Note 6) (347) 477
Stock-based compensation expense 63 55
Provision for sales returns and allowances (20) ---
Revaluation of notes payable --- 95
Warrant liability revaluation --- 984
Changes in operating assets and liabilities:
Accounts receivable 1,258 1,867
Prepaid expenses and other current assets (201) (236)
Accounts payable 338 (1,093)
Accrued expenses 10 249
Deferred revenue 86 410
----------------- ----------------
Net cash provided by (used in) operating activities 2,552 (3,167)
----------------- ----------------
Cash Flows from Investing Activities:
Change in other assets and deposits 17 ---
Purchase of property and equipment, net (640) (357)
----------------- ----------------
Net cash used in investing activities (623) (357)
----------------- ----------------
Cash Flows from Financing Activities:
Proceeds from the exercise of stock options 195 9
Proceeds from the sale of stock under the Employee
Stock Purchase Plan 75 44
Proceeds from the exercise of warrants 6 ---
----------------- ----------------
Net cash provided by financing activities 276 53
----------------- ----------------
Effect of exchange rates on cash and cash equivalents 500 (266)
----------------- ----------------
Net increase (decrease) in cash and cash equivalents 2,705 (3,737)
Cash and cash equivalents, beginning of period 9,767 9,437
----------------- ----------------
Cash and cash equivalents, end of period $ 12,472 $ 5,700
================= ================
The accompanying notes are an integral part of these
consolidated financial statements.
5
ON TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
1. Interim Financial Statements
The accompanying unaudited consolidated financial statements have been
presented by ON Technology Corporation (together with its consolidated
subsidiaries, the "Company") in accordance with generally accepted accounting
principles for interim financial statements and with the instructions to Form
10-Q 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,
consisting only of normal and recurring adjustments, which management considers
necessary for a fair presentation of financial position as of September 30, 2002
and results of operations for the three and nine months ended September 30, 2002
and September 30, 2001. 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 Annual Report on Form
10-K.
2. Stockholders' Equity
In conjunction with an Exchange Agreement between the Company and two
institutional investors dated December 18, 2000, the institutional investors
exchanged warrants they had acquired in their December 1999 equity investment
for new warrants to purchase a total of 2,800 shares of the Company's common
stock for $0.01 per share and for contingent promissory notes from the Company
totaling $1,000. In accordance with the Exchange Agreement terms, these notes
were cancelled at December 31, 2001, because the average closing price for the
shares of the Company's common stock on the last 20 days prior to December 31,
2001 exceeded $3.00 per share and a registration statement was effective during
such period. The Company had recorded the notes payable issued as part of the
exchange for the outstanding warrants at fair value in the accompanying
consolidated financial statements. For the quarter ended September 30, 2001, the
Company had recognized an increase in fair value of $100 as a charge to other
expense in the Company's consolidated statement of operations. For the nine
months ended September 30, 2001, the Company had recognized a net increase in
the fair value of the debt of $95 as a charge to other expense in the Company's
consolidated statement of operations.
The Exchange Agreement was amended on June 28, 2001, which had the effect
of changing the nature of the warrants to meet the criteria of equity
instruments. Prior to the amendments, the Company designated and recorded the
outstanding warrants to purchase 2,800 shares of common stock as a liability in
accordance with EITF Issue No. 00-19. Accordingly, the outstanding warrants had
been recorded at fair value at each exercise and reporting period date with any
changes in the fair value included in the results of operations. Prior to the
amendment in June 2001, the Company had recognized a charge of $984 related to
an increase in the valuation of the warrants during the nine months ended
September 30, 2001. This amount was included in other expense in the Company's
consolidated statement of operations.
3. Concentration of Credit Risk
The financial instruments that subject the Company to credit risk consist
of cash and cash equivalents and accounts receivable. The Company has no
significant off-balance sheet risk such as foreign exchange contracts, option
contracts or other foreign hedging arrangements. The Company maintains the
majority of cash balances with two highly rated financial institutions. The
Company's accounts receivable credit risk is not concentrated within any
geographic area.
During the three months ended September 30, 2002, no customer represented
more than 10% of the Company's total revenue; during the three months ended
September 30, 2001, one customer accounted for 16.9% of the Company's total
revenue.
6
ON TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
During the nine months ended September 30, 2002 and 2001, one customer
accounted for 12.4% and 13.6% of the Company's total revenue for each period,
respectively.
As of September 30, 2002, no customer represented more than 10% of the
Company's accounts receivable. One customer represented 11.2% of the Company's
accounts receivable at December 31, 2001.
4. Net Income (Loss) per Share
Basic net income (loss) per share is calculated by dividing net income
(loss) by the weighted average number of common shares outstanding for the
period. Diluted net income (loss) per share is computed by dividing the net
income (loss) by the weighted average number of shares of common stock and
potential common stock outstanding during the period, if dilutive. For the three
and nine months ended September 30, 2002 and 2001, respectively, certain stock
options and warrants have been excluded from the diluted weighted average shares
outstanding calculation, as their effect would be anti-dilutive. For periods
that the Company reports a net loss, all potential common stock is considered
anti-dilutive; for periods when the Company reports net income, only potential
common shares with exercise prices in excess of the Company's average common
stock fair value during the related period are considered anti-dilutive.
Basic and diluted net income (loss) per share are as follows (in thousands,
except per share amounts):
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------------- ----------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net income (loss) $ 16 $ (1,694) $ 609 $ (6,767)
============ ============ ============ ============
Weighted average shares outstanding - basic 23,229 15,376 23,065 15,341
Weighted average potential common stock 835 --- 1,050 ---
------------ ------------ ------------ ------------
Weighted average shares outstanding - diluted 24,064 15,376 24,115 15,341
============ ============ ============ ============
Basic net income (loss) per share $ 0.00 $ (0.11) $ 0.03 $ (0.44)
Diluted net income (loss) per share $ 0.00 $ (0.11) $ 0.03 $ (0.44)
Securities that were not included in diluted weighted
average shares outstanding are as follows:
Common stock options and warrants 3,514 5,607 3,029 5,706
7
ON TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
5. Comprehensive Income (Loss)
Total comprehensive income was $90 for the three months ended September 30,
2002 and total comprehensive loss was $1,808 for the three months ended
September 30, 2001. For the nine months ended September 30, 2002 and 2001, total
comprehensive income was $860 and total comprehensive loss was $6,508,
respectively. Total comprehensive income (loss) consists of net income (loss)
and the net change in the foreign currency translation adjustment, included in
accumulated other comprehensive income, which is presented separately as a
component of stockholders' equity.
6. Foreign Currency Transaction Gains (Losses)
During the quarters ended September 30, 2002 and 2001, the Company incurred
a net foreign exchange loss of $6 and a net foreign exchange gain of $372,
respectively. For the nine months ended September 30, 2002 and 2001, the Company
incurred a net foreign exchange gain of $310 and a net foreign exchange loss of
$541, respectively. These amounts primarily resulted from revaluing intercompany
loans to foreign subsidiaries and U.S. dollar-denominated debt at a foreign
subsidiary. The net foreign exchange gains or losses are included in other
income (loss), net in the accompanying consolidated statement of operations. As
of September 30, 2002, the Company had not entered into any foreign currency
contracts to hedge this exposure.
7. Segment Reporting
For all periods presented, the Company operated in one reportable segment.
8. Disposition of Meeting Maker Business
On June 30, 2000, the Company entered into a license agreement with a newly
organized privately held company named Meeting Maker, Inc. (MMI), which, among
other things, provided for the grant of an exclusive worldwide license to market
and distribute the Meeting Maker product (including a license to the underlying
source code and object code). The Company received quarterly royalty payments,
subject to certain minimums, from MMI in connection with the exclusive license.
All fees were recognized as earned. On June 29, 2001, MMI exercised its buyout
option for the remaining minimum payments plus an additional fee. As a result of
the buyout, there will be no future payments received by the Company under this
agreement. The Company recognized $568 in royalty fees during the nine months
ended September 30, 2001. This amount is shown as other revenue in the
accompanying consolidated statement of operations.
9. Letter of Credit
As of September 30, 2002 and December 31, 2001, the Company had an
outstanding $1,069 letter of credit guarantee outstanding securing its Waltham,
Massachusetts leased facility, which expires in December 2002. The Company was
required to maintain a cash balance of $1,069 as collateral for this guarantee.
This amount is shown as restricted cash as of September 30, 2002 and December
31, 2001 in the accompanying consolidated balance sheet. At September 30, 2002,
the Company had no line of credit arrangement. On October 22, 2002 the Company
renegotiated the letter of credit (see Note 15)
10. Reclassifications
Certain amounts from prior periods have been reclassified to conform to the
current period's presentation.
8
ON TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
11. Income Taxes
The Company recorded tax provisions of $230 and $660 during the three and
nine months ended September 30, 2002, respectively, and $33 and $66 for the
three and nine months ended September 30, 2001. The tax provisions recorded in
each of these periods principally reflect income taxes owed by the Company's
profitable foreign operations; no tax benefit was recorded on losses in the
United States.
12. Reimbursable Out-of-Pocket Expenses
In November 2001, the Emerging Issues Task Force (EITF), a committee of the
Financial Accounting Standards Board, issued Topic No. D-103 (Topic D-103)
relating to the accounting for reimbursements received for out-of-pocket
expenses. In accordance with Topic D-103, reimbursements received for
out-of-pocket expenses incurred are characterized as revenue in the statement of
operations with corresponding costs included in cost of revenue. The Company
adopted Topic D-103 on January 1, 2002 and reclassified prior periods to conform
to Topic D-103 presentation. Prior to adoption, the Company had accounted for
reimbursements received for out-of-pocket expenses incurred as an offset to
costs incurred and all net amounts were reported as part of cost of service and
maintenance revenue in the consolidated statement of operations. Accordingly,
the Company recognized $30 for both the three months ended September 30, 2002
and 2001, as service and maintenance revenue and as a corresponding charge to
cost of service and maintenance revenue in the consolidated statement of
operations. For the nine months ended September 30, 2002 and 2001, the Company
recognized $114 and $103, respectively, as an increase in service and
maintenance revenue and as a corresponding charge to cost of service and
maintenance revenue in the consolidated statement of operations. In January
2002, the EITF renamed Topic D-103 to EITF Issue 01-14; no changes were made to
the guidance or effective date.
13. Stock Option Plans
On May 16, 2002, the Company adopted the 2002 Employee and Consultant Stock
Option Plan (the Plan). Pursuant to the Plan, the Company may grant to
employees, directors and consultants of the Company statutory and non-statutory
stock options to purchase up to 1,600 shares of common stock. Options are
typically issued with exercise prices equal to the common stock's fair market
value on the date of grant and vest over a four-year term. Options expire ten
years from the date of grant. Consultants may receive options with shorter
vesting periods or below market exercise prices.
The Company also adopted the 2002 Directors Stock Option Plan (the
"Director's Plan") on May 16, 2002. This plan provides for the granting of
options to purchase up to 400 shares of common stock to directors who are not
employees of the Company. Beginning in 2003, a non-statutory stock option to
purchase 12,500 shares will be granted automatically to all eligible directors
on the date of each Annual Meeting of the Company. Options are issued with
exercise prices equal to the common stock's fair market value on the date of
grant and vest over a three-year term. Options expire ten years from the date of
grant.
Both Plans are administered by the Company's Board of Directors. As of
September 30, 2002, 1,977 shares remained available for grant under both Plans.
The Company's prior option plans lapsed or have been terminated and the
remaining 555 authorized but unissued stock options thereunder are no longer
available for granting. Stock options granted under the prior option plans,
which remain outstanding after the plan termination, were not impacted and will
expire in accordance with their respective terms.
9
ON TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)
(unaudited)
14. Recent Accounting Pronouncements
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). This statement
addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). SFAS No.
146 requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. EITF 94-3 allowed for an
exit cost liability to be recognized at the date of an entity's commitment to an
exit plan. SFAS 146 also requires that liabilities recorded in connection with
exit plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early adoption encouraged. The Company does not expect the adoption
of SFAS 146 will have a material impact on its financial position or results of
operations.
15. Subsequent Events
On August 21, 2002, the Company amended its Waltham office sublease
agreement that previously expired in December 2002. The amendment called for the
Company, subject to receipt of landlord approval and appropriate permits, to
relocate on or about October 18, 2002 within the same building to approximately
23,000 square feet versus the 34,000 square feet previously leased. As part of
this amended agreement, the Company is in the process of reducing its letter of
credit guarantee, and the current collateral, to $100 (see Note 9). In
connection with the amendment, the Company's new facility lease expires on
September 30, 2006 and provides for total future minimum lease payments to be
made by the Company as follows:
$
2002 135
2003 545
2004 565
2005 600
2006 495
============
2,340
============
The amended sublease also provides for prorata amounts payable based on
increases in real estate taxes and other common area charges above those
incurred in 2003 (the base year). There is also a renewal option exercisable for
an additional 28 months at a market rate to be determined.
10
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
ON Technology Corporation and its subsidiaries ("ON" or the "Company")
provide remote software management solutions for desktops, mobile PCs, handhelds
and servers. The Company's principal product, ON Command CCM(R), or CCM, is used
by enterprise IT organizations and service providers to rapidly deliver
business-critical software over corporate networks. Our products are designed to
reduce operational costs while enhancing both IT productivity and end-user
satisfaction.
At September 30, 2002, the Company had approximately 180 employees
worldwide, of which approximately 110 were located in Europe. The Company's
headquarters is located in Waltham, Massachusetts and its main European office
is located in Starnberg, Germany. For the quarter ended September 30, 2002, the
United States accounted for approximately 18% of total revenue compared to 27%
for the same period in 2001; for the nine months ended September 30, 2002, the
United States accounted for approximately 29% of total revenue as compared to
26% for the same period in 2001.
The Company's discussion and analysis of its financial condition and
results of operations are based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenue and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, the
Company evaluates its estimates, including those related to revenue and bad debt
reserve levels, income taxes and contingencies and litigation. The Company bases
its estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
The Company's significant accounting policies are described in Note 1
to its consolidated financial statements included in Item 14 of its Form 10-K.
The Company believes the following accounting policies are critical to an
understanding of its financial statements and involve the more significant
judgments and estimates used in the preparation of its consolidated financial
statements.
Revenue Recognition
The Company recognizes revenue in accordance with the American
Institute of Certified Public Accountants' (AICPA) Statement of Position (SOP)
No. 97-2, Software Revenue Recognition. Software licenses consist principally of
revenue earned under perpetual software license agreements and are generally
recognized upon shipment of the software if persuasive evidence of the
arrangement exists, collection of the resulting receivable is reasonably
assured, the fee is fixed or determinable, and vendor-specific objective
evidence exists for all undelivered elements to allow allocation of the total
fee to all delivered and undelivered elements of the arrangement. Revenue under
such arrangements, which may include multiple software products and services
sold together, is allocated to each element based on the residual method in
accordance with SOP 98-9, Modification of SOP 97-2, Software Revenue
Recognition, with Respect to Certain Transactions. Under the residual method,
the fair value of the undelivered elements is deferred and subsequently
recognized when earned. The Company has established sufficient vendor specific
objective evidence for professional services, training and maintenance and
support services based on the price charged when these elements are sold
separately. Accordingly, software license revenue is recognized using the
residual method upon shipment in arrangements in which software is sold with
professional services, training and maintenance and support services that are
not essential to the functionality of the software.
11
The Company also sells products to resellers under arrangements that
generally do not provide any right of return. The Company typically does not
ship products to resellers until an end user is identified, at which point, the
Company recognizes revenue under the arrangement. The Company records a returns
reserve based on its historical experience for arrangements that provide for
returns or where the Company grants a right of return, although not
contractually obligated.
Service revenue from time and expense contracts and consulting and
training services is generally recognized as the related services are performed.
Amounts billed in excess of revenue recognized related to services and
maintenance are reflected as deferred revenue in the accompanying consolidated
balance sheet.
Accounts Receivable
Accounts receivable are reduced by an allowance for amounts that may
become uncollectible in the future. The estimated allowance for uncollectible
amounts is based primarily on historical write-off experience and management's
evaluation of the customers in the receivable portfolio. While management
believes the allowance is adequate, if the financial condition of the Company's
customers were to deteriorate, resulting in impairment of their ability to make
payments, additional allowances may be required.
Accounting for Income Taxes
As part of the process of preparing its consolidated financial
statements, the Company is required to estimate income taxes in each of the
jurisdictions in which it operates. This process involves the Company estimating
actual current tax exposure together with assessing temporary differences
resulting from differing treatment of items for tax and financial reporting
purposes. These differences result in deferred tax assets, which are included
within the consolidated balance sheet. The Company must then assess the
likelihood that its deferred tax assets will be recovered from future taxable
income, and if the Company does not believe it meets the "more likely than not"
threshold, it must establish a valuation allowance. To the extent the Company
establishes a valuation allowance or increases this allowance in a period, the
Company must record an expense within the tax provision in the consolidated
statement of operations.
Significant management judgment is required in determining the
Company's provision for income taxes, its deferred tax assets and liabilities
and any valuation allowance recorded against its net deferred tax assets. The
Company had recorded a valuation allowance of $22.3 million as of September 30,
2002, due to uncertainties related to its ability to utilize a significant
portion of its deferred tax assets. The valuation allowance is based on the
Company's estimates of taxable income by jurisdiction in which it operates and
the period over which its deferred tax assets will be recoverable, specifically,
a full valuation allowance has been recorded against all U.S. deferred tax
assets. In the event that actual results differ from these estimates or the
Company adjusts these estimates in future periods, the Company may need to
establish an additional valuation allowance, which could materially impact its
financial position and results of operations.
The net deferred tax asset as of September 30, 2002 was $964 thousand,
net of the aforementioned valuation allowance. The net deferred tax assets
relates entirely to the Company's German operations, management believes this
asset is realizable as of September 30, 2002.
12
Results of Operations
The following table sets forth, for the periods indicated, certain
financial data as percentages of the Company's total revenue:
Three Months Ended Nine Months Ended
-------------------------------- ---------------------------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Revenue:
Net CCM and related products 59.4% 61.8% 64.6% 60.3%
Service and maintenance 40.6% 38.2% 35.4% 36.3%
Other - - - 3.4%
------------------------------- --------------------------------
Total revenue 100.0% 100.0% 100.0% 100.0%
Cost of revenue:
Cost of CCM and related products revenue 8.6% 11.4% 12.1% 11.9%
Cost of service and maintenance revenue 9.1% 5.1% 8.2% 5.5%
------------------------------- --------------------------------
Total cost of revenue 17.7% 16.5% 20.3% 17.4%
------------------------------- --------------------------------
Gross profit 82.3% 83.5% 79.7% 82.6%
------------------------------- --------------------------------
Operating expenses:
Sales and marketing 41.6% 53.5% 37.9% 54.7%
Research and development 24.5% 34.2% 23.8% 36.3%
General and administrative 13.9% 30.1% 14.6% 22.7%
------------------------------- --------------------------------
Total operating expenses 80.0% 117.8% 76.3% 113.7%
------------------------------- --------------------------------
Income (loss) from operations 2.3% (34.3)% 3.4% (31.1)%
Interest income, net 0.7% 0.6% 0.4% 0.8%
Other income (expense), net (0.1)% 4.8% 1.2% (9.6)%
------------------------------- --------------------------------
Income (loss) before
provision for income taxes 2.9% (28.9)% 5.0% (39.9)%
Provision for income taxes 2.7% 0.6% 2.6% 0.4%
------------------------------- --------------------------------
Net income (loss) 0.2% (29.5)% 2.4% (40.3)%
=============================== ================================
Net CCM and Related Products. The Company's net CCM and related products revenue
is derived primarily from the licensing of software products. For the three
months ended September 30, 2002, this revenue increased $1.5 million or 42% from
the same period in 2001. This increase is primarily due to an additional $1.1
million in CCM license revenue and $600 thousand in third party software license
revenue due to revenue growth of 88% in Europe over the same period in 2001,
offset by a decrease in like US revenue. For the nine months ended September 30,
2002, CCM and related products revenue increased $6.4 million or 63% from the
same period in 2001. This nine-month increase is primarily due to an increase of
$3.9 million in CCM license revenue and approximately $1.5 million in third
party software license revenue. The US experienced an 89% growth in CCM and
related products revenue for the first nine months of 2002 as compared to the
same period in 2001, resulting from an increase in the number of US enterprise
deals in the first half of 2002, while like European revenue grew at 54%. For
the three and nine months ended September 30 2002, hardware sales to one
European customer decreased by $250 thousand and increased by $900 thousand,
respectively, over the same periods in 2001. The Company believes hardware sales
will greatly diminish going forward because the customer will be dealing with
its suppliers directly.
Service and Maintenance. The Company's service and maintenance revenue consists
of maintenance revenue, training and professional services. This revenue
increased by $1.2 million or 57% from the three months ended September 30, 2001
as compared to the same period in 2002. The increase was primarily due to an
increase in maintenance revenue of $820 thousand, resulting from an increase in
the Company's customer base. Additionally, US consulting and training revenue
increased $219 thousand over the same period in 2001. For the nine months ended
September 30, 2002, this revenue increased by $2.9 million or 48% from the same
period in 2001. Like the quarter, this increase was primarily due to an increase
in maintenance revenue of $2.3 million, as a result of an increase in the
Company's installed base. Additionally, US consulting and training revenue
increased by $516 thousand over the same period in 2001.
13
Other. For the nine months ended September 30, 2001, the Company's other revenue
was $568 thousand, consisting of royalties associated with the licensing of the
Company's Meeting Maker technology to Meeting Maker, Inc. (MMI). This revenue
had no associable cost in the period. As the June 2001 payment included a buyout
exercised by MMI, the Company does not expect any additional revenue from the
Meeting Maker product line.
Cost of CCM and Related Products Revenue. Cost of CCM and related product
revenue consists primarily of expenses associated with product documentation,
production and fulfillment costs, costs of European hardware sales and royalty
and license fees associated with products that are licensed from third party
developers. Cost of CCM and related products revenue, as a percentage of like
revenue, was 14.4% and 18.5% for the three months ended September 30, 2002 and
2001, respectively. This percentage decrease primarily was due to decreased
hardware sales and related costs in 2002 and an increase in high margin revenue
over 2001. For the nine months ended September 30, 2002 and 2001, cost of CCM
and related products revenue, as a percentage of like revenue, was 18.7% and
19.7%, respectively. This decrease is principally due to higher third party
costs in 2001, partly as a result of a lower margins realized on a significant
2001 enterprise deal.
Cost of Service and Maintenance Revenue. Cost of service and maintenance revenue
consists primarily of expenses associated with direct consulting and training
costs as well as costs of the Company's help desk. Cost of service and
maintenance, as a percentage of like revenue, was 22.5% and 13.4% for the three
months ended September 30, 2002 and 2001, respectively. For the nine months
ended September 30, 2002 and 2001, cost of service and maintenance, as a
percentage of like revenue, was 23.2% and 15.2%, respectively. These increases
were primarily attributable to increased utilization of the US consulting group,
which generated the aforementioned additional $219 thousand and $516 thousand in
consulting and training revenue, respectively, for the three and nine months
ended September 30, 2002 versus the same periods in 2001.
Sales and Marketing Expense. Sales and marketing expense primarily consists of
compensation paid to sales and marketing personnel, the costs of direct mail and
telemarketing campaigns and the costs of product trials requested by potential
customers. Sales and marketing expense also includes the costs of trade shows,
seminars, conferences, travel and telephone and information technology costs
associated with sales activities. Prior to 2002, sales and marketing also
included the cost of public relations. In 2002, the general and administrative
department is coordinating the public relations function. Sales and marketing
expense increased $452 thousand for the three months ended September 30, 2002,
over the comparable period in 2001. The increased spending is primarily due to
an increase in sales salaries and commissions of $521 thousand as a result of
higher commissionable revenue and 16 additional employees in the sales
organization. Additionally, promotional spending increased by $287 thousand for
seminars & trade shows and was offset by a $350 thousand decrease in outside
consultants, primarily resulting from Europe hiring or replacing many of its
sales consultants with full time employees. Additionally, 2001 also included $34
thousand in public relations costs. For the nine months ended September 30,
2002, sales and marketing expense increased by $498 thousand over the same
period in 2001. The increased spending is primarily due to an increase in sales
salaries and commissions of $1 million as a result of higher revenue and the
aforementioned addition of sales personnel. This increase was offset by a $591
thousand decrease in outside consultants related to the aforementioned hiring or
replacing of European consultants. Promotional spending for the nine months
ended September 30, 2002 also increased by $161 thousand, principally due to
seminars and trade shows. Additionally, 2001 also included $118 thousand in
public relations costs.
Research and Development Expense. Research and development expense includes
costs associated with the development of new products, the enhancement of
existing products and costs associated with providing indirect technical
support, training and consulting, as well as certain information technology
costs. Research and development expenses increased $108 thousand for the three
months ended September 30, 2002, over the comparable period in 2001. The
increase was primarily due to an increase in consultant expense in Europe of
$120 thousand and an increase in allocated occupancy costs of $230 thousand. The
majority of these increased costs were offset by an increase in the utilization
of the consulting group in the United States during 2002 to support professional
services revenue resulting in those costs being recorded as cost of revenue. For
the nine months ended September 30, 2002, research and development costs
decreased $28 thousand over the same period in 2001. The decrease is due to an
increase in allocated occupancy costs of $530 thousand, the aforementioned
consultant costs of $120 thousand and an increase in incentive compensation of
$280 thousand due to a 2002 compensation program designed to reward the
consulting group based on defined performance targets. These increased costs
were offset by an increase in the utilization of the consulting group in the
United States during 2002 to support professional
14
services revenue resulting in those costs being recorded as cost of revenue.
General and Administrative Expense. General and administrative expense includes
executive compensation and the continued administrative expense associated with
the Company's foreign operations, executive support costs, accounting
operations, planning, investor relations, public relations and other public
company costs, and business development operations. General and administrative
expense decreased approximately $550 thousand during the three months ended
September 30, 2002 versus the same period in 2001. This decrease principally
resulted from the absence of $482 thousand in acquisition evaluation costs in
2001 as well as a decrease in provision for bad debt of $199 thousand due to the
2001 provision increase in Europe as a result of increased reseller exposure.
The expense reductions were partially offset by increased accounting and tax
expenses of $71 thousand for foreign tax planning and assistance with ongoing
tax audits. Additionally, incentive compensation expense was higher by $44
thousand in 2002 due to a lowering of estimated payouts in the third quarter of
2001. Finally, public relations expenses, previously recorded in the marketing
department, totaled $25 thousand. For the nine months ended September 30, 2002,
general and administrative expense decreased approximately $76 thousand over the
same period in 2001. Increases in incentive compensation, audit and tax fees,
and public relations and decreases in consulting fees and bad debt provision as
discussed above also impacted the nine-month comparison. In addition, investor
relation costs increased $80 thousand due to an increased emphasis on investor
communications and insurance costs increased $110 thousand, principally due to
an increase in directors and officers insurance.
Interest Income, Net. For the three months ended September 30, 2002, net
interest income increased approximately $21 thousand from the same period in
2001. This increase was due to an increase in cash available for investing
purposes of approximately $6.8 million offset by reduced investment yields. For
the nine months ended September 30, 2002, interest income decreased $41 thousand
over the same period in 2001. This decrease was primarily due to a 2002 interest
assessment of $30 thousand related to a prior year tax audit as well as reduced
yields on invested cash balances.
Other Income (Expense), Net. Other income (expense), net for the three and nine
months ended September 30, 2002 consisted primarily of a $5 thousand charge and
$347 thousand non-cash credit from the exchange rate impact on temporary
intercompany obligations, respectively, as a result of the changing value of the
Euro in relation to the U.S. dollar.
For the three months ended September 30, 2001, other expense, net consisted
primarily of non-cash charges from revaluation of the notes payable and from the
exchange rate impact on temporary intercompany obligations. The Company
recognized a charge of $100 thousand from the revaluation of the notes payable
to these institutional investors (see Note 2 of the notes to the condensed
consolidated financial statements in this Form 10-Q for a more complete
discussion of these transactions). Due to a strengthening of the Deutsche Mark
against the U.S. dollar, the Company also recognized a non-cash credit of $400
thousand on its temporary intercompany obligations for the quarter ended
September 30, 2001.
For the nine months ended September 30, 2001, the charge of $1,608 thousand
principally consists of a $984 thousand charge on the unexercised warrants, a
$95 thousand charge on the revaluation of notes payable to the institutional
investors, and a $477 thousand foreign exchange charge on its temporary
intercompany obligations.
The Company continues to evaluate hedging alternatives and is working with its
advisors and financial institutions to maintain its strategy of repatriating
funds while minimizing realizable foreign exchange losses and income taxes.
Income Taxes. For the three and nine months ended September 30, 2002, the
Company recorded an income tax provision of $230 thousand and $660 thousand,
respectively, primarily to reflect estimated foreign taxes due by its profitable
foreign operations; no tax benefit was recorded on losses in the United States.
The Company continues to work with its tax advisors to develop additional tax
strategies to minimize foreign income taxes payable.
Due to the Company's taxable net loss position, both domestically and
internationally, a minimal tax provision of $33 thousand and $66 thousand was
recorded for the three and nine months ended September 30, 2001, respectively.
15
Liquidity and Capital Resources
The Company has funded its operations to date primarily through private
and public placements of capital stock and the net proceeds received from the
sale of product lines. At September 30, 2002, the Company had available cash and
cash equivalents of $12.5 million and working capital of $9.8 million. As of
September 30, 2002, the Company also had restricted cash of $1.1 million
securing the Company's Waltham, Massachusetts facility lease.
Net cash provided by (used in) operating activities for the nine months
ended September 30, 2002 and 2001 was $2.6 million and ($3.2) million,
respectively. In 2002, net cash provided by operating activities consisted
mainly of net income of $609 thousand adjusted for non-cash depreciation and
amortization of $819 thousand and a non-cash credit of $347 thousand relating to
the revaluation of intercompany balances, a decrease in accounts receivable of
$1.2 million and an increase in accounts payable of $338 thousand. In 2001, net
cash used in operating activities consisted mainly of a net loss of $6.8 million
and a decrease in accounts payable of $1.1 million, offset by non-cash charges
for the unexercised warrants and revaluation of notes payable of $1.1 million, a
decrease in accounts receivable of $1.9 million, depreciation and amortization
of $847 thousand, a non-cash charge of $477 thousand due to foreign exchange on
intercompany balances and an increase in deferred revenue of $410 thousand.
Net cash used in investing activities for the nine months ended
September 30, 2002 and 2001 was $623 thousand, and $357 thousand, respectively.
Both of these amounts related primarily to the purchase of computer equipment.
Net cash provided by financing activities for the nine months ended
September 30, 2002 and 2001 was $276 thousand and $53 thousand, respectively. In
2002, this cash activity resulted from the exercise of stock options of $195
thousand, the sale of stock under the Employee Stock Purchase Plan of $75
thousand and the exercise of warrants of $6 thousand. In 2001, this cash
activity resulted from the exercise of stock options of $9 thousand and the sale
of stock under the Company's 1995 Employee Stock Purchase Plan of $44 thousand.
On August 21, 2002, the Company amended its Waltham office sublease
agreement, which previously expired in December 2002. The amendment called for
the Company, subject to receipt of landlord approval and appropriate permits, to
relocate on or about October 18, 2002 within the same building to approximately
23,000 square feet versus the 34,000 square feet previously leased. As part of
this amended agreement, the Company is in the process of reducing its letter of
credit guarantee, and the current collateral, to $100 (see Note 9). In
connection with the amendment, the Company's new facility lease expires on
September 30, 2006 and provides for total future minimum lease payments to be
made by the Company as follows:
$
2002 135
2003 545
2004 565
2005 600
2006 495
=========
2,340
=========
For the nine months ended September 30, 2002, the Company's cash and
cash equivalents increased by $2.7 million compared to negative cash flows of
$3.7 million for the same period in 2001. The Company believes that its
available cash resources, including cash and cash equivalents and cash it
expects to generate from sales of products and services, will be sufficient to
finance presently anticipated operating expenses and capital expenditure
requirements at least through the next twelve months. The future liquidity of
the Company is, however, dependent
16
on a number of factors, including but not limited to, the Company's
ability to reach forecasted sales targets and to maintain current expense
levels. There can be no assurance that the Company will not require additional
capital resources during this period of time. If the Company does require
additional capital resources, it may seek to sell additional equity or debt
securities, secure a bank line of credit, or consider strategic alliances. The
sale of additional equity or convertible debt securities could result in
additional dilution to stockholders. There can be no assurance that additional
financing, in any form, will be available at all or, if available, will be on
terms acceptable to the Company.
Recent Accounting Pronouncement
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"). This statement
addresses financial accounting and reporting for costs associated with exit or
disposal activities and nullifies EITF Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" ("EITF 94-3"). SFAS No.
146 requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. EITF 94-3 allowed for an
exit cost liability to be recognized at the date of an entity's commitment to an
exit plan. SFAS 146 also requires that liabilities recorded in connection with
exit plans be initially measured at fair value. The provisions of SFAS 146 are
effective for exit or disposal activities that are initiated after December 31,
2002, with early adoption encouraged. The Company does not expect the adoption
of SFAS 146 will have a material impact on its financial position or results of
operations.
For additional information concerning risks associated with the
Company's liquidity and capital resources see "Certain Factors That May Affect
Future Results".
17
Certain Factors That May Affect Future Results
This Report on Form 10-Q contains forward-looking statements within the meaning
of the Federal Securities Laws. In addition, from time to time, management may
make forward-looking statements in press releases, in other public discussions
and in other documents that we file with the Securities and Exchange Commission
(including those documents incorporated by reference into this Form 10-Q). The
Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for
these statements. For this purpose, a forward-looking statement is any statement
that is not a statement of historical fact. You can identify forward-looking
statements by the words "may," "believes," "anticipates," "plans," "expects,"
"estimates" and similar expressions. Our forward-looking statements are based on
currently available information and management's expectations of future results
but necessarily involve certain assumptions. We caution readers that our
assumptions involve substantial risks and uncertainties. Consequently, any
forward-looking statement could turn out to be wrong. Many factors could cause
actual results to differ materially from our expectations. Below we describe
some of the important factors that could affect our revenue or results of
operations
WE HAVE EXPERIENCED CASH FLOW DEFICITS IN THE PAST AND MAY EXPERIENCE CASH FLOW
DEFICITS IN THE FUTURE.
Although we had an operating profit of $871 thousand for the nine months ended
September 30, 2002, for the fiscal year ended December 31, 2001, we had an
operating loss of approximately $5.0 million producing significant negative cash
flow. Both management's 2002 operating plan and its initial expectations for
2003 indicate that the Company will be operationally profitable for 2002 and
2003. Based upon these assumptions, management believes the Company has
sufficient cash to fund its operations for the next twelve months. If the
Company is unable to attain forecasted revenue levels and management is
unsuccessful in controlling expenses, the Company may have to seek additional
external equity or debt financing to continue its operations. There can be no
assurance that we will be able to secure such external financing.
OUR BUSINESS COULD BE MATERIALLY ADVERSELY AFFECTED AS A RESULT OF GENERAL
ECONOMIC AND BUSINESS CONDITIONS.
Our business is subject to the effects of general economic and business
conditions. ON's operating results have been affected by recent unfavorable
economic conditions and reduced information technology spending. In addition,
the continued fallout from the September 11 terrorist attacks and the heavily
publicized corporate transgressions and resulting investigations causing
investor uncertainty about the integrity of US financial markets have added (or
exacerbated) general economic, political and other uncertainties. If economic
and market conditions do not improve and these uncertainties continue to exist,
ON's business, condition (financial or otherwise), prospects and results of
operations could be adversely affected.
OUR MARKETING REQUIRES SIGNIFICANT INVESTMENTS
Sales of products require significant up-front investments in marketing,
technical and financial resources. We have adopted a sales and marketing
strategy using a direct sales force and in-house field service organization.
This strategy requires significant investments in identifying and hiring
qualified sales and technical personnel, ongoing product development, and
expansion of an in-house field service organization. We have developed valuable
marketing and service experience and expertise in Europe and, recently, in the
United States. However, there can be no assurance that we will be able to
continue to expand and apply such experience and expertise to our target market.
WE DERIVE A SIGNIFICANT PORTION OF OUR REVENUE FROM A RELATIVELY SMALL NUMBER OF
CUSTOMERS
For the years ended December 31, 2001, 2000 and 1999, two customers accounted
for $4.3 million (17.8%), $6.3 million (24.0%), and $7.4 million (24.0%) of
total revenue, respectively. For the three months ended September 30, 2002, no
customer accounted for more than 10% of total revenue. For the nine months ended
September 30, 2002, one customer accounted for $3.2 million (12.4%) of total
revenue. It is possible that, in the future, other customers will account for
more than 10% of ON's total revenue. The loss of significant customers could
have a materially adverse effect on our business, condition (financial or
otherwise), prospects and results of operations.
18
WE WILL NEED TO EXPAND OUR DISTRIBUTION CHANNELS IN ORDER TO DEVELOP OUR
BUSINESS AND INCREASE REVENUE
We sell our products through our direct sales force and a number of
distributors, and we provide maintenance and support services through our
technical and customer support staff. We plan to continue to invest large
amounts of resources in our direct sales force. In addition, we are developing
additional sales and marketing channels through value added resellers, system
integrators, original equipment manufacturers and other channel partners. We may
not be able to attract channel partners that will be able to market our products
effectively, or that will be qualified to provide timely and cost-effective
customer support and service. If we establish distribution through such indirect
channels, our agreements with channel partners may not be exclusive. As a
result, such channel partners may also carry competing product lines. If we do
not establish and maintain such distribution relationships, this could
materially adversely affect our business, condition (financial or otherwise),
prospects and results of operations.
IF THE MARKET FOR OUR ENTERPRISE DESKTOP MANAGEMENT SOFTWARE SOLUTIONS DOES NOT
CONTINUE TO DEVELOP AS WE ANTICIPATE, OUR ABILITY TO GROW OUR BUSINESS AND SELL
OUR PRODUCTS WILL BE ADVERSELY AFFECTED
In recent years, the market for enterprise software solutions has been
characterized by rapid technological change, frequent new product announcements
and introductions and evolving industry standards. In response to advances in
technology, customer requirements have become increasingly complex, resulting in
industry consolidation of product lines offering similar or related
functionality. In particular, we believe that a market exists for integrated
enterprise-wide infrastructure management solutions. If such a market does not
fully develop, this could have a materially adverse effect on our business,
condition (financial or otherwise), prospects and results of operations.
Regardless of the development of a market for integrated infrastructure
management solutions, factors adversely affecting the pricing of, demand for, or
market acceptance of our enterprise desktop management applications could have a
material adverse effect on our business, condition (financial or otherwise),
prospects and results of operations.
IF WE DO NOT RESPOND ADEQUATELY TO OUR INDUSTRY'S EVOLVING TECHNOLOGY STANDARDS,
OR DO NOT CONTINUE TO MEET THE SOPHISTICATED NEEDS OF OUR CUSTOMERS, SALES OF
OUR PRODUCTS MAY DECLINE
As a result of rapid technological change in our industry, product advances can
quickly erode our position in existing markets or other markets that we may
enter. The life cycles of our products are difficult to estimate. Our growth and
future financial performance depend in part upon our ability to improve existing
products and develop and introduce new products that keep pace with
technological advances, meet changing customer needs and respond to competitive
products. Our product development efforts will continue to require substantial
investments. We may not have sufficient resources to make the necessary
investments.
We have experienced product development delays in the past and may experience
delays in the future. Difficulties in product development could delay or prevent
the successful introduction or marketing of new or improved products. Any such
new or improved products may not achieve market acceptance. Our current or
future products may not conform to industry requirements. Our ability to
continue to enhance our current products to meet customer and market
requirements will depend substantially on our ability to effectively manage this
development effort, to attract and retain the required development personnel in
Waltham, Massachusetts and Starnberg, Germany and to coordinate and manage
geographically remote development efforts. If, for technological or other
reasons, we are unable to develop and introduce new and improved products in a
timely manner, our business, condition (financial or otherwise), prospects and
results of operations could be adversely affected.
19
ERRORS IN OUR PRODUCTS COULD RESULT IN SIGNIFICANT COSTS TO US AND COULD IMPAIR
OUR ABILITY TO SELL OUR PRODUCTS
Because our software products are complex, these products may contain errors
that could be detected at any point in a product's life cycle. In the past, we
have discovered software errors in certain of our products and have experienced
delays in shipment of our products during the period required to correct these
errors. Despite testing by ON and by current and potential customers, errors in
our products may be found in the future. Detection of such errors may result in,
among other things, loss of, or delay in, market acceptance and sales of our
products, diversion of development resources, injury to our reputation or
increased service and warranty costs. If any of these results were to occur, our
business, condition (financial or otherwise), prospects and results of
operations could be materially adversely affected.
IN THE FUTURE, INCLUSION OF FUNCTIONS PROVIDED BY OUR PRODUCTS IN SYSTEM
SOFTWARE AND APPLICATION SUITES MAY AFFECT OUR COMPETITIVE POSITION
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 functions that are currently provided by our
products. In addition, some vendors may bundle these products in their existing
application suites at no additional charge. The widespread inclusion of the
functions provided by our products as standard features of operating system
software could render our products obsolete and unmarketable particularly if the
quality of such functions were comparable to the functions offered by our
products. Furthermore, even if the software functions provided as standard
features by operating systems are more limited than those of our products, there
is no assurance that a significant number of customers would not elect to accept
such functions instead of purchasing additional software. If we were unable to
develop new software products to further enhance operating systems and to
successfully replace any obsolete products, our business, condition (financial
or otherwise), prospects and results of operations could be materially adversely
affected.
THE INTENSE COMPETITION IN THE MARKET FOR OUR PRODUCTS COULD ADVERSELY AFFECT
OUR ABILITY TO SELL OUR PRODUCTS
The market for our products is highly competitive, and we expect competition to
continue to increase in the future. We believe that the principal competitive
factors affecting the market for our products include brand name recognition,
company reputation, performance, functionality, ease-of-use, breadth of product
line, quality, customer support, adherence to industry standards, integration
with third-party solutions and price.
As is the case in many segments of the software industry, we may encounter
increasing price competition in the future. This could reduce average selling
prices and, therefore, profit margins. Competitive pressures could result not
only in sustained price reductions but also in a decline in sales volume, which
could adversely affect our business, condition (financial or otherwise),
prospects and results of operations. There can be no assurance that we will
continue to compete effectively against existing and potential competitors in
our markets, many of whom have substantially greater financial, technical,
marketing and support resources and name recognition than we have.
The widespread inclusion of the functionality of our products as standard
features of Microsoft operating systems software could render our products
obsolete and unmarketable, particularly if the quality of such functionality
were comparable to that our products. If we were unable to develop new
functionality or unique applications for our technology to successfully replace
any obsolete products, our business, condition (financial or otherwise),
prospects and results of operations could be materially adversely affected.
The market for our products is highly competitive and diverse. The technology
for remote software management products can change rapidly. New products are
frequently introduced and existing products are continually enhanced.
Competitors vary in size and in the scope and breadth of the products and
services offered. The Company has faced competition from a number of sources,
including:
.. Large and established companies such as Microsoft, Computer Associates
International and IBM/Tivoli which offer remote software delivery and
management capabilities as part of their systems management, or network
management frameworks;
20
.. Software companies such as Novidigm and Marimba and others who provide
software management utilities and suites such as Symantec, Intel, and
Altiris;
.. Hardware suppliers such as IBM, Hewlett-Packard, and Compaq that offer or
bundle software management capabilities in conjunction with their hardware
offerings; and
.. The internal information technology departments of those companies with
infrastructure management needs.
In addition, Microsoft has bundled new management capabilities in its Windows
2000 and XP operating systems that, in conjunction with its Systems Management
Server (SMS) framework, directly compete with capabilities provided by ON
Command CCM. Even if the functionality provided with Microsoft's operating
system software were more limited than that of our software management products,
customers or potential customers might elect to accept more limited
functionality in lieu of purchasing additional software. Competition resulting
from this type of bundling could lead to price reductions for our products,
which would reduce our margins and correspondingly affect our business,
condition (financial or otherwise), prospects and results of operations.
Some of our current and many of our potential competitors have much greater
financial, technical, marketing, and other resources than we have. As a result,
they may be able to respond more quickly to new or emerging technologies and
changes in customer needs. They may also be able to devote greater resources to
the development, promotion, and sale of their products than the Company can. The
Company may not be able to compete successfully against current and future
competitors. In addition, competitive pressures faced by the Company may
materially adversely affect the Company's business, condition (financial or
otherwise), prospects and results of operations.
NEW COMPETITORS AND ALLIANCES AMONG EXISTING COMPETITORS COULD IMPAIR OUR
ABILITY TO RETAIN AND EXPAND OUR MARKET SHARE
Because competitors can easily penetrate the software market, we anticipate
additional competition from other established and new companies as the market
for enterprise desktop management applications develops. In addition, current
and potential competitors have established or may in the future establish
cooperative relationships among themselves or with third parties. Large software
companies may acquire or establish alliances with our smaller competitors. We
expect that the software industry will continue to consolidate. It is possible
that new competitors or alliances among competitors may emerge and rapidly
acquire significant market share.
DUE TO THE TECHNOLOGICAL CHALLENGES ASSOCIATED WITH OUR CURRENT PRODUCTS, WE MAY
NOT HAVE THE FINANCIAL RESOURCES NECESSARY TO CONDUCT THE BUSINESS AS PRESENTLY
CONTEMPLATED
Based on management's 2002 forecasts and initial expectations for 2003, product
development, marketing and sales costs for our current products are expected to
range from approximately $1.75 million to $1.9 million per month. Based on our
existing cash and forecasted revenue, we believe that we have enough cash to
fund these costs for the next 12 months. There can be no assurance, however,
that our estimate of the marketing, sales and product development costs of the
CCM products is correct, or that these costs will not exceed our available
financial resources, or that we will be able to locate additional sources of
financing, if and when needed.
21
OUR INCREASING RELIANCE ON INTERNATIONAL REVENUE COULD ADVERSELY AFFECT OUR
OPERATING RESULTS
For fiscal years 2001, 2000, and 1999, total international revenue from the
Company's foreign subsidiaries and other foreign sources was 74%, 67% and 51% of
total revenue, respectively. For the quarter ended September 30, 2002, total
international revenue from the Company's foreign subsidiaries was 82%. For the
nine months ended September 30, 2002, total international revenue from the
Company's foreign subsidiaries was 71%. We expect that international revenue
will continue to constitute a significant portion of our total revenue in the
future. Accordingly, a significant percentage of our total revenue may be
subject to the risks inherent in international sales, including the impact of
fluctuating exchange rates on demand for our 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 our
future international license revenue.
Our continued growth and profitability will require continued expansion of our
international operations, particularly with continued expansion in Europe and
initial inroads into Latin America and the Pacific Rim. Accordingly, we intend
to expand our current international operations and enter additional
international markets. Such expansion will require significant management
attention and financial resources. We have only limited experience in developing
local-language versions of our products and marketing and distributing our
products internationally. We may not be able to successfully translate, market,
sell and deliver our products internationally. If we are unable to expand our
international operations successfully and in a timely manner, our business,
condition (financial or otherwise), prospects and results of operations could be
adversely affected.
AS OUR EXPANDING INTERNATIONAL OPERATIONS IN EUROPE AND ELSEWHERE ARE
INCREASINGLY CONDUCTED IN CURRENCIES OTHER THAN THE U.S. DOLLAR, FLUCTUATIONS IN
THE VALUE OF FOREIGN CURRENCIES COULD RESULT IN CURRENCY EXCHANGE LOSSES
A large portion of our business is conducted in foreign currencies. Fluctuations
in the value of foreign currencies relative to the U.S. dollar have caused and
will continue to cause currency transaction gains and losses. We cannot predict
the effect of exchange rate fluctuations upon future operating results. We may
experience currency losses in the future. We may implement a foreign exchange
hedging program, consisting principally of purchases of forward-rate currency
contracts. However, if undertaken, our hedging activities may not adequately
protect us against the risks associated with foreign currency fluctuations.
FUTURE FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS DUE TO A NUMBER OF
FACTORS, MANY OF WHICH ARE BEYOND OUR CONTROL, COULD ADVERSELY AFFECT OUR STOCK
PRICE
Our quarterly operating results have varied significantly in the past and may
vary significantly in the future depending upon a number of factors, many of
which are beyond our control. These factors include, among others:
. our ability to develop, introduce and market new and enhanced versions
of our software on a timely basis;
. market demand for our software;
. the size, timing and contractual terms of significant orders;
. the timing and significance of new software product announcements or
releases by ON or our competitors;
. changes in our pricing policies or those of our competitors;
22
. changes in our business strategies;
. budgeting cycles of our potential customers;
. changes in the mix of software products and services sold;
. reliance on indirect sales forces;
. changes in the mix of revenues attributable to domestic and
international sales and the related rates of exchange;
. the impact of acquisitions of competitors;
. seasonal trends;
. the cancellations of maintenance agreements;
. product life cycles, software defects and other product quality
problems; and
. personnel changes.
We have often recognized a substantial portion of our revenue in the last month
or weeks of a quarter. As a result, license revenue in any quarter is
substantially dependent on orders booked and shipped in the last month or weeks
of that quarter. Due to the foregoing factors, quarterly revenue and operating
results are not predictable with any significant degree of accuracy. In
particular, the timing of revenue recognition can be affected by many factors,
including the timing of contract execution and delivery. The timing between
initial customer contact and fulfillment of criteria for revenue recognition can
be lengthy and unpredictable, and revenue in any given quarter can be adversely
affected as a result of such unpredictability.
OUR SALES CYCLE IS LONG AND UNPREDICTABLE, AND POTENTIAL DELAYS IN THE CYCLE
MAKE OUR REVENUE SUSCEPTIBLE TO FLUCTUATIONS
The licensing of our software generally requires us to engage in a sales cycle
that typically takes approximately four to nine months to complete. The length
of the sales cycle may vary depending on a number of factors over which we may
have little or no control, including the size of the transaction and the level
of competition that we encounter in our selling activities. During the sales
cycle, we typically provide a significant level of education to prospective
customers regarding the use and benefits of our products. Any delay in the sales
cycle of a large license or a number of smaller licenses could have a material
adverse effect on our business, condition (financial or otherwise), prospects
and results of operations.
SEASONAL TRENDS IN SALES OF OUR SOFTWARE PRODUCTS MAY AFFECT OUR QUARTERLY
OPERATING RESULTS
Our business has experienced and is expected to continue to experience
seasonality. Our revenue and operating results in our December quarter typically
benefit from purchase decisions made by the large concentration of customers
with calendar year-end budgeting requirements, and from the efforts of our sales
force to meet fiscal year-end sales quotas. In addition, we are currently
attempting to expand our presence in international markets, including Europe.
International revenue comprises a significant percentage of our total revenue,
and we may experience additional variability in demand associated with seasonal
buying patterns in such foreign markets.
23
FUTURE ACQUISITIONS PRESENT RISKS WHICH COULD ADVERSELY AFFECT OUR BUSINESS
In the future, ON may evaluate and make acquisitions of, or large investments
in, other businesses that offer products, services, and technologies that
further our goal of providing enterprise desktop management software solutions
to businesses or which complement our current business. Any future acquisitions
or investments that we may evaluate or complete present risks commonly
encountered with these types of transactions. The following are examples of such
risks:
.. significant out of pocket expenses during the evaluation period
.. difficulty in combining the technology, operations, or work force of
the acquired business;
.. disruption of on-going businesses;
.. difficulty in realizing the potential financial and strategic position
of ON through the successful integration of the acquired business;
.. difficulty in maintaining uniform standards, controls, procedures, and
policies;
.. possible impairment of relationships with employees and clients as a
result of any integration of new businesses and management personnel;
.. difficulty in adding significant numbers of new employees, including
training, evaluation, and coordination of effort of all employees
towards our corporate mission;
.. diversion of management attention; and
.. potential dilutive effect on earnings.
The risks described above, either individually or in the aggregate, could
materially adversely affect our business, operating results, and financial
condition. Future acquisitions, if any, could provide for consideration to be
paid in cash, shares of ON common stock, Company debt, or a combination of cash,
ON common stock, and Company debt.
OUR ABILITY TO MANAGE GROWTH WILL AFFECT OUR ABILITY TO ACHIEVE AND MAINTAIN
PROFITABILITY
Over the last 4 years, total CCM and related revenue has increased significantly
from $11.3 million in fiscal 1998 to $23.7 million in fiscal 2001 and $25.5
million year to date. If we achieve our future growth plans, such growth may
burden our operating and financial systems. This burden will require large
amounts of senior management attention and will require the use of other ON
resources. Our ability to compete effectively and to manage future growth (and
our future operating results) will depend in part on our ability to implement
and expand operational, customer support, and financial control systems and to
expand, train, and manage our employees. We may not be able to augment or
improve existing systems and controls or implement new systems and controls in
response to future growth, if any. Any failure to do so could materially
adversely affect our business, condition (financial or otherwise), prospects and
results of operations.
OUR BUSINESS DEPENDS IN LARGE PART UPON THE PROTECTION OF OUR PROPRIETARY
TECHNOLOGY, THE LOSS OF WHICH WOULD HAVE A MATERIAL ADVERSE EFFECT ON OUR
BUSINESS
Our success is heavily dependent upon our proprietary software technology. We
rely on a combination of contractual rights, trademarks, trade secrets and
copyright to establish and protect our proprietary rights in software.
We use a printed "shrink-wrap" license for users of our products distributed
through traditional distribution channels in order to protect our copyrights and
trade secrets in those products. Since the licensee does not sign these
shrink-wrap licenses, many authorities believe that they may not be enforceable
under many state laws and the laws of many foreign jurisdictions. If such
licenses were not enforceable, the user would not be bound by the license terms,
including the terms that seek to protect our proprietary technology. If the
printed shrink-wrap licenses prove to be unenforceable, this may have a material
adverse effect on our business, condition (financial or otherwise), prospects
and results of operations.
24
The laws of some foreign countries either do not protect our proprietary rights
or offer only limited protection for those rights. Furthermore, in countries
with a high incidence of software piracy, we may experience a higher rate of
piracy of our products.
We have obtained registrations in the United States for the following
trademarks: ON Technology, CCM, ON Command, and ON Command CCM. We have only
obtained registration for the trademark ON Command CCM in the European Union and
Australia and for ON Technology and ON Command in Canada. As a result, we may
not be able to prevent a third party from using our trademarks in many foreign
jurisdictions. We have not to date registered any of our copyrights.
There can be no assurance that the steps taken by ON to protect our proprietary
software technology will be adequate. Lesser sensitivity by corporate,
government or institutional users to avoiding infringement of propriety rights
could have a material adverse effect on our business, condition (financial or
otherwise), prospects and results of operations.
There has been substantial litigation in the software industry involving
intellectual property rights of technology companies. We have not been involved
in any such litigation. Although we do not believe that we are infringing the
intellectual property rights of others, any involvement in this type of
litigation may have a material adverse effect on our business, condition
(financial or otherwise), prospects and results of operations. In addition,
since we currently license, or may in the future license or acquire a portion of
the software included in our products from third parties, our exposure to
infringement actions may increase because we must rely upon these third parties
for information as to the origin and ownership of any software. We generally
obtain representations as to the origin and ownership of such acquired or
licensed software and we generally obtain indemnification to cover any breach of
such representations. However, there can be no assurance that these
representations are accurate or that such indemnification will provide us with
adequate compensation for a breach of these representations. In the future, we
may need to initiate litigation to enforce and protect trade secrets and other
intellectual property rights owned by us. We 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. This litigation
could be costly and cause diversion of management's attention, either of which
could have a material adverse effect on our business, condition (financial or
otherwise), prospects and results of operations. Adverse rulings or findings in
such litigation could result in the loss of our proprietary rights, subject us
to significant liabilities, require us to seek licenses from third parties or
prevent us from manufacturing or selling our products. Any one of these items
could have a material adverse effect on our business, condition (financial or
otherwise), prospects and results of operations. Furthermore, there can be no
assurance that any necessary licenses will be available to us on reasonable
terms, or at all.
IF WE FAIL TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, COMPETITORS MAY BE ABLE
TO USE OUR TECHNOLOGY OR TRADEMARKS AND THIS COULD WEAKEN OUR COMPETITIVE
POSITION, REDUCE OUR REVENUE AND INCREASE COSTS
We rely primarily on a combination of copyright and trademark laws, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary rights. Such laws provide only limited protection. Despite
precautions that we take, it may be possible for unauthorized third parties to
copy aspects of our current or future products or to obtain and use information
that we regard as proprietary. In particular, we may provide our licensees with
access to our data model and other proprietary information underlying our
licensed applications. Such means of protecting our proprietary rights may not
be adequate. Policing unauthorized use of software is difficult and, while we do
not expect software piracy to be a persistent problem, some foreign laws do not
protect our proprietary rights to the same extent as United States laws.
Litigation may be necessary in the future to enforce our intellectual property
rights, to protect our trade secrets or to determine the validity and scope of
the proprietary rights of others. Litigation could result in substantial costs
and diversion of resources, and could materially adversely affect our business,
condition (financial or otherwise), prospects and results of operations.
25
THIRD PARTIES COULD ASSERT, FOR COMPETITIVE OR OTHER REASONS, THAT OUR PRODUCTS
INFRINGE THEIR INTELLECTUAL PROPERTY RIGHTS, AND SUCH CLAIMS COULD INJURE OUR
REPUTATION, CONSUME TIME AND MONEY, AND ADVERSELY AFFECT OUR ABILITY TO SELL OUR
PRODUCTS
While we are not aware that any of our software product offerings infringe the
proprietary rights of third parties, third parties may claim infringement with
respect to our current or future products. We expect that software product
developers will increasingly be subject to infringement claims as the number of
products and competitors in the software industry grows and the functionality of
products in different industry segments overlaps. Any such claims, with or
without merit, could be time consuming, result in costly litigation, cause
product shipment delays or require us to enter into royalty or licensing
agreements. Royalty or licensing agreements may not be available on acceptable
terms, or at all. As a result, infringement claims could have a material adverse
effect on our business, condition (financial or otherwise), prospects and
results of operations.
WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS THAT COULD RESULT IN SIGNIFICANT
COSTS TO US
Our license agreements with our customers typically contain provisions designed
to limit exposure to potential product liability claims. Such limitation of
liability provisions may, however, not be effective under the laws of certain
jurisdictions. Although we have not experienced material product liability
claims to date, the sale and support of our products entails the risk of such
claims. We may be subject to such claims in the future. A material product
liability claim could materially adversely affect our business, condition
(financial or otherwise), prospects and results of operations.
OUR SENIOR MANAGEMENT AND OTHER KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS, AND
IF THEY CHOOSE TO LEAVE, IT COULD HARM OUR BUSINESS
Our success will depend to a significant extent on the continued service of our
senior management and certain other key employees, including selected sales,
consulting, technical and marketing personnel. While our employees are required
to sign standard agreements concerning confidentiality and ownership of
inventions and many of our employees are bound by an employment or
non-competition agreement, enforcing these agreements may be difficult and
costly, particularly with respect to provisions concerning non-competition. In
addition, we do not generally maintain key man life insurance on any employee.
The loss of the services of one or more of our executive officers or key
employees or the decision of one or more such officers or employees to join a
competitor or otherwise compete directly or indirectly with us could have a
material adverse effect on our business, condition (financial or otherwise),
prospects and results of operations.
WE WILL NEED TO RECRUIT AND RETAIN ADDITIONAL QUALIFIED PERSONNEL TO
SUCCESSFULLY GROW OUR BUSINESS
Our future success will likely depend in large part on our ability to attract
and retain additional highly skilled technical, sales, management and marketing
personnel. Competition for such personnel in the computer software industry is
intense, and in the past we have experienced difficulty in recruiting qualified
personnel. New employees generally require substantial training in the use of
our products. We may not succeed in attracting and retaining such personnel. If
we do not, our business, condition (financial or otherwise), prospects and
results of operations could be materially adversely affected.
26
PROVISIONS IN OUR CHARTER DOCUMENTS AND IN DELAWARE LAW MAY DISCOURAGE POTENTIAL
ACQUISITION BIDS FOR ON AND PREVENT CHANGES IN OUR MANAGEMENT WHICH OUR
STOCKHOLDERS FAVOR
Certain provisions of ON's charter documents eliminate the right of stockholders
to act by written consent without a meeting and specify certain procedures for
nominating directors and submitting proposals for consideration at stockholder
meetings. Such provisions are intended to increase the likelihood of continuity
and stability in the composition of the ON board of directors and in the
policies set by the board. These provisions also discourage certain types of
transactions, which may involve an actual or threatened change of control
transaction. These provisions are designed to reduce the vulnerability of ON to
an unsolicited acquisition proposal. As a result, these provisions could
discourage potential acquisition proposals and could delay or prevent a change
in control transaction. These provisions are also intended to discourage certain
tactics that may be used in proxy fights. However, they could have the effect of
discouraging others from making tender offers for ON's shares. As a result,
these provisions may prevent the market price of ON common stock from reflecting
the effects of actual or rumored takeover attempts. These provisions may also
prevent changes in the management of ON.
ON's board of directors has the authority to issue up to 2,000,000 shares of
preferred stock in one or more series. The board of directors can fix the price,
rights, preferences, privileges, and restrictions of such preferred stock
without any further vote or action by ON's stockholders. The issuance of
preferred stock allows ON to have flexibility in connection with possible
acquisitions and other corporate purposes. However, the issuance of shares of
preferred stock may delay or prevent a change in control transaction without
further action by the ON stockholders. As a result, the market price of the ON
common stock and the voting and other rights of the holders of ON common stock
may be adversely affected. The issuance of preferred stock may result in the
loss of voting control to others. ON has no current plan to issue any shares of
preferred stock.
ON is subject to the anti-takeover provisions of the Delaware General
Corporation Law, which regulates corporate acquisitions. The Delaware law
prevents certain Delaware corporations, including ON, from engaging, under
certain circumstances, in a "business combination" with any "interested
stockholder" for three years following the date that such stockholder became an
interested stockholder. For purposes of Delaware law, a "business combination"
includes, among other things, a merger or consolidation involving ON and the
interested stockholder and the sale of more than 10% of ON's assets. In general,
Delaware law defines an "interested stockholder" as any entity or person
beneficially owning 15% or more of the outstanding voting stock of a company and
any entity or person affiliated with or controlling, or controlled by such
entity or person. Under Delaware law, a Delaware corporation may "opt out" of
the anti-takeover provisions. ON has not "opted out" of the anti-takeover
provisions of Delaware law.
OUR STOCK WILL LIKELY BE SUBJECT TO SUBSTANTIAL PRICE AND VOLUME FLUCTUATIONS
WHICH MAY PREVENT STOCKHOLDERS FROM RESELLING THEIR SHARES AT OR ABOVE THE PRICE
AT WHICH THEY PURCHASED THEIR SHARES
In the past, the market price of our common stock has varied greatly and the
volume of our common stock traded has fluctuated greatly as well. We expect such
fluctuation to continue. The fluctuation results from a number of factors
including:
.. any shortfall in revenue or income as compared to revenue or income
projected by management or expected by investors and securities analysts;
.. announcements of new products by ON or our competitors;
.. quarterly fluctuations in our financial results or the results of other
software companies, including those of our direct competitors;
.. changes in analysts' estimates of our financial performance, the financial
performance of our competitors, or the financial performance of software
companies in general;
.. general conditions in the software industry;
27
.. changes in prices for our products or the products of our competitors;
.. changes in our revenue growth rates or the growth rates of our competitors;
.. sales of large blocks of ON common stock; and
.. conditions in the financial markets in general.
In addition, the stock market may from time to time experience extreme price and
volume fluctuations. Many technology companies, in particular, have experienced
such fluctuations. Often, such fluctuations have been unrelated to the operating
performance of the specific companies. The market price of our common stock may
experience significant fluctuations in the future.
THE SHARES OF COMMON STOCK ISSUED UPON EXERCISE OF CERTAIN WARRANTS WILL HAVE A
DILUTIVE EFFECT
In 2000, we entered into exchange agreements with two institutional investors
pursuant to which the investors exchanged certain existing warrants for new
warrants exercisable for an aggregate of 2,800,000 shares of common stock and
promissory notes in the aggregate principal amount of $1 million (which were
cancelled on December 31, 2001). The number of shares of ON's common stock
issued or issuable upon exercise of the new warrants (the "Warrant Shares") was
fixed at 2,800,000 in the aggregate (subject to adjustment for stock splits,
stock dividends and similar events and to weighted average antidilution
adjustments in the case of certain below-market securities issuances by ON);
however, because the exercise price is $0.01 per share (subject to adjustment
for stock splits, stock dividends and similar events and to weighted average
antidilution adjustments in the case of certain below-market securities
issuances by ON), the issuance of the Warrant Shares has (in the case of Warrant
Shares already issued) or will have a dilutive effect on the stockholders of ON.
As of November 11, 2002, 2,549,563 Warrant Shares had been issued and 250,437
Warrant Shares remained issuable.
RISK OF DELISTING BY THE NASDAQ STOCK MARKET
Under rules adopted by the NASDAQ Stock Market, ON's common stock is subject to
possible delisting from the NASDAQ National Market if, among other requirements,
the minimum bid price for the Company's common stock falls below $1.00 for a
period of 30 consecutive business days or if the Company's stockholders' equity
falls below $10 million. An issuer failing to meet the minimum stockholders'
equity requirement can avoid delisting if it satisfies an alternative-listing
standard that imposes, among other requirements, a minimum bid price of $3.00.
As of September 30, 2002, ON's stockholders equity was $9.8 million and at
November 11, 2002, the closing bid price of ON's common stock was $2.70. As a
result, management anticipates that shortly after filing this Quarterly Report
on Form 10-Q, ON will be notified by the NASDAQ Stock Market that ON's common
stock no longer meets the requirements for continued listing on the NASDAQ
National Market and that the NASDAQ Stock Market intends to commence the process
of delisting ON's common stock. Based on management's operating estimates for
the fourth quarter of 2002 and initial operating expectations for the first
quarter of 2003, management believes that ON's stockholders' equity will shortly
exceed $10 million and that, as a result, the NASDAQ Stock Market process for
delisting ON's common stock process will cease. If management's expectations are
incorrect, however, ON's common stock may be delisted unless ON takes
affirmative action to increase its stockholders' equity (such as by issuing
securities in an equity financing) or it satisfies an alternative listing
standard. Delisting could have a material adverse effect on the price of ON's
common stock and on the level of liquidity currently available to the Company's
shareholders.
28
Item 3: Quantitative And Qualitative Disclosure About Market Risk
The Company is exposed to the impact of interest rate changes and foreign
currency fluctuations based on ON's investment changes.
Interest Rate Risk. The Company's exposure to market rate risk for changes
in interest rates relates primarily to the Company's cash equivalent
investments. The Company has not used derivative financial instruments. The
Company invests its excess cash in short-term floating rate instruments and
senior secured floating rate loan funds, which carry a degree of interest rate
risk. These instruments may produce less income than expected if interest rates
fall.
Foreign Currency Risk. International revenue from the Company's foreign
subsidiaries and other foreign sources for the quarter ended September 30, 2002
was approximately 82% of total revenue. International sales are made primarily
from the Company's subsidiary in Germany and are denominated in the local
currency. Accordingly, the Company's German subsidiary uses the local currency
as its functional currency. The Company is exposed to foreign currency exchange
rate fluctuations as the financial results of its foreign subsidiary are
translated into U.S. dollars in consolidation. As exchange rates vary, these
results, when translated, may vary from expectations and adversely impact
overall profitability.
Investment Risk. The Company may invest in the future in the equity
instruments of privately held companies for business and strategic purposes.
However, as of September 30, 2002, the Company holds no such material
investments. For these non-quoted investments, the Company's policy is to
regularly review the assumptions underlying the operating performance and cash
flow forecasts in assessing the carrying values. The Company identifies and
records impairment losses on long-lived assets when events or circumstances
indicate that such assets might be impaired.
Item 4: Controls and Procedures.
a) Evaluation of disclosure controls and procedures. Based on their
evaluation of the Company's disclosure controls and procedures (as
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange
Act of 1934) as of a date within 90 days of the filing date of this
Quarterly Report on Form 10-Q, the Company's chief executive officer
and chief financial officer have concluded that the Company's
disclosure controls and procedures are designed to ensure that
information required to be disclosed by the Company in the reports
that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified
in the SEC's rules and forms and are operating in an effective manner.
b) Changes in internal controls. There were no significant changes in the
Company's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their
most recent evaluation.
29
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
FORM 10-Q, September 30, 2002
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, the Company may be a party to litigation and claims
incident to the ordinary course of its business. As of the date of
this Quarterly Report on Form 10-Q, there is no litigation pending
against the Company that would have a material adverse effect on the
Company's results of operations or financial position.
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The exhibits listed in the accompanying Exhibit Index on page 34
are filed or incorporated by reference as part of this Quarterly
Report on Form 10-Q.
(b) Reports on Form 8-K
None
30
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
FORM 10-Q, September 30, 2002
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/ Robert L. Doretti
------------------------------------------
Date: November 13, 2002 Name: Robert L. Doretti
Title: Chairman, President, and
Chief Executive Officer
/s/ Steven R. Wasserman
------------------------------------------
Date: November 13, 2002 Name: Steven R. Wasserman
Title: Vice President of Finance,
Chief Financial Officer, and
Chief Accounting Officer
31
CERTIFICATIONS REQUIRED BY RULES 13A-14 AND 15D-14
UNDER THE SECURITIES EXCHANGE ACT OF 1934
Certification of President
I, Robert L. Doretti, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ON Technology
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /s/ Robert L. Doretti
--------------------------------
Name: Robert L/Doretti
Title: Chairman, President, and
Chief Executive Officer
32
Certification of Chief Financial Officer/Chief Accounting Officer
I, Steven R. Wasserman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ON Technology
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 13, 2002 /s/ Steven R. Wasserman
--------------------------------
Name: Steven R. Wasserman
Title: Vice President of Finance,
Chief Financial Officer, and
Chief Accounting Officer
33
INDEX TO EXHIBITS
EXHIBIT NO. EXHIBIT TITLE
- ----------- -------------
10.1*# Employment letter between ON Technology and Michael Carey
dated August 8, 2002
99.1# Certification of Chief Executive Officer
99.2# Certification of Chief Financial Officer
- --------------------------
# Filed with this report.
+ Previously filed.
* Management contracts or compensatory plans or arrangements covering executive
officers or directors the Company.
34