Back to GetFilings.com
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ to ________
Commission file number 0-26376
ON TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 04-3162846
(State of incorporation) (IRS Employer Identification Number)
One Cambridge Center
Cambridge, Massachusetts 02142
(617) 374-1400
http://www.on.com
(Address and telephone of principal executive offices)
___________
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
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 (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO______
----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
Aggregate market value of the voting stock held by nonaffiliates of the
registrant, based upon the closing sale price of the Company's common stock on
March 7, 1997, as reported by the Nasdaq National Market:
$57,450,143
Indicate the number of outstanding shares of each issuer's classes of common
stock as of March 7, 1997:
Common Stock, par value $0.01 per share: 12,094,767
Form 10-K
Reference
--------
DOCUMENTS INCORPORATED BY REFERENCE
(1) Definitive Proxy Statement for Annual Meeting for Shareholders
Scheduled for April 30, 1997 Part III
(2) Registration Statement No. 33-92562 on Form S-1, as amended Part IV
(3) Quarterly Report on Form 10-Q for the quarters ended
September 30, 1995 and June 30, 1996
THIS DOCUMENT CONTAINS _______ PAGES.
THE EXHIBIT INDEX IS ON PAGE ______.
PART I
------
ITEM 1 BUSINESS
THE COMPANY
ON Technology Corporation (the "Company" or "ON") develops, markets and
supports communications and network management software, including client/server
tools for group scheduling, electronic mail ("e-mail"), and software metering.
The Company provides software for heterogeneous networks that is designed to be
simple to install and easy to use, support multiple client platforms, require
minimal training, and address proven customer needs. The Company sells its
products primarily to large and medium-sized corporations, institutions and
government entities through a 30-day free trial marketing strategy.
The Company was founded in 1985 and entered the communications software
market in 1990 believing that the rapid proliferation of new client operating
systems (Windows, DOS, Macintosh and OS/2, among others) would create
heterogenous networks of various types and generations of personal computers
running the latest as well as older operating systems. The Company believed
that these heterogenous networks would create a demand for communications
software products that run on leading edge as well as on less advanced hardware
platforms. The Company began shipping e-mail products in 1990 and in 1993
expanded its product line to group scheduling software with the acquisition of
substantially all of the assets of ON Technology, Inc. ("OTI"). The Company
entered the software metering business by obtaining the exclusive worldwide
rights to SofTrack in December 1993. The Company expanded its e-mail offerings
with the acquisition of DaVinci Systems Corporation in 1994. In August of 1995,
the Company completed an initial public offering of 2,360,000 of its common
stock resulting in net proceeds of $31,647,000. In the first quarter of 1996,
the Company entered the firewall software and anti-virus software business
through the acquisitions of neTrend Corporation and Leprechaun Software
International, Ltd., respectively and purchased the LAN software business from
Technocom plc. The Company began shipping ONGuard, the Company's firewall
software product, and Macro Virus Track, the Company's anti-virus software
product, during the second quarter of 1996. The purchase of the LAN software
business from Technocom plc was the Company's first physical expansion into
European and international markets by establishing an office in the UK. Since
that time the Company has opened sales and support offices in Sydney, Paris and
Gothenburg (Sweden). On August 6, 1996, the Company announced and implemented a
reorganization and restructuring plan (the "Plan") of its operations. The Plan
was designed to consolidate the three acquisitions made in the first quarter of
1996 and to reflect the Company's decreased emphasis on its mature e-mail
business and certain catalog products. In 1997 the Company entered into the
Internet usage monitoring and PC Desktop software management businesses through
the acquisition of Purview Technologies Inc. and csd Software GmbH. The Company
has applied its free trial marketing and installation technology to all of the
software acquired and licensed from third parties.
BACKGROUND
During the 1980s, local area networks ("LANs") connected a heterogeneous
mix of personal computers and workstations running various generations of
operating systems and applications software. The introduction of LANs created a
need for communications software that takes advantage of the installed LAN
infrastructure. Starting with e-mail, several types of communications software
evolved, including electronic group scheduling and network management software.
Communications software is most effective when all members of a workgroup use
the application. However, many organizations and workgroups have not found
communications software that operates satisfactorily across a multi-platform
computing environment. Moreover, communications software is often so feature-
laden and complex that it requires extensive user training. This dramatically
increases the cost of deploying the application and discourages day-to-day use
by the less technically oriented users.
As the number and size of LANs grew, demand emerged for network utilities.
The earliest network utilities provided basic functions such as network backup,
virus protection and printing redirection. Later, network management software
evolved to enable the network administrator to manage the relationship between
the data on the network and the users in the workgroup. For example, network
administrators want to save money by ensuring that they are not purchasing
additional software licenses while some existing licensees sit idle. Also,
network administrators need to understand who is accessing their servers, what
files are being accessed, or who is changing network security rights and other
information. In addition, corporate officers may need to audit the network
activities of even trusted network supervisors. Much of the available network
management software attempts to combine many of these and other functions into a
single software
2
product. The resulting product can be difficult to use to solve specific
problems. With the current shortage of trained network administrators and the
prevalence of part-time administrators, easy to use tools that target specific
problems faced by administrators are often preferred.
PRODUCTS AND TECHNOLOGY
ON provides network management and communications software for
heterogeneous networks that is designed to be simple to install and easy to use,
support multiple client platforms, require minimum training and address specific
customer needs. ON's communications software is designed to deliver increased
productivity; faster, more accurate and actionable communications; better
leverage of expensive corporate assets; and higher velocity of information.
ON's network management products are designed to deliver lower software
licensing costs; compliance with software licensing requirements; improved
network security; information on network activities; and network diagnostic
assistance. The Company uses a Free Trial Marketing strategy to enhance
customer satisfaction and generate close customer relationships.
The following table sets forth certain information about ON's principal
products, including the networks and operating systems supported by each:
Client Operating First Latest List
Product Principal Network Systems Release Release Price Per
Category Products Supported Supported Date(1) Date 100 Users
- ----------------------------------------------------------------------------------------------------
Group Meeting Maker XP NetWare DOS, Windows 3/91 12/96 $8,500
Scheduling VINES Macintosh
IPX Windows 95
NetBIOS OS/2, Unix
TCP/IP Power Macintosh
AppleTalk
Internet
Internet ON Guard TCP/IP, IPX DOS, Windows 5/96 10/96 $6,490
Firewall Macintosh
Windows 95
Metering SofTrack for NetWare DOS, Windows 11/93 11/96 $1,245
NetWare Macintosh, OS/2
Windows 95
SofTrack for Windows NT Windows, Windows 95 11/96 11/96 $1,245
Windows NT
E-mail Notework NetWare DOS, Windows 2/90 12/96 $5,500
Macintosh
Windows 95
DaVinci E-MAIL NetWare DOS, Windows 2/88 11/95 $5,900
VINES Macintosh
LANtastic Windows 95
Virus Macro NetWare, TCP/IP Windows 11/96 11/96 $3,995
Protection VirusTrack Windows NT, Windows 95
NetBIOS Windows NT
(1) Some products were first released prior to the Company's ownership.
(2) U.S. list prices at December 31, 1996.
This report includes trademarks of companies other than the Company. All other
company or product names are trademarks or registered trademarks of their
respective owners.
3
COMMUNICATIONS SOFTWARE
Notework is an entry-level, easy to use e-mail application for NetWare
LANs. While offering the basic features required by practically all e-mail
users, Notework is designed to be installed in five minutes, used by end-users
within five minutes, and administered with minimal effort. Notework maintains
its simplicity by eliminating complex and little used features while making it
less complicated to perform basic e-mail functions, such as creating, sending,
reading and filing mail. Support is provided for DOS, Windows, Windows NT, and
Windows under OS/2. Notework Mobile Office extends the simplicity theme over to
remote users by utilizing the same mail address for both LAN-based and remote
messages -- providing a convenience factor that even sophisticated e-mail
packages cannot offer. With a gateway in place, Notework can interoperate with
most private and commercial e-mail systems.
DaVinci eMAIL is a full-featured e-mail application for DOS, Windows, and
Macintosh client platforms. Although DaVinci can run on most types of LANs, the
majority of its installations are operating on NetWare networks. DaVinci's
administrative functions are designed to benefit from NetWare's underlying
binderies and user directories to eliminate the need for an administrator to
create each user twice, once for the network and once for e-mail. DaVinci
supports the new, robust MHS Services transport under NDS and NetWare 4.1, and
also supports NetWare 2.x and 3.x, Global MHS 2.0, Connect2 and MHS 1.5. Behind
its intuitive and easy-to-use interface is a powerful and customizable
application. A configurable toolbar, conversation threading, collapsible
folders, as well as add-on modules for Rules and Remote users, make DaVinci
eMAIL suitable for large organizations and medium-to-small businesses alike.
Meeting Maker is a client/server, cross-platform network scheduling
application that automates the process of proposing meetings, coordinating
agendas, and securing meeting locations with the necessary equipment. To
schedule a meeting using Meeting Maker, a user merely proposes a time for the
meeting and selects the guests. The Meeting Maker client checks with the
Meeting Maker server to determine whether all guests are available at the
appointed time. On approval from the meeting initiator, Meeting Maker will
issue an invitation to all guests. If they are not available, Meeting Maker can
automatically determine the first time when all guests are available to meet.
Meeting Maker then tracks the RSVPs from guests in order to keep the host
informed as to the people who will and will not attend the meeting. Through its
cross-platform architecture, Meeting Maker can be run on Windows (Windows
3.1/95/NT), Macintosh, PowerMac, Unix, and OS/2 workstations -- or seamlessly on
any combination of these platforms in an integrated environment. Meeting Maker
supports networks running either TCP/IP, IPX, AppleTalk, NetBIOS -- or any
combination of these protocols. Large enterprise installations can use the
Windows NT or Unix server options to support thousands of users; workgroups
typically use a Windows, Macintosh or NetWare server platform. Using IP,
organizations can easily connect Meeting Maker servers around the world via the
Internet. With support for SMTP and MAPI, Meeting Makers can easily send
meeting notices to colleagues, customers, business partners and vendors through
many e-mail packages. Mobile users can use Meeting Maker with their Newton,
Psion, Casio, Sharp, HP and Timex Data Watch portable devices.
NETWORK MANAGEMENT SOFTWARE
SofTrack for NetWare is a license metering tool for Novell NetWare LAN
servers that monitors the number of copies of a software application in use on
each file server and desktop across the network. SofTrack allows organizations
to buy software licenses based on actual usage instead of buying one copy for
every user. By monitoring usage, SofTrack users can comply with software
license agreements, reduce costs and avoid software piracy. SofTrack for
NetWare supports NetWare 4.x and NetWare 3.x servers as well as NetWare
Directory Services, providing network administrators with an efficient and time-
saving solution for administrating servers, users, group and other objects in a
global network environment.
SofTrack for Windows NT is a native NT Service that provides network
administrators with the ability to centrally manage software licenses, ensure
compliance with licensing terms, and save money when buying upgrades and new
applications. In combination with SofTrack for NetWare, SofTrack for Windows NT
automatically shares licenses among NetWare and Windows NT application servers,
providing the network administrator with the flexibility to automate load
balancing by instructing SofTrack to reallocate unused licenses between servers.
SofTrack for Windows NT is invisible to the local user and tamper-proof,
preventing clever users from attempting to bypass license metering.
NETWORK SECURITY
ON Guard Internet firewall product is designed to provide computer network
security for medium to large-size organizations with Internet or Intranet
exposure. The ON Guard firewall creates a barrier between an organization's
network
4
and the Internet through which only authorized traffic can pass. ON Guard is
optimized for Novell NetWare and Microsoft Windows NT networks. ON Guard
combines the proven firewall technique known as Stateful Multi-Layer Inspection,
the price and performance advantages of the Windows and Intel architectures, and
the comprehensive coverage provided by support for both IP-and IPX-based
networks. The ON Guard firewall is designed to accept or reject any type of
Internet or network-segment traffic. ON Guard's optional Address Translation
technology dynamically maps all internal IP addresses to one "safe" address on
the firewall. This added layer of protection prevents hackers from gaining
access to internal networks and servers by impersonating valid IP addresses. A
Windows-based configuration program prompts the network technician through a
series of screens to select the types of traffic and services to accept through
the firewall. A Rules Tester checks the configuration against a collection of
Computer Emergency Response Team (CERT) advisories for added assurance. ON Guard
is independently certified by the National Computer Security Association.
Macro VirusTrack for Microsoft Word detects and removes Word macro viruses
before the malicious programs corrupt a Microsoft Word document or spread to
other computer users. It is a sophisticated anti-virus program that provides
full background protection by scanning every Word document whenever the user
attempts to open one, or can be configured to scan and clean documents on
workstations and network drives without opening each one individually. Macro
VirusTrack for Microsoft Word provides transparent protection without
workstation or server performance degradation, and is compatible with other
anti-virus products.
Macro VirusTrack for Microsoft Excel detects and removes the current strain
of macro viruses before the malicious programs corrupt a Microsoft Excel
spreadsheet or spread to other computer users. It is a sophisticated anti-virus
program that provides full background protection by scanning every Excel
spreadsheet whenever the user attempts to open one, or can be configured to scan
and clean spreadsheets on workstations and network drives without opening each
one individually. Macro VirusTrack for Microsoft Excel provides transparent
protection without workstation or server performance degradation, and is
compatible with other anti-virus products.
VirusTrack is a comprehensive anti-virus protection solution for networks
that provides proactive background protection against all types of viruses,
including the classic DOS and executable viruses as well as the new macro
viruses. VirusTrack offers point-of-entry protection at the network level to
stop viruses before they have a chance to spread across the LAN, and
workstation-based protection to prevent loss of data and user productivity.
The Purview Internet Manager is a complete enterprise solution for the
management and monitoring of Internet usage in an organization. The Internet
Manager features advanced technology that captures all network traffic to World
Wide Web, FTP, Telnet and Gopher sites, and records it in a relational database
in real-time. This allows corporations to create detailed reports and graphs
showing where their employees are going on the Web, who's using it the most, and
what they're downloading to internal networks, for example. In addition to
monitoring usage, corporations can also choose to block specific sites in order
to enforce corporate usage guidelines. The Internet Manager installs on a
single, centralized Windows NT client or workstation, is transparent to
end-users, and does not add network overhead or require network reconfiguration.
It can be used to monitor any IP client in an Ethernet-based environment such as
DOS, Windows, Unix and Macintosh systems.
The ON Command Systems Management Environment (SME) solves the single
largest problem facing PC systems administrators: reducing the cost of PC
ownership. Industry analysts estimate that the combined costs of installation,
problem fixing, and training costs exceed $10,000/year for each PC. To slash
this burden, ON Command SME provides total system software installation and
configuration. Unlike all other management applications, SME can remotely format
disks, install Microsoft Windows, and all application software. And in contrast
to other similar management tools, SME can individually set per-system
configuration parameters (such as network addresses and interrupt vectors) as
well as application options (like default document directory settings). SME is
cross platform, with servers running on several Unix platforms as well as
NetWare, using either IP or IPX to communicate with desktops running any version
of Microsoft's desktop operating systems. SME is already in use at dozens of
very large enterprises, actively managing over 50,000 PCs in its largest
installation.
SALES AND MARKETING
The Company concentrates its sales and marketing efforts on an integrated
Free Trial Marketing strategy, complemented by public relations, trade shows,
trade advertising, direct mail and electronic distribution via the Internet.
Free Trial Marketing
One of the first questions that network administrators ask of software
vendors is: "Will this software work in my network environment?" ON resolves
this concern for potential customers by providing them with 30-day free trials
of all of the Company's principal products. The trials are full featured
versions of the product that are internally designed to cease operation in 30
days ("Free Trial Marketing"). The Company's Free Trial Marketing strategy
reaches and supports its prospects through a combination of direct mail, trade
shows, press relations, telemarketing and advertising. The Company's telephone
sales ("telesales") personnel actively market ON's products to prospective and
existing customers whose names and profiles are provided through ON's lead
generating programs. Another significant focus of the Company's telesales force
is to contact existing customers to cross-sell additional communications
software and network management software. The Company's periodic upgrade
programs are intended to enhance the functionality of ON's products, ensure the
compatibility of the product with new versions of operating systems and provide
an opportunity for the Company's telesales force to market new products and
increase the number of users licensed at each site.
The Company's house list records contain information such as contact name,
contact title, network size, number of servers and the type of client platforms
used at a site. The database also records ON's contacts with prospects and
customers by either sales or customer support personnel. The Company has found
that prospects who decide not to purchase the first product they trial are still
receptive to trying and buying subsequent products offered to them. In
addition, whenever the Company upgrades a product, it offers a retrial to
previous tried-but-did-not-buy prospects. The Company also maintains a private
use database at a bonded third party database contractor. This private use
database contains more than 100 key industry mailing lists. Using this
database, the Company can focus its mailings on particular target segments. For
example, Meeting Maker XP sells well to operators of LANs where a significant
minority of the users run Macintosh computers. A
5
search for all the people who both subscribe to a Macintosh publication and a
network publication yields a well focused mailing list for a Meeting Maker XP
offer. The private use database was constructed to ON's specifications and only
ON has access to it.
Adapting the Free Trial Marketing Strategy to the International Market
In 1996, approximately 18% of ON's revenues came from outside of the United
States. ON's international distributors and resellers adapt ON's marketing
techniques to local conditions but overall follow the same Free Trial Marketing
disciplines and focus on getting trials installed and evaluated. ON's
international team is concentrating on supporting current distributors and
resellers and finding compatible distributors and resellers for new markets.
Other Marketing Activities
ON promotes its products through advertising activities in trade
publications and direct mail campaigns, including its Editor's Choice catalog,
which also offers network products produced by other vendors. While revenue
from the Editor's Choice catalog is not expected to be significant to the
Company's total revenue, the catalog business is profitable and management
believes that the catalog provides valuable market intelligence and
relationships. By monitoring and measuring the sale of different products and
product categories through the catalog, the Company can guide the development of
its own product line. In addition, the Company is developing relationships with
some of the smaller firms that provide products in the catalog. Management
believes that these relationships will provide a number of opportunities for the
Company to license or acquire technology in the future.
The Company also distributes its software trials through electronic
distribution via the Internet. The Company operates a World Wide Web server on
the Internet and has its free trials available for download from that server.
In addition, the Company has its trials available for download from
Cybersource's Software.net server. The Company does not believe that Internet
prospects need any less sales support than do mailing response prospects.
Therefore, in order to download a trial of the Company's products from either
ON's server or Software.net, the prospect must fill out a questionnaire. That
prospect gets the same support calls as any mailed-in customer. The Company
maintains forums on CompuServe and America Online, which enable subscribers of
these services to discuss issues related to communications software and network
management software and make inquiries regarding ON's products.
ON has a limited number of original equipment manufacturer arrangements.
Total revenue derived through these arrangements, however, is not significant.
The Company also attends trade shows and publishes quarterly newsletters which
are mailed to existing and prospective customers.
Beginning late in 1996, ON began to complement direct sales with its new
Enterprise Sales program. This effort focuses on key accounts with larger
companies where the opportunity exists for volume sales and long-term, repeat
business. Through the Enterprise program, ON is building relationships in which
its knowledge of the customer's needs translates into purchasing advantages and
maximized support. Regular visits to the customer's site provide our sales
representatives with valuable feedback for technology development, future
upgrades, and service enhancements.
PRODUCT DELIVERY
The Company has a variety of means to fulfill the product demand created by
its marketing program.
Direct Fulfillment
Most of the Company's orders are delivered through direct fulfillment
contractors that manufacture and assemble components, store inventory, and
process customer orders received from ON for either same or next day shipment.
Orders are recorded by the ON sales department and transferred electronically to
the fulfillment contractor for processing. ON owns all of its inventory and has
an in-house production staff to purchase inventory and help ensure availability
for shipments. Once orders are shipped by the fulfillment contractor, shipping
confirmation is returned to ON electronically.
Independent Distributors
ON utilizes independent distributors to market its products internationally
and, to a substantially lesser extent, in North America. ON's international
distributors are responsible for marketing the Company's software and for
providing technical and customer support to their customers. While these
distributors include some large systems integrators, most are small companies
that market ON's software along with products of other companies that they
represent. The agreements between the Company and its international
distributors typically obligate the distributor to provide technical support and
the most current versions of the Company's products to the distributor's
customers and to provide the Company with information about its licensees.
International distribution agreements generally are terminable by the Company
under certain circumstances, including failure of the distributor to meet
specified sales targets.
6
Resellers
ON also markets its products through resellers, including Egghead Software,
Corporate Software, Software Spectrum and 800 Software. These resellers focus
primarily on licensing the Company's software to corporate and government
customers.
CUSTOMERS
The Company markets its products primarily to large and medium size
corporate, government and institutional customers. None of the Company's
customers accounted for more than 10% of the Company's total revenue in 1994,
1995 and 1996.
CUSTOMER SUPPORT
Approximately one-half of the Company's customer support calls occur during
the 30-day Free Trial period. The Company believes that quality technical
support is critical to the success of any software business, but is especially
critical if the support must be given in advance of the purchase decision.
Accordingly, the Company has invested heavily both in the support personnel and
in software and hardware tools to improve the quality of support. In
particular, the Company utilizes a sophisticated shared database to provide
problem-solution combinations to its representatives. The Company employs a
full time knowledge engineer to design better solution delivery tools for its
support representatives.
RESEARCH AND DEVELOPMENT
The Company's product development organization, currently consisting of 46
employees and additional full-time and part-time contract programmers, is
responsible for developing new products, adapting acquired products to fit the
ON product strategy and enhancing existing products. Generally, the Company's
contract programmers do not work exclusively for the Company. In addition, the
development organization provides free trial expiration technology, registration
technology and installation technology to third party developers who are
building products for license to ON. For example, SofTrack which is licensed by
the Company from a third party on an exclusive worldwide basis, was modified by
its developers as a condition of the license to incorporate ON's Free Trial
Marketing and installation technology.
A key development consideration for ON is that its products must serve and
win over the user during the 30-day trial. For this reason, products are
designed to prove themselves useful without imposing a substantial burden on the
user's time. ON's design objectives require that sophisticated technical
functions be expressed in highly usable and simple to operate features. The
Company's marketing, technical support and sales departments are involved in all
phases of the development process. The technical support department provides
input on potential enhancements to existing products and participates in the
design of new products.
A key element of the Company's research and development strategy is to make
its products available on platforms that are important to its customers. The
Company is currently extending some of its products to support OS/2, Windows 95,
Windows NT and two dialects of UNIX.
The Company runs a large heterogeneous network and is therefore able to
serve as the first site (the alpha site) where its new communications and
network management software is operated and tested in an actual production
environment. The Company solicits feedback from its internal users to improve
product usability and to identify and correct software errors. Thereafter, beta
test sites are selected from the prospect database to provide experience in a
variety of network environments. During beta tests, ON dedicates staff from the
support and sales department to follow up beta sites and solicit detailed beta
reports on usability and errors occurring in customer environments. Many
quality assurance personnel have been recruited from the technical support
department because they are able to test products with greater awareness of the
issues which might confuse customers.
The Company intends to continue to evaluate strategic acquisitions of
complementary products that will enable ON to offer expanded communications and
network management software. The Company also has full-time staff evaluating
products developed by third parties for possible product or technology licensing
or acquisition, potential joint ventures or strategic alliances.
7
The Company expended approximately $5,277,000, $7,015,000 and $8,456,000 in
1994, 1995, and 1996, respectively, on research and development, excluding
charges for purchased incomplete research and development projects. The
Company's practice to date has been to expense all software development costs as
incurred.
COMPETITION
The market for the Company's products is highly competitive, and the
Company expects competition to increase in the future. The Company believes
that the principal competitive factors affecting the market for its products
include performance, functionality, ease of use, ease of installation, quality,
customer support, breadth of product line, speed of product delivery, frequency
of upgrades and updates, brand name recognition, company reputation and price.
Certain of the criteria upon which the performance and quality of the Company's
communications and network management software compete include speed of
response, ease of use, interoperability with other messaging systems and
simplicity of administration. Although the Company has only recently entered
the network management software market, which itself continues to be an emerging
market, the Company believes that it generally competes favorably with respect
to each of these factors. However, certain of the Company's competitors, such
as Blue Lance, and Funk Software, have been in the market longer than the
Company, and other competitors, such as Intel, McAfee, Seagate and Symantec, are
larger and may have greater name recognition than the Company. As is the case
in many segments of the software industry, the Company may encounter increasing
price competition in the future. This could reduce average selling prices and,
therefore, profit margins. Competitive pressures could result not only in
sustained price reductions but also in a decline in sales volume, which could
adversely affect the Company's business, financial condition or results of
operations. There can be no assurance that the Company will continue to compete
effectively against existing and potential competitors in the communications and
network management software market, many of whom have substantially greater
financial, technical, marketing and support resources and name recognition than
the Company. In addition, there can be no assurance that software vendors who
currently use traditional distribution methods will not in the future decide to
compete more directly with the Company by utilizing free trial marketing.
Both the communications software market and the network management software
market are highly fragmented, with products offered by many vendors. In the e-
mail market, the Company competes with offerings from CE Software, Infinite
Technologies, Lotus, Microsoft, Novell, Netscape, and numerous shareware and
freeware developers. In the group scheduling market, the Company competes with
Campbell Services, CE Software, Lotus, Microsoft, Microsystems Software, Novell,
Now Software, and with personal information managers products ("PIMs") that have
been enhanced to include some group scheduling features. Lotus, Microsoft and
Novell have in the past bundled communications software with their operating
system products or software application suite offerings and have publicly
announced, or the Company believes are likely to provide, such bundles with
future offerings. There can be no assurance that the Company can continue to
compete effectively against communications software which is included free with
the operating system, as these bundled products are improved in the future. In
addition, the trend toward enterprise-wide communications software solutions may
result in a consolidation of the communications software market around a smaller
number of vendors who are able to provide all of the necessary software and
support capabilities.
In the network management software market, the Company's principal
competitors include Intel, McAfee, Symantec, Seagate, Check Point, Software
Technologies Ltd., Raptor Systems, numerous shareware authors who distribute
products through electronic software distribution, and numerous smaller
companies that may in the future develop into stronger competitors or be
consolidated into larger competitors. Shareware is software that is made
available electronically on bulletin boards. Shareware users are encouraged to
evaluate the software for a short period of time and then either cease using it
or pay a license fee. The Company also faces competition from large and
established software companies such as Lotus, Microsoft and Novell, which offer
communications and network management software as enhancements to their network
operating systems or as part of their software application suites. The Company
believes that as these markets develop, it may face increased competition from
these large companies, as well as other companies seeking to enter the market.
Historically, the Company's international revenue has been generated
primarily through independent distributors in Europe, Australia, Israel, South
Africa and South America, certain of which are bound by contracts with the
Company but which generally do not represent the Company exclusively. During
1996, the Company established sales and support offices in Australia, France and
Sweden. It also established its international headquarters in the UK to sale,
support and market its products within the UK and support its other
international offices. The competitive environment for communications software
tools internationally is similar to that in North America. The Company has only
recently begun to compete in Asian markets, which have significantly lagged
behind North America and Europe in their adoption of LAN technology. There can
be no assurance that the Company will be able to continue to compete
successfully in international markets.
8
The widespread inclusion of the functionality of the Company's products as
standard features of operating systems software could render the Company's
products obsolete and unmarketable, particularly if the quality of such
functionality were comparable to that of the Company's products. If the Company
were unable to develop new communications and network management software to
further enhance operating systems and to replace successfully any obsolete
products, the Company's business, financial condition and results of operations
would be materially and adversely affected.
PROPRIETARY TECHNOLOGY
The Company's success is heavily dependent upon its proprietary software
technology. The Company relies on a combination of contractual rights,
trademarks, trade secrets and copyrights to establish and protect its
proprietary rights in its software. The Company has not to date registered any
of its copyrights. The Company has obtained registrations in the United States
for the following trademarks: ON Technology, Notework, Meeting Maker, ON
Technology & Design, ON Location, Instant Update and DaVinci Systems. The
Company uses a printed "shrink-wrap" license for users of its products
distributed through traditional distribution channels in order to protect its
copyrights and trade secrets in those products. Since these licenses are not
signed by the licensee, many authorities believe that they may not be
enforceable under many state laws and the laws of many state and foreign
jurisdictions.
In addition, the laws of some foreign countries either do not protect the
Company's proprietary rights or offer only limited protection for those rights.
Furthermore, the Company has obtained only four foreign registrations of its
Notework mark and two foreign registrations of its Meeting Maker mark due to the
significant costs involved. As a result, the Company may not be able to prevent
a third party from using its trademarks in many foreign jurisdictions. If such
licenses are not enforceable, the user would not be bound by the terms thereof,
including the terms which seek to protect the Company's proprietary technology.
There can be no assurance that the steps taken by the Company to protect
its proprietary software technology will be adequate to deter misappropriation
of this technology. In addition, the Company provides customer support to
unlicensed users during the Free Trial period. Lesser sensitivity by corporate,
government or institutional users to avoiding copyright infringement could have
a material adverse effect on the Company's business, financial conditions and
results of operation. While the Company to date has not taken any legal action
to enforce its intellectual property rights against infringing users, it
believes, based upon current interpretations of law, that its use of Free Trial
Marketing and the widespread availability of its trials do not significantly
impact its ability to enforce its intellectual property rights against
infringing users, including corporate, institutional and government entities.
However, there can be no assurance that a court or other authority may not rule
otherwise in the future. Such a ruling would have a material adverse effect on
the Company's business, financial condition and results of operations.
There has also been substantial litigation in the software industry
involving intellectual property rights, although, to date, the Company has not
been subject to any such litigation. Although the Company does not believe that
it is infringing the intellectual property rights of others, there can be no
assurance that such claims, if asserted, would not have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, as the Company may acquire or license a portion of the software
included in its future products from third parties, its exposure to infringement
actions may increase because the Company must rely upon such third parties for
information as to the origin and ownership of any software being acquired. The
Company generally obtains representations as to the origin and ownership of such
acquired or licensed software and generally obtains indemnification to cover any
breach of such representations. However, there can be no assurance that such
representations are accurate or that such indemnification will provide adequate
compensation for a breach of such representations. In the future, litigation
may be necessary to enforce and protect trade secrets and other intellectual
property rights owned by the Company. The Company may also be subject to
litigation to defend against claimed infringement of the rights of others or to
determine the scope and validity of the proprietary rights of others. Any such
litigation could be costly and cause diversion of management's attention, either
of which could have a material adverse effect on the Company's business,
financial condition or results of operations. Adverse determinations in such
litigation could result in the loss of the Company's proprietary rights, subject
the Company to significant liabilities, require the Company to seek licenses
from third parties or prevent the Company from manufacturing or selling its
products, any one of which could have a material adverse effect on the Company's
business, financial condition or results of operations. Furthermore, there can
be no assurance that any necessary licenses will be available on reasonable
terms, or at all.
OPERATIONS
9
The Company designs most of its product, marketing and sales materials in-
house. Product and trial orders are fulfilled under contract with outside
fulfillment agencies. First calls for catalog orders are handled by an outside
agency, with difficult calls forwarded to the Company. The balance of other
sales and support calls are handled directly by the Company.
EMPLOYEES
From December 31, 1995 to December 31, 1996, the number of Company
employees decreased from 346 to 288, primarily due to the restructuring
implemented by the Company in the third quarter of 1996. Competition for
qualified management and technical personnel is intense in the software
industry. The Company's continued success will depend in part on its ability to
attract and retain qualified personnel. None of the Company's employees is
represented by a labor union and the Company believes that its employee
relations are good.
MANAGING BUSINESS GROWTH WITH ACQUISITIONS
The Company may in the future undertake acquisitions that could present
challenges to the Company's management, such as integrating and incorporating
new operations, product lines, technologies and personnel. If the Company's
management is unable to manage these challenges, the Company's business,
financial condition or results of operations could be materially adversely
affected. Any acquisition, depending on its size, could result in the use of a
significant portion of the Company's available cash, or if such acquisition is
made utilizing the Company's securities, could result in significant dilution to
the Company's stockholders. Furthermore, there can be no assurance that any
acquired products will gain acceptance in the Company's markets.
ITEM 2. PROPERTIES
The Company's headquarters, located in Cambridge, Massachusetts, currently
occupies approximately 41,200 square feet under a lease expiring September 30,
1999 and approximately 7,500 square feet under a sublease expiring January 31,
1998. The Company's Morrisville, North Carolina offices occupy approximately
6,900 square feet under a lease expiring November 30, 2001. The Company's San
Jose, California offices occupy approximately 4,200 square feet under a lease
expiring May 15, 1999. The Company's Marietta, Georgia offices occupy
approximately 3,500 square feet under a lease expiring June 15, 1999. The
Company's international offices are located in the UK, France and Australia of
which each of the offices occupy approximately 14,000 square feet, 156 square
feet, and 516 square feet, respectively. The lease for the occupancy in the
United Kingdom expires March 31, 2005 whereas the leases in France and Australia
expire in April and May 1997, respectively. The Company believes that its
existing facilities are adequate for the present and that additional space will
be available as needed.
ITEM 3 LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1996.
10
PART II
-------
ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
The Company effected its initial public offering on August 1, 1995 at a
price of $15.00 per share. Since that date, the Company's Common Stock has
traded on the Nasdaq National Market under the symbol ONTC. The following table
sets forth, for the period indicated, the high and low closing sales prices for
the Common Stock, all as reported by Nasdaq.
HIGH LOW
------ ------
YEAR ENDED DECEMBER 31, 1996
First Quarter $19.13 $11.00
Second Quarter 14.75 10.25
Third Quarter 10.63 4.63
Fourth Quarter 7.88 5.00
YEAR ENDED DECEMBER 31, 1995
Third Quarter (from August 1, 1995) 19.50 14.75
Fourth Quarter 17.00 12.00
As of March 7, 1996, there were approximately 1,918 stockholders of record of
the Company's Common Stock.
DIVIDEND POLICY
The Company has not declared or paid cash dividends on its Common Stock
since 1992 when it converted from an S Corporation to a C Corporation. The
Company currently intends to retain any earnings for use in developing and
growing its business, and does not anticipate paying any cash dividends on its
Common Stock in the foreseeable future. The Company's bank line of credit does
not contain any restrictions on the payment of dividends, unless the payment of
such dividends would result in a default thereunder.
RECENT SALES OF UNREGISTERED SECURITIES
During 1996 and the first quarter of 1997, the Company issued 2,042,561
shares of its common stock with an aggregate fair value of $17,751,143 as part
of the consideration for the acquisitions of neTrend Corporation, Leprechaun
Software International, Ltd. and csd Software GmbH, respectively. Each such
sale was a private offering. The Company relied on Section 4(2) of the
Securities Act of 1993 (the "Securities Act") for the exemption of such sales
from registration under the Securities Act. See "Notes to Consolidated
Financial Statements".
11
ITEM 6 SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected financial data derived from the
Consolidated Financial Statements of the Company. The Consolidated Financial
Statements have been audited by Arthur Andersen LLP, independent public
accountants. The data should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto and with Management's Discussion and
Analysis of Financial Condition and Results of Operations.
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1992 1993 1994 1995 1996
--------------------------------------------------
(In thousands, except per share data)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenue:
Net product revenue $3,306 $ 7,728 $25,240 $43,381 $ 50,165
Other revenue 138 177 588 740 1,627
--------------------------------------------------
Total revenue 3,444 7,905 25,828 44,121 51,792
--------------------------------------------------
Operating expenses:
Cost of product revenue 143 763 6,716 8,199 11,951
Sales and marketing 2,121 5,009 10,824 20,984 24,176
Research and development 744 2,364 5,277 7,014 9,456
General and administrative 429 1,183 2,319 3,184 4,407
Charge for purchased research
and development -- 1,537 4,700 -- 13,285
Charge for restructuring -- -- -- -- 5,415
--------------------------------------------------
Income (loss) from operations 7 (2,951) (4,008) 4,740 (16,898)
Interest income (expense), net -- (13) (80) 554 1,134
--------------------------------------------------
Income (loss) before provision
for taxes 7 (2,964) (4,088) 5,294 (15,764)
Provision for income taxes (5) -- (11) (1,622) (97)
--------------------------------------------------
Net income (loss) $ 2 $(2,964) $(4,099) $ 3,672 $ (15,861)
==================================================
Cash dividend per common share $0.13 -- -- -- --
Pro forma net income (loss) per
share(1) $(0.59) $0.40 $(1.46)
================================
Pro forma weighted average common
and common equivalent shares
outstanding(2) 6,952 9,087 10,854
================================
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1992 1993 1994 1995 1996
--------------------------------------------------
(In thousands)
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 509 $ 101 $ 2,798 $33,338 $ 20,774
Working capital (deficit) 578 (1,182) 1,299 35,562 25,347
Total assets 1,250 3,929 13,168 50,173 44,142
Long-term obligations, less current
portion -- 280 878 1,506 510
Redeemable convertible preferred stock 1,189 3,205 12,188 -- --
Total stockholders' equity (deficit) (414) (3,235) (7,840) 40,306 33,493
(1) Reflects the conversion of all outstanding shares of the Company's
Convertible Preferred Stock into 3,841,632 shares of
Common Stock at the closing of the Company's initial public offering on August
1, 1995.
(2) Computed on the basis described in Note 1 of Notes to Consolidated Financial
Statements.
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
ON Technology Corporation is a leading providing of network security, network
management and network scheduling software and services that help people work
together on networks and across the Internet. ON product brand names include ON
Guard, an award winning Internet firewall; VirusTrack, innovative technology for
preventing the spread of macro viruses; SofTrack, a market-leading software
metering solution for both NetWare and Windows NT networks; Meeting Maker, a
leading calendaring and scheduling solution; and DaVinci and Notework, two best-
selling e-mail packages specifically for NetWare LANs. ON products operate on
NetWare, Windows NT, LAN Manager and Internet networks that include combinations
of Windows, Windows 95, Windows NT, Macintosh, PowerMac, OS/2, Unix and
DOS/Windows workstations using IP, IPX, NetBIOS and AppleTalk protocols.
RESULTS OF OPERATIONS
The following table sets forth, for the years indicated, certain financial data
as percentages of the Company's total revenue:
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
-------------------------------
Revenue:
Net product revenue 97.7% 98.3% 96.9%
Other revenue 2.3 1.7 3.1
-------------------------------
Total revenue 100.0 100.0 100.0
-------------------------------
Operating expenses:
Cost of product revenue 26.0 18.6 23.1
Sales and marketing 41.9 47.6 46.6
Research and development 20.4 15.9 18.3
General and administrative 9.0 7.2 8.5
Charge for purchased R&D 18.2 -- 25.6
Charge for restructuring -- -- 10.5
-------------------------------
(Loss) income from operations (15.5) 10.7 (32.6)
-------------------------------
Interest (expense) income, net (0.3) 1.3 2.2
-------------------------------
Net (loss) income before provision for
income taxes (15.8) 12.0 (30.4)
-------------------------------
Provision for income taxes -- (3.7) (.2)
-------------------------------
Net (loss) income (15.8)% 8.3% (30.6)%
===============================
NET PRODUCT REVENUE. The Company's net product revenue is derived primarily
from the licensing of software products. Net product revenue also includes
revenue from catalog sales of third party products and catalog advertising
space. The Company sells advertising space in its catalog for cash or receives
third party advertised product. Revenue for catalog advertising space for cash
sales is recognized the day the catalog is mailed to customers. Revenue for
third party advertised product received is recognized as each item is sold. Net
product revenue increased 72.0% from 1994 to 1995, and 15.6% from 1995 to 1996,
due primarily to the increase in volume of sales of communications and new
network management software to new customers and to customers upgrading existing
licenses. In addition, net product revenue for the first six months of 1994
includes the recognition of approximately $1.5 million of product revenue
relating to products shipped in 1993 for which the Company had significant
customer obligations which were satisfied by the shipment of a final product
version in the first quarter of 1994.
OTHER REVENUE. The Company's other revenue consists of rentals of portions of
the Company's customer lists, royalties received in connection with licensing
ON's software to third parties and maintenance revenue. Other revenue increased
by 25.9% from 1994 to 1995, and 119.9% from 1995 to 1996. These increases were
primarily due to an increase in revenue generated from maintenance agreements.
COST OF PRODUCT REVENUE. Cost of product revenue consists primarily of expenses
associated with product documentation, production and fulfillment costs, and
royalty fees associated with products that are licensed from third party
developers. In addition, cost of product revenue includes the cost of third
party products resold through the Company's catalog, the cost of
13
producing the catalog and amortization of purchased intangibles. Cost of product
revenue decreased as a percentage of total revenue from 26.0% in 1994 to 18.6%
in 1995 as catalog revenue decreased as a percentage of total revenue in both
1994 and 1995. The four editions of the Editors' Choice catalog published in
1995 were similar in breadth of product offering to the four editions published
in 1994. The revenue growth of the other product offerings of the Company
significantly outpaced the growth of catalog revenue, as the catalog had
substantially reached its mature revenue level per edition. Cost of product
revenue increased as a percentage of total revenue from 18.6% in 1995 to 23.1%
in 1996. This increase was primarily due to a $571,000 elimination of profit for
inventory previously sold to Technocom, plc, prior to the Company's acquisition
of their LAN software business, a $2.0 million inventory write down related to
the restructuring in the third quarter of 1996, and an increase in product sales
from 1995 to 1996. As part of the Company's restructuring plan and
reorganization of its operations, the Company has decreased its emphasis on the
e-mail business and certain catalog products and has ceased to market, sell,
develop, and support other product lines. As a result, the product inventory
relating to the de-emphasized products, and discontinued product lines were
subsequently identified and written off, all of which is included in cost of
product revenue in the amount of $2.0 million. The product sales related
increase was consistent as a percentage of total revenue from 1995 to 1996.
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 administering
the catalog operation, the costs of public relations, trade shows and
conferences, and the telephone and information technology costs associated with
sales activities. Sales and marketing expense increased as a percentage of total
revenue from 41.9% in 1994 (46.1% excluding the impact of the 1993 deferred
revenue) to 47.6% in 1995 due principally to the Company's investment in its
telemarketing organization in North Carolina. Sales and marketing expense
decreased slightly as a percentage of total revenue from 47.6% in 1995 to 46.7%
in 1996. This slight decrease is a result of the restructuring of the Company,
offset by the additional sales personnel required to support the growth in the
customer base, the costs associated with the Company's marketing efforts of
existing products, the beginning of ON Technology UK Ltd.'s marketing programs
in Europe, and the launch of the Company's new firewall product, ON Guard. The
Company anticipates that sales and marketing expense will continue to increase
in absolute dollars as the Company continues to expand direct marketing efforts,
but that sales and marketing expense will remain consistent or decrease as a
percentage of total revenue.
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 technical support.
Research and development expense decreased as a percentage of total revenue from
20.4% in 1994 to 15.9% in 1995 primarily as a result of increased licensing of
third party network management software products which more than offset the cost
of continued development of incomplete products acquired from DaVinci in 1994.
Research and development expense increased as a percentage of total revenue from
15.9% in 1995 to 18.3% in 1996. This increase in absolute dollars was primarily
related to the increase in the size of the product portfolio, the associated
costs of product development, enhancements and maintenance, and the additional
costs associated with the Company's acquisitions of neTrend Corporation and
Leprechaun Software International, Ltd. in the first quarter of 1996. The
Company plans to continue to make significant investments in research and
development.
GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense includes
executive compensation, executive support costs, accounting operations,
planning, and business development operations. General and administrative
expense increased in absolute dollars from $5.3 million in 1994 to $7.0 million
in 1995 due to personnel growth and associated costs, and decreased as a
percentage of total revenue from 9.0% in 1994 to 7.2% in 1995. General and
administrative expense increased in absolute dollars from $7.0 million in 1995
to $9.5 million in 1996 and as a percentage of sales from 7.2% in 1995 to 8.5%
in 1996. The increase reflects personnel growth and associated costs in general
support areas including costs associated with the Company's acquisition of the
LAN software business from Technocom plc in the first quarter of 1996, resulting
in the newly formed ON Technology UK Ltd., and the related expenses of
administering that office.
CHARGE FOR PURCHASED RESEARCH AND DEVELOPMENT. In connection with the
acquisition of DaVinci in 1994, the Company allocated $4.7 million of the
purchase price to incomplete research and development projects. In connection
with the acquisitions of neTrend Corporation, Leprechaun Software International,
Ltd. and the LAN Software business from Technocom plc in 1996, the Company
allocated an aggregate of $13.3 million of the respective purchase prices to
incomplete
14
research and development projects. These costs were expensed as of the
acquisition dates and the allocations represent the estimated fair values
related to the incomplete projects determined by independent appraisals using
appropriate assumptions and valuation techniques. The development of these
projects had not yet reached technological feasibility and the technology had no
alternative future use. The technology acquired in these acquisitions have
required substantial additional development by the Company.
CHARGE FOR RESTRUCTURING. On August 6, 1996, the Company announced that it had
implemented a reorganization of its operations and a restructuring plan (the
"Plan"). The Plan included write-offs and writedowns of certain assets,
including accruing the costs related to a significant reduction in the Company's
work force, primarily in the technical support and sales and marketing
departments, and the de-emphasis of certain product lines, resulting in a non-
recurring charge of $5.4 million. Included in the Plan was an inventory
writedown of $2.0 million which is included in cost of product revenue in
accordance with Emerging Issues Task Force (EITF) 96-9, Classification of
Inventory Markdowns and Other Costs Associated with a Restructuring.
The following are the significant components of the $5.4 million charge for
restructuring:
Employee severance, benefits and related costs $1.5
Write-off and writedown of assets to net realizable value excluding inventory 3.5
Provision for lease loss and related costs in closing facility .4
----
$5.4
====
The employee severance, benefits and related costs includes the costs associated
with the involuntary termination of approximately 100 employees which was
approved as part of the Plan, and communicated to the affected employees on the
day the restructuring was announced, August 6, 1996. All employee service
required to earn or qualify for the benefits accrued for had been rendered at
August 6, 1996.
The writedown of assets to net realizable value includes the write-off of
certain assets for which there is no future economic benefit to the Company.
These costs include approximately $280,000 of equipment at the facility being
closed, $1,558,000 million to write-off capitalized direct marketing costs,
$764,000 of prepaid expenses consisting of prepaid license fees, royalties and
trade show costs, $589,000 of customer deductions and concessions and $397,000
in the write-off of purchased intangibles related to product lines for which the
Company announced its plan to cease active pursuit of new customers and to no
longer provide technical support to existing customers.
The facility and lease loss accrual of $360,000 consists of costs related to the
planned shutdown of the Company's current facility in Morrisville, NC,
including the net book value of remaining leasehold improvements of $115,000.
INCOME TAXES. The provision for income taxes during 1994 consisted of federal
alternative minimum and minimum state taxes. The tax provision for 1995 was
calculated based upon the Company's effective tax rate, giving benefit to
available net operating loss and credit carryforwards. In the year ended
December 31, 1996, the Company incurred a significant operating loss. However,
included in the book charges were amounts not currently deductible for income
taxes. The 1996 tax provision includes the amount currently payable with an
offsetting deferred tax benefit to record a portion of the Company's deferred
tax asset.
15
SELECTED QUARTERLY OPERATING RESULTS
The following tables set forth certain unaudited quarterly results of
operations for each of the eight quarters in the period ended December 31, 1996.
In the opinion of management, this information has been prepared on the same
basis as the audited Consolidated Financial Statements and includes all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of this information in accordance with generally accepted
accounting principles. Such quarterly results are not necessarily indicative of
future results of operations and should be read in conjunction with the audited
Consolidated Financial Statements and the Notes thereto.
THREE MONTHS ENDED
----------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT 30, DEC. 31, MAR. 31, JUNE 30, SEPT 30, DEC. 31,
1995 1995 1995 1995 1996 1996 1996 1996
----------------------------------------------------------------------------------------
Revenue:
Net product revenue $8,637 $10,359 $11,331 $13,054 $ 10,967 $13,405 $12,248 $13,546
Other revenue 174 166 168 232 342 421 389 474
----------------------------------------------------------------------------------------
Total revenue 8,811 10,525 11,499 13,286 11,309 13,826 12,637 14,020
----------------------------------------------------------------------------------------
Operating expenses:
Cost of product revenue 1,719 1,975 2,093 2,412 2,770 2,520 4,423 2,238
Sales and marketing 4,265 5,044 5,440 6,235 5,471 6,577 6,172 5,953
Research and development 1,600 1,706 1,774 1,934 1,965 2,317 2,493 2,681
General and administrative 744 731 798 911 947 1,142 1,102 1,217
Charge for purchased R&D -- -- -- -- 13,285 -- -- --
Charge for restructuring -- -- -- -- -- -- 5,415 --
----------------------------------------------------------------------------------------
Income (loss ) from operations 483 1,069 1,394 1,794 (13,129) 1,270 (6,968) 1,931
----------------------------------------------------------------------------------------
Interest (expense) income, net (26) (26) 214 392 342 282 259 250
----------------------------------------------------------------------------------------
Net income (loss) before provision for
income taxes 457 1,043 1,608 2,186 (12,787) 1,552 (6,709) 2,181
----------------------------------------------------------------------------------------
(Provision) benefit for income taxes (140) (320) (492) (670) (327) (112) 483 (141)
----------------------------------------------------------------------------------------
Net income (loss) $ 317 $ 723 $ 1,116 $ 1,516 $(13,114 ) $ 1,440 $(6,226) $ 2,040
========================================================================================
The following table sets forth certain unaudited quarterly results of operations
expressed as a percentage of total revenue for each of the eight quarters in the
period ended December 31, 1996:
THREE MONTHS ENDED
---------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT 30, DEC. 31, MAR. 31, JUNE 30, SEPT 30, DEC. 31,
1995 1995 1995 1995 1996 1996 1996 1996
---------------------------------------------------------------------------------------
Revenue:
Net product revenue 98.0% 98.4% 98.5% 98.3% 97.0% 97.0% 96.9% 96.6%
Other revenue 2.0 1.6 1.5 1.7 3.0 3.0 3.1 3.4
----------------------------------------------------------------------------------------
Total revenue 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
---------------------------------------------------------------------------------------
Operating expenses:
Cost of product revenue 19.5 18.8 18.2 18.2 24.5 18.2 35.0 16.0
Sales and marketing 48.4 47.9 47.3 46.9 48.4 47.6 48.8 42.5
Research and development 18.2 16.2 15.5 14.6 17.4 16.8 19.7 19.1
General and administrative 8.4 6.9 6.9 6.9 8.3 8.3 8.7 8.7
Charge for purchased R&D -- -- -- -- 117.5 -- -- --
Charge for restructuring -- -- -- -- -- -- 42.9 --
----------------------------------------------------------------------------------------
Income (loss ) from operations 5.5 10.2 12.1 13.4 (116.1) 9.1 (55.1) 13.8
----------------------------------------------------------------------------------------
Interest (expense) income, net (0.3) (0.3) 1.9 3.0 3.0 2.1 2.0 1.8
----------------------------------------------------------------------------------------
Net income (loss) before provision for
income taxes 5.2 9.9 14.0 16.4 (113.1) 11.2 (53.1) 15.6
----------------------------------------------------------------------------------------
(Provision) benefit for income taxes (1.6) (3.0) (4.3) (5.0) (2.9) (.8) 3.8 (1.0)
----------------------------------------------------------------------------------------
Net income (loss) 3.6% 6.9% 9.7% 11.4% (116.0)% 10.4% (49.3)% 14.6%
=======================================================================================
Historically, revenues in the first quarter have been lower than in the
preceding fourth quarter due to customer budgeting and purchasing patterns. The
Company's results of operations have been and may in the future be subject to
16
significant quarterly fluctuations. These fluctuations may be due to a variety
of factors, including the timing of significant orders, the timing of the
introduction or announcement of new or enhanced products by the Company or its
competitors, variations in net revenue by product and distribution channel,
increased price and other competition, capital spending patterns of end-users,
delays in shipping new or existing products, conditions within the software and
networking industries, and economic conditions generally.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash flow
from operations and private and public placements of capital stock. At December
31, 1994, 1995, and 1996 the Company had available cash and cash equivalents of
$2.8 million, $33.3 million and $20.8 million, respectively, and working capital
of $1.3 million, $35.6 million and $25.3 million, respectively. On April 1,
1996, the Company acquired a new line of credit with a commercial bank for $10.0
million that allows the Company to borrow up to the lesser of $10.0 million or
the sum of 80% of qualified domestic accounts receivable and 40% of qualified
foreign accounts receivable. Borrowings bear interest at the bank's prime rate.
The line expires April 1, 1998. Advances pursuant to the line of credit are
secured by liens granted on the Company's accounts receivables. At December 31,
1994, 1995 and 1996, the Company did not have an outstanding balance under the
line of credit agreement.
Net cash provided by (used in) operating activities for the years ended
December 31, 1994, 1995 and 1996 was $1.2 million, $(265,000) and $(656,000),
respectively. In 1994, net cash provided by operating activities consisted of a
$4.1 million net loss which was the result of a $4.7 million charge for
incomplete research and development relating to the acquisition of DaVinci, a
$2.4 million increase in accounts receivable, a $712,000 increase in direct
marketing costs and a $1.4 million decrease in deferred revenue offset by an
increase of $1.9 million in accounts payable, $1.4 million in accrued expenses
and $1.2 million in the reserve for distributor inventory. The increase in the
reserve for distributor inventory represents the Company's estimate of product
paid for by distributors that will be returned. In 1995, net cash used in
operating activities consisted of approximately $3.7 million of net income from
operations, a $311,000 decrease in accrued expenses, a $91,000 decrease in
accounts payable, a $2.0 million increase in accounts receivable, a $279 ,000
decrease in reserve for distributor inventory, and a $2.0 million increase in
inventories. The increase in inventories was due primarily to new product
introductions, increased stocking levels as a result of increased revenue and
related unit shipments, and procedures put in place by the Company during 1995
to help ensure more complete availability of product in stock. In 1996, net cash
used in operating activities consisted of approximately $15.9 million net loss
from operations which was the result of a $13.3 million charge for incomplete
research and development relating to the acquisitions of Leprechaun Software
International, Ltd., neTrend Corporation and the LAN software business from
Technocom, plc, a $3.0 million charge for restructuring, depreciation and
amortization of $3.2 million, offset by an increase in accounts receivable of
$3.2 million and increase in prepaid assets of $1.4 million.
Net cash used in investing activities for the years ended December 31,
1994, 1995 and 1996 was $6.1 million, $611,000 and $9.5 million,
respectively. This primarily reflects purchases of property and equipment of
$374,000, $1.2 million, and $4.5 million, respectively, and direct costs of
the acquisition of DaVinci of $5.0 million in 1994 and of Leprechaun Software
International, Ltd., neTrend Corporation, and the LAN software business from
Technocom plc of $628,000, $2.2 million, and $2.0 million, respectively.
While the Company expects capital expenditures to increase as revenue and the
number of employees increases, there are currently no plans to change the
Company's current pattern of investment in property and development on either a
long or short term basis.
Net cash (used in) provided by financing activities for the years ended
December 31, 1994, 1995 and 1996 was $7.6 million, $31.4 million and ($2.6)
million, respectively. In 1994, this was the result of multiple private
placements of capital stock of $8.5 million, borrowings under the line of credit
of $562,000, payments under the line of credit of $1.2 million and
principal repayments on obligations of capital leases of $280,000. In 1995,
this was a result of principal repayments on obligations of capital leases of
$869,000, and $31.6 million in net proceeds from the issuance of common
stock from the initial public offering in August 1995. In 1996, this was a
result of principal repayments on obligations of capital leases of $1.2 million
and the purchase of treasury stock of $1.6 million.
On January 24, 1997, the Company acquired the stock of Purview Technologies,
Inc., a development stage company engaged in Internet usage monitoring software
development. The Company paid $1 million in cash and issued 205,712 shares of
its common stock. The aggregate purchase price including estimated direct
acquisition costs was approximately $2.3 million. This transaction will be
accounted for as a purchase in accordance with APB No. 16.
17
On January 28, 1997, the Company acquired the stock of csd Software GmbH ,
a German developer and marketer of PC Desktop Software Management Tools. The
Company paid $5 million in cash and issued 1,315,790 shares of its common stock.
The aggregate purchase price including estimated direct acquisition costs was
approximately $15.6 million. This transaction will be accounted for as a
purchase in accordance with APB No. 16.
For each of these acquisitions, the Company is in the process of obtaining
independent appraisals to value the intangible assets acquired including
incomplete purchased research and development. The Company anticipates that a
substantial portion of the purchase price for these two acquisitions will be
charged to operations as purchased incomplete research and development.
The Company believes that its existing cash balances, funds generated from
operations, and available borrowings under its line of credit will be sufficient
to finance the Company's operations for the next 12 months. In the event the
Company acquires one or more businesses or products, the Company's capital
requirements could increase substantially, and there can be no assurance that
additional capital will be available on terms acceptable to the Company, if at
all.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
Some statements contained in this Form 10-K that are not historical
statements (including but not limited to, statements concerning estimates of
future revenues, operating expense levels and such operating levels relative to
the Company's total revenues) constitute forward-looking statements under the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
The risk factors discussed below, among other factors (including the accuracy of
the Company's internal estimates of revenue and operating expense level and the
other risk factors disclosed from time to time in the Company's filings with the
Securities and Exchange Commissions), may cause the Company's actual results to
differ materially from the estimated results stated in such forward-looking
statements.
VARIABILITY OF QUARTERLY OPERATING RESULTS
The Company's licensing activity and results of operations can fluctuate
significantly on a quarterly basis. Causes of such fluctuations may include,
among other factors the volume and timing of new and repeat orders, the
introduction or announcement of new products or product enhancements by ON or
third parties, failure to ship trials, changes in response rates to the
Company's mailings and telemarketing programs, interruption in the Company's
overnight delivery, telephone or internal networks and databases, work
stoppages, changes in product prices, changes in operating expenses, changes in
product mix, increase in international sales as a percentage of total revenue,
seasonality, trends in the computer industry, unavailability of product,
potential software viruses and perceived threats thereof, customer order
deferrals, general economic conditions, extraordinary events such as
acquisitions or litigation and the occurrence of unexpected events. While to
date, the Company has not experienced any significant failure to ship trials,
work stoppages or unavailability of products, there can be no assurance any of
such events will not occur in the future. The occurrence of any such event could
have a material adverse effect on the Company's business, financial condition or
results of operations. Because of the nature of its distribution methods, the
Company has virtually no backlog and generally cannot predict when users will
license products. Historically, repeat orders have accounted for a significant
portion of the Company's total revenue; however, there can be no assurance that
the Company will be able to sustain current repeat order rates in the future.
Furthermore, since the Company's cost of total revenue is relatively low and its
operating expenses are relatively fixed, any revenue shortfall in a quarter will
result in a substantially similar shortfall in net income. In addition,
significant quarterly fluctuations in licensing activity will cause significant
fluctuations in the Company's cash flows and the cash and cash equivalents,
accounts receivable and deferred revenue accounts on the Company's balance
sheet.
The Company's business has experienced and is expected to continue to
experience seasonality, due in part to customer buying patterns. In recent
years, the Company generally has had greater demand for its products in the
fourth quarter and has had weaker demand for its products during the first
quarter. These fluctuations are caused primarily by customer budgeting and
purchasing patterns. The Company believes this pattern will continue.
The Company believes that period-to-period comparisons of its financial
results should not be relied upon as an indication of future performance.
18
RISKS ASSOCIATED WITH RAPID TECHNOLOGICAL CHANGE
The communications and network management software markets are
characterized by rapid technological developments, changes in customer
requirements, evolving industry standards and frequent new product
introductions. The Company's future success will depend, in part, upon its
ability to enhance its existing applications, develop and introduce new products
that take advantage of technological advances, and respond promptly to new
customer requirements and evolving industry standards. While the Company
believes that it currently offers a broad product line in the communications and
network management software markets, these markets are continuing to evolve and
customer requirements are continuing to change. In response to these changes the
Company believes that it will need to continue to expand its product offerings.
The Company has identified a number of enhancements to its existing products
offerings which it believes are important to its continued success in the
communications and network management software markets, including products for
Windows 95 and Windows NT and Internet-enabling products. There can be no
assurance that the Company will be successful in developing and marketing, on a
timely basis, enhancements to its existing products or new products, or that its
new products will adequately address the changing needs of the marketplace.
Failure by the Company in any of these areas could materially and adversely
affect the Company's business, financial condition or results of operations. In
addition, from time to time the Company or its competitors may announce new
products with capabilities or technologies that could have a potential to
replace or shorten the life cycles of the Company's existing products or render
such products obsolete. There can be no assurance that announcements by the
Company or its competitors of new products will not cause customers to defer
purchasing the Company's existing products. In addition, there can be no
assurance that future changes in DOS, Windows, NetWare or other popular
operating systems would not result in incompatibility with the Company's
products. The Company's failure to introduce new products on a timely basis that
are compatible with operating systems and environments preferred by desktop
computer users would have a material adverse effect on the Company's business,
financial condition and results of operations.
COMPETITIVE RISKS
The market for the Company's products is highly competitive, and the
Company expects competition to increase in the future. The Company believes that
the principal competitive factors affecting the market for its products include
performance, functionality, ease of use, ease of installation, quality, customer
support, breadth or product line, speed of product delivery, frequency of
upgrades and updates, brand name recognition, company reputation and price.
Certain of the criteria upon which the performance and quality of the Company's
communications and network management software compete include speed of
response, ease of use, ease of installation, interoperability with other
messaging systems and simplicity of administration. The Company believes that it
generally competes favorably with respect to each of these factors; however,
there can be no assurance that the Company will be able to continue to compete
successfully against current and future competitors. Certain of the Company's
competitors have been in the market longer than the Company, and other
competitors are larger and may have greater name recognition that the Company.
As is the case in many segments of the software industry, the Company may
encounter increasing price competition in the future. This could reduce average
selling prices and, therefore, profit margins. Competitive pressures could
result not only in sustained price reductions but also in a decline in sales
volume, which could adversely affect the Company's business, financial condition
or results of operations. There can be no assurance that the Company will
continue to compete effectively against existing and potential competitors in
the communications and network management software markets, many of whom have
substantially greater financial, technical, marketing and support resources and
name recognition than the Company. In addition, there can be no assurance that
software vendors who currently use traditional distribution methods will not be
in the future decide to compete more directly with the Company by utilizing free
trial marketing. See "--Risks Associated with Free Trial Marketing."
Both the communications software market and the network management software
market are highly fragmented, with products offered by many vendors. In the
e-mail market, the Company competes with offerings from software, shareware and
freeware developers. Shareware is software that is made available electronically
on bulletin boards systems. Shareware users are encouraged to evaluate the
software for a short period of time and then either cease using it or pay a
license fee. In the group scheduling market, the Company also competes with
personal information manager products ("PIMs") that have been enhanced to
include some group scheduling features. Certain competitors have in the past
bundled communications and network management software with their operating
system products or software application suite offerings and have publicly
announced, or the Company believes are likely to provide, such bundles with
future offerings. There can be no assurance that the Company can continue to
compete effectively against communications software which is included free with
the operating system, as these bundled products are improved in the future. In
addition, the trend toward
19
enterprise-wide communications software solutions may result in a consolidation
of the communications software market around a smaller number of vendors who are
able to provide all of the necessary software and support capabilities.
Historically, the Company's international revenue has been generated
primarily through independent distributors in Europe, Australia, Israel, South
Africa and South America, certain of which are bound by contracts with the
Company but which generally do not represent the Company exclusively. The
competitive environment for communications software tools internationally is
similar to that in North America. The Company has only recently begun to compete
in Asian markets, which have significantly lagged behind North America and
Europe in their adoption of LAN technology. There can be no assurance that the
Company will be able to continue to compete successfully in international
markets.
The widespread inclusion of the functionality of the Company's products as
standard features of operating systems software could render the Company's
products obsolete and unmarketable, particularly if the quality of such
functionality were comparable to that of the Company's products. If the Company
were unable to develop new communications and network management software to
further enhance operating systems and to replace successfully any obsolete
products, the Company's business, financial condition and results of operations
would be materially and adversely affected.
RISKS ASSOCIATED WITH PRODUCT DEVELOPMENT
The Company has in the past experienced delays in software development, and
there can be no assurance that it will not experience further delays in
connection with its current or future product development activities. The
Company puts all of its products through alpha and beta test cycles and makes
significant efforts to debug all products before commercial release. The Company
makes well-marked alpha and beta versions of its software available for
evaluation and testing and solicits and responds to input from evaluators.
However, there can be no assurance that the Company's products will not contain
undetected errors or version compatibility issues, particularly when first
introduced or when new versions are released, resulting in loss of or delay in
market acceptance. Delays and difficulties associated with new product
introductions or product enhancements could have a material adverse effect on
the Company's business, financial condition or results of operations.
In addition to developing new products, the Company's internal development
staff is focused on developing upgrades and updates to existing products and
modifying, enhancing and completing any acquired products and incomplete
projects. Future enhancements may, among other things, include additional
functionality, respond to user problems or address issues of compatibility with
changing operating systems and environments. The Company believes that the
ability to provide these enhancements to users frequently and at a low cost is
key to its success. Failure to release such enhancements on a timely basis could
have a material adverse effect on the Company's business, financial condition or
results of operation. There can be no assurance that the Company will be
successful in these efforts.
The Company licenses SofTrack a from third party. The license will expire
December 1999. If the Company believes that a licensed product continues to be
valuable after the expiration of the initial license term, it will seek to
extend the term of the license. There can be no assurance that the Company will
be able to extend the term of expiring licenses, or that the economic
arrangements for such extensions would be comparable to the arrangements in
effect during the initial license term.
RISKS OF INCLUSION OF COMMUNICATIONS SOFTWARE AND NETWORK MANAGEMENT SOFTWARE IN
SYSTEM SOFTWARE AND APPLICATION SUITES
In the future, vendors of operating system software and group of
applications sold for a single price (generally referred to as application
suites) may continue to enhance their products to include certain functions that
are currently provided most often by communications and network management
software or may bundle these products in their application suites at no
additional charge. The widespread inclusion of the functions provided by the
Company's products as standard features of operating system software could,
particularly if the quality of such functions were comparable to that of the
Company's products, render the Company's products obsolete and unmarketable.
Furthermore, even if the communications and network management software
functions provided as standard features by operating systems are more limited
than that of the Company's products, there is no assurance that a significant
number of customers would not elect to accept such functions in lieu of
purchasing additional software. If the Company were unable to develop new
communications software and network management software products to further
enhance operating systems and to replace successfully any obsolete products, the
Company's business, financial condition and results of operations would be
materially and adversely affected.
DEPENDENCE ON EMERGENCE OF NETWORK MANAGEMENT SOFTWARE
20
The market for the Company's network management software is new and
evolving, and its growth depends upon the broader market acceptance of network
management software. In addition, there are a number of potential approaches to
the market, including incorporating network management software into network
operating systems. Therefore, even if network management software products gain
broader market acceptance, there can be no assurance that the Company's products
will be chosen by organizations which acquire network management software.
Moreover, a change in the licensing policies of Microsoft or other software
vendors which changes the basis on which concurrent users are measured or priced
could adversely effect the Company's network management software products.
Furthermore, to the extent that the network management software market does
develop, the Company expects that competition will increase. See "-- Competitive
Risks," and "-- Risks of Inclusion of Communications Software and Network
Management Software in System Software and Application Suites."
RISKS ASSOCIATED WITH FREE TRIAL MARKETING
The Company provides its customers with 30-day free trials of all of the
Company's principal products ("Free Trial Marketing"). The trials are full
featured versions of the product that are internally designed to cease operation
in 30 days. The Company uses Free Trial Marketing as its primary sales channel.
The Company depends on direct mail, trade shows and telemarketing to find
prospects and install trials. This model represents a significant departure from
marketing strategies relying on a direct sales force, exclusive distributor
relationships and magazine space advertising. While to date this marketing
strategy has successfully resulted in the licensing of the Company's products by
corporate, government and institutional users, given the relatively unproven
nature of this form of marketing, there can be no assurance that this strategy
will continue to be effective in the future for either current or new products.
The failure of this strategy to continue to effectively generate license revenue
would have a material adverse effect on the Company's business, financial
condition and results of operations. While the Company has experienced
significant growth over the past years, the Company's distribution strategy may
make its products less attractive to customers who prefer to purchase through
traditional channels and, as a result, may have the effect of limiting the
Company's potential market. In addition, as mailings are mailed repeatedly to
the same customers, customers' responsiveness to particular offers and products
declines. There can be no assurance that the Company will be able to sustain
current response rates to its mailings in the future. In addition, there can be
no assurance that the Company can continue to create sufficient attractive
offers and to introduce interesting products at a rate sufficient to support the
Company's growth plan or even current revenue. The Company's growth depends both
on its ability to select names from rented lists and to grow its "house list."
The availability and relevance of rentable names to the Company's products are
not certain. In addition, since the ability of the Company to grow its house
list is dependent on the supply of rentable names, house list growth cannot be
assured.
The Company depends on the distribution of Free Trial Marketing disks to
accomplish much of its marketing. If some of the Company's Free Trial Marketing
disks were to become infected with a computer virus, they would cause
difficulties for prospects and could damage the Company's reputation. The
Company does extensive testing for viruses. The Company's use of outside
fulfillment contractors increases the risk that a virus could be shipped
undetected on disks bearing the Company's label. There can be no assurance that
ON would be able to collect adequate compensation from such fulfillment
contractors if such a virus infected disks bearing the Company's label.
The Company fulfills orders received directly from customers through a
third-party fulfillment contractor, which warehouses the Company's products and
ships them directly to ON's customers. The Company also maintains a private use
prospects list at a bonded third-party database firm. In the event that either
the customer fulfillment contractor or the private use database firm experience
a substantial business interruption, whether through business failure or
interruption or some natural calamity, or the Company's relationship with either
of such parties is terminated for any reason, the Company's ability to continue
to mail free trial offers to prospective customers and to fulfill orders placed
by customers would be adversely affected.
In both the domestic and international markets, increases in postal rates
(including modifications in the classification of mail) or telephone rates, or
changes in postage or telephone regulations which prohibit unsolicited direct
mail or unsolicited telephone calls, could significantly impact the economics of
the Company's Free Trial Marketing strategy. In addition, it is possible that
other software vendors could adopt all or parts of the Company's strategy and
compete more directly or effectively with the Company.
21
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS
The Company may in the future undertake additional acquisitions that could
present challenges to the Company's management, such as integrating and
incorporating new operations, product lines, technologies and personnel. If the
Company's management is unable to manage these challenges, the Company's
business, financial condition or results of operations could be materially
adversely affected. Any acquisition, depending on its size, could result in
significant dilution to the Company's stockholders. Furthermore, there can be no
assurance that any acquired products will gain acceptance in the Company's
markets.
RISKS OF INDIRECT CHANNELS OF DISTRIBUTION
The Company markets its products through distributors and resellers in
addition to its Free Trial Marketing strategy. These distributors and resellers
also sell other products that are complementary to, or compete with, those of
ON. There can be no assurance that these distributors and resellers will not
give greater priority to products of other suppliers. They have no long-term
obligation to purchase products from the Company. Since the Company's agreements
with its distributors provide for a right of return, revenue recognized upon
sales to distributors is subject to a reserve for returns. Although management
believes that the current reserve balance is adequate to cover this exposure,
there can be no assurance that any future period reserves for returns will be
adequate. In addition, the Company may be unaware of the nature and scope of the
representations made to customers by these distributors and resellers. For
example, they could make representations to customers about the Company's
current and future products which are inaccurate or incomplete. This could
result in the products not meeting the customers' expectations or requirements.
Although the Company's agreements with its distributors generally provide the
Company with recourse against unauthorized action taken by the distributors,
there can be no assurance that the Company could recover adequate compensation
to cover the damage caused by an inaccurate representation. See "--Risks
Associated with International Revenue."
RISKS ASSOCIATED WITH PROTECTION OF PROPRIETARY TECHNOLOGY
The Company's success is heavily dependent upon its proprietary software
technology. The Company relies on a combination of contractual rights,
trademarks, trade secrets and copyrights to establish and protect its
proprietary rights in its software. The Company has not to date registered any
of its copyrights. The Company has obtained registrations in the United States
for the following trademarks: ON Technology, Notework, Meeting Maker, ON
Technology & Design, ON Location, Instant Update and DaVinci Systems. The
Company uses a printed "shrink-wrap" license for users of its products
distributed through traditional distribution channels in order to protect its
copyrights and trade secrets in those products. Since these shrink-wrap licenses
are not signed by the licensee, many authorities believe that they may not be
enforceable under many state laws and the laws of many foreign jurisdictions. If
such licenses are not enforceable, the user would not be bound by the terms
thereof, including the terms which seek to protect the Company's proprietary
technology. There can be no assurance that the Company's proprietary technology
will be protected by the use of the printed shrink-wrap licenses. If the printed
shrink-wrap licenses prove to be unenforceable, this may have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, the laws of some foreign countries either do not protect the
Company's proprietary rights or offer only limited protection for those rights.
Furthermore, the Company has obtained only four foreign registrations of its
Notework mark and two foreign registrations of its Meeting Maker mark, due to
the significant costs involved in obtaining foreign registrations. As a result,
the Company may not be able to prevent a third party from using its trademarks
in many foreign jurisdictions. If such licenses are not enforceable, the user
would not be bound by the terms thereof, including the terms which seek to
protect the Company's proprietary technology.
There can be no assurance that the steps taken by the Company to protect
its proprietary software technology will be adequate to deter misappropriation
of this technology. In addition, the Company does provide customer support to
unlicensed users during the Free Trial Marketing period. Lesser sensitivity by
corporate, government or institutional users to avoiding copyright infringement
could have a material adverse effect on the Company's business, financial
condition and results of operation. While the Company to date has not taken any
legal action to enforce its intellectual property rights against infringing
users, it believes, based upon current interpretations of law, that its use of
Free Trial Marketing and the widespread availability of its trials do not
significantly impact its ability to enforce its intellectual property rights
against infringing users, including corporate, institutional and government
entities. However, there is no assurance that a court or other authority may
22
not rule otherwise in the future. Such a ruling would have a material adverse
effect on the Company's business, financial condition and results of operations.
There has been substantial litigation in the software industry involving
intellectual property rights of technology companies, although, to date, the
Company has not been subject to any such litigation. Although the Company does
not believe that it is infringing the intellectual property rights of others,
there can be no assurance that such claims, if asserted, would not have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, as the Company may acquire or license a
portion of the software included in its future products from third parties, its
exposure to infringement actions may increase because the Company must rely upon
such third parties for information as to the origin and ownership of any
software being acquired. The Company generally obtains representations as to the
origin and ownership of such acquired or licensed software and generally obtains
indemnification to cover any breach of such representations. However, there can
be no assurance that such representations are accurate or that such
indemnification will provide adequate compensation for a breach of such
representations. In the future, litigation may be necessary to enforce and
protect trade secrets and other intellectual property rights owned by the
Company. The Company may also be subject to litigation to defend against claimed
infringement of the rights of others or to determine the scope and validity of
the proprietary rights of others. Any such litigation could be costly and cause
diversion of management's attention, either of which could have a material
adverse effect on the Company's business, financial condition or results of
operations. Adverse determinations in such litigation could result in the loss
of the Company's proprietary rights, subject the Company to significant
liabilities, require the Company to seek licenses from third parties or prevent
the Company from manufacturing or selling its products, any one of which could
have a material adverse effect on the Company's business, financial condition or
results of operations. Furthermore, there can be no assurance that any necessary
licenses will be available on reasonable terms, or at all.
RISKS ASSOCIATED WITH INTERNATIONAL REVENUE
In 1996, total revenue from international licenses (license revenue from
outside the United States) represented approximately 18% of the Company's total
revenue. The Company expects that total revenue from international licenses will
increase in future years; however, there can be no assurance that the Company
will be successful in penetrating international markets. Substantially all of
the Company's license fees are in United States dollars. Risks inherent in the
Company's international sales generally include the impact of fluctuating
exchange rates on demand for its products, longer payment cycles, greater
difficulty in protecting intellectual property, greater difficulty in accounts
receivable collection, unexpected changes in regulatory requirements,
seasonality due to the slowdown in European business activity during the third
quarter, and tariffs and other trade barriers. There can be no assurance that
these factors will not have a material adverse effect on the Company's future
international license revenue. Further, in countries with a high incidence of
software piracy, the Company may experience a higher rate of piracy of its
products.
In addition, a significant portion of the Company's international revenue
is generated through independent distributors and resellers. Since these
distributors and resellers are not employees of the Company and are not required
to offer the Company's products exclusively, there can be no assurance that they
will continue to market the Company's products. Also, despite the Company's
substantial dependence in the international market upon the marketing, sales and
customer support of its distributors and resellers, the Company currently has
limited control over its distributors and resellers, and the Company may be
unaware of the nature and scope of the representations made to customers by
these agents. For example, independent agents could make representations to
customers about the Company's current and future products which are inaccurate
or incomplete, which could result in the products not meeting customers'
expectations or requirements.
DEPENDENCE UPON KEY PERSONNEL
The Company's success depends to a significant extent upon a number of key
technical and management employees. While the Company's employees are required
to sign standard agreements concerning confidentiality and ownership of
inventions, the employees, with the exception of Messrs. Risley, Platzman,
Batson, Bogdan, Rizzi and O'Sullivan are generally not otherwise subject to
employment agreements or noncompetition covenants. The loss of the services of
any of the Company's key employees could have a material adverse effect on the
Company's business, financial condition or results of operation. The Company
does not maintain life insurance policies on key employees. The Company's
success also depends in large part upon its ability to attract and retain highly
skilled technical, managerial, sales and marketing personnel.
23
Competition in the software industry for such personnel is intense. There can be
no assurance that the Company will be successful in retaining its existing key
personnel and in attracting and retaining the personnel it requires.
VOLATILITY OF STOCK PRICE
The trading price of the Company's Common Stock has been, and in the future
may be, subject to wide fluctuations in response to actual or anticipated
quarterly operating results of the Company, announcements of technological
innovations or new applications by the Company or its competitors and general
market conditions in the software industry, as well as other events or factors.
In addition, stock markets have experienced extreme price and volume trading
volatility in recent years. This volatility has had a substantial effect on the
market price of many technology companies and has often been unrelated to the
operating performance of those companies. This volatility may adversely effect
the market price of the Company's Common Stock.
RISKS ASSOCIATED WITH STRATEGIC REORGANIZATION
In August 1996, the Company implemented a reorganization and restructuring
of its operations. This action was designed to consolidate the three
acquisitions the Company made during the first quarter ended March 31, 1996, to
decrease the Company's emphasis on mature products, such as e-mail, and to
better focus the Company's resources on bringing new products to the rapidly
changing network management software market. There can be no assurance that
these objectives will be achieved. Furthermore, there can be no assurance that
the Company will not engage in further reorganizations or restructurings in the
future.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements and supplementary data of the Company required by
this item are set forth at the pages indicated in Item 14(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
24
PART III
--------
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
The information required hereunder is incorporated by reference from the
Company's Proxy Statement filed in connection with the Company's Annual Meeting
of Stockholders to be held on April 30, 1997.
ITEM 11. EXECUTIVE COMPENSATION
The information required hereunder is incorporated by reference from the
Company's Proxy Statement filed in connection with the Company's Annual Meeting
of Stockholders to be held on April 30, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required hereunder is incorporated by reference from the
Company's Proxy Statement filed in connection with the Company's Annual Meeting
of Stockholders to be held on April 30, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required hereunder is incorporated by reference from the
Company's Proxy Statement filed in connection with the Company's Annual Meeting
of Stockholders to be held on April 30, 1997.
25
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements:
Page Number
-----------
Report of Independent Public Accountants 27
Consolidated Balance Sheets:
December 31, 1996 and 1995 28
Consolidated Statements of Operations:
Years ended December 31, 1996, 1995 and 1994 29
Consolidated Statements of Redeemable Convertible
Preferred Stock and Stockholders' Equity (Deficit):
Years ended December 31, 1996, 1995 and 1994 30
Consolidated Statements of Cash Flows:
Years ended December 31, 1996, 1995 and 1994 31-32
Notes to the Consolidated Financial Statements 33-44
(a)(2) Consolidated Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts
Years ended December 31, 1996, 1995 and 1994 36
Other Schedules are omitted because the conditions required for filing
do not exist or the required information is included in the financial statements
or notes thereto.
(a)(3) Exhibits: See Index to Exhibits on Page 48. The Exhibits listed in the
accompanying Index of Exhibits are filed or incorporated by reference as
part of this report.
(b) Reports on Form 8-K: None in the fourth quarter of 1996.
26
ARTHUR ANDERSON
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To ON Technology Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of ON
Technology Corporation (a Delaware corporation) and subsidiaries as of
December 31, 1996 and 1995, and the related consolidated statements of
operations, redeemable convertible preferred stock and stockholders' equity
(deficit) and cash flows for each of the three years in the period ended
December 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material mistreatment. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of ON Technology
Corporation and subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the three
years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
/s/ Arthur Andersen LLP
Boston, Massachusetts
January 21, 1997
(except for the matters discussed in Note 12
as to which the dates are January 24, 1997
and January 28, 1997, respectively )
27
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
December 31,
--------------------------------
1996 1995
--------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 20,774 $ 33,338
Accounts receivable, net of allowance
of $1,191 and $605, respectively 9,852 6,377
Inventories 2,323 2,834
Prepaid expenses and other current assets 2,537 1,374
------------- --------------
Total current assets 35,486 43,923
------------- --------------
Property and Equipment, at cost:
Computers and equipment 6,226 2,173
Equipment under capital leases 3,895 3,804
Furniture and fixtures 247 133
Less-Accumulated depreciation and amortization 4,527 2,069
------------- --------------
5,841 4,041
------------- --------------
Direct marketing costs 1,067 1,554
Other assets and deposits 86 127
Purchased intangibles, net of $1,261 and $993
of accumulated amortization, respectively 1,662 528
$ 44,142 $ 50,173
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of capital lease obligations $ 1,063 $ 1,143
Accounts payable 5,619 3,392
Accrued expenses 2,252 2,265
Reserve for distributor inventories 204 934
Deferred revenue 1,001 627
------------- --------------
Total current liabilities 10,139 8,361
------------- --------------
Capital lease obligations, net of current portion 510 1, 506
------------- --------------
Commitments (Note 7)
Stockholders' Equity:
Common stock, $.01 par value - Authorized - 20,000,000 shares
Issued and outstanding 11,008,243 shares and
10,180,024 shares, respectively 110 102
Additional paid-in capital 55,637 45,051
Accumulated deficit (20,354) (4,493)
Accumulated deficit of S corporation (354) (354)
Cumulative translation adjustment 88 ---
Treasury stock (257,867 shares at cost) (1,634) ---
------------- --------------
Total stockholders' equity 33,493 40,306
------------- --------------
$ 44,142 $ 50,173
============= ==============
The accompanying notes are an integral part of these consolidated
financial statements.
28
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Year ended December 31,
-----------------------------------------------------------------------------
1996 1995 1994
---------------------- --------------------- ---------------------
Revenue:
Net product revenue $ 50,165 $ 43,381 $ 25,240
Other revenue 1,627 740 588
---------------------- --------------------- ---------------------
Total revenue 51,792 44,121 25,828
---------------------- --------------------- ---------------------
Operating expenses:
Cost of product revenue 11,951 8,199 6,716
Sales and marketing 24,176 20,984 10,824
Research and development 9,456 7,014 5,277
General and administrative 4,407 3,184 2,319
Charge for purchased incomplete research
and development 13,285 --- 4,700
Charge for restructuring 5,415 --- ---
---------------------- --------------------- ---------------------
(Loss) income from operations (16,898) 4,740 (4,008)
Interest expense (250) (288) (97)
Interest income 1,384 842 17
---------------------- --------------------- ---------------------
(Loss) income before provision
for income taxes (15,764) 5,294 (4,088)
Provision for income taxes (97) (1,622) (11)
--------------------- --------------------- ---------------------
Net (loss) income $ (15,861) $ 3,672 $ (4,099)
===================== ===================== =====================
Pro forma net (loss) income per common
and common equivalent share (1.46) $ 0.40 $ (0.59)
===================== ===================== =====================
Pro forma weighted average number of
common and common equivalent shares
outstanding $ 10,853,814 $ 9,086,764 $ 6,951,836
====================== ===================== =====================
29
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands)
Redeemable Convertible Preferred Stock
-----------------------------------------------------------------------------
Series A Series B Series C
-------------------- --------------------- ----------------------
Number $.01 Number $.01 Number of $.01
of Par of Par of Par
shares value shares value shares value Total
-------------------- -----------------------------------------------------
Balance, December 31, 1993 231 $ 1,275 1,166 $ 1,930 -- $ -- $ 3,205
Sale of Series C redeemable
convertible preferred stock,
net of issuance costs of $25 -- -- -- -- 14,921 8,500 8,500
Exercise of common stock options -- -- -- -- -- -- --
Retirement of common stock -- -- -- -- -- -- --
Accretion of preferred stock
dividends -- 86 -- -- -- 397 483
Net loss -- -- -- -- -- -- --
--------------------------------------------------------------------------
Balance , December 31, 1994 231 1,361 1,166 1,930 14,921 8,897 12,188
Exercise of common stock options -- -- -- -- -- -- --
Accretion of preferred -- 50 -- -- -- 397 447
stock dividends
Sale of common stock, net
of issuance
costs of $1,275 -- -- -- -- -- -- --
Conversion of preferred stock (231) (1,411) (1,166) (1,930) (14,921 ) (9,294) (12,635)
Tax benefit from stock
options -- -- -- -- -- -- --
Net income -- -- -- -- -- -- --
Balance, December 31, 1995 -- -- -- -- -- -- --
Issuance of common stock in
connection with acquisitions -- -- -- -- -- -- --
Sale of common stock under the
Employee Stock Purchase Plan -- -- -- -- -- -- --
Exercise of common stock options -- -- -- -- -- -- --
Purchase of treasury stock -- -- -- -- -- -- --
Cumulative translation adjustment -- -- -- -- -- -- --
Net loss -- -- -- -- -- -- --
-----------------------------------------------------------------------------
Balance, December 31, 1996 -- $ -- -- $ -- -- $ -- $ --
=============================================================================
Stockholder's Equity (Deficit)
----------------------------------------------------------------------------------------------
Common Stock Treasury Stock
------------ --------------
Number $.01 Additional Accumulated Cummulative Number
of Par Paid-in Accumulated Deficit Translation of
shares value Capital Deficit S Corporation Adjustment shares Cost Total
---------------------------------------------------------------------------------------------------
Balance, December 31, 1993 3,161 $ 31 $ 225 $ (3,136) $ (354) $ -- -- $ -- $ (3,234)
Sale of Series C redeemable
convertible preferred stock,
net of issuance costs of $25 -- -- (25) -- -- -- -- -- (25)
Exercise of common stock options 377 4 (2) -- -- -- -- -- 2
Retirement of common stock (5) -- -- -- -- -- -- -- ---
Accretion of preferred stock
dividends -- -- -- (483) -- -- -- -- (483)
Net loss -- -- -- (4,099) -- -- -- -- (4,099)
--------------------------------------------------------------------------------------------------
Balance , December 31, 1994 3,533 35 198 (7,718) (354) -- -- -- (7,839)
Exercise of common stock options 445 4 148 -- -- -- -- -- 152
Accretion of preferred
stock dividends -- -- -- (447) -- -- -- -- (447)
Sale of common stock, net
of issuance costs of $1,275 2,360 24 31,623 -- -- -- -- -- 31,647
Conversion of preferred stock 3,842 39 12,596 -- -- -- -- -- 12,635
Tax benefit from stock
options -- -- 486 -- -- -- -- -- 486
Net income -- -- -- 3,672 -- -- -- -- 3,672
--------------------------------------------------------------------------------------------------
Balance, December 31, 1995 10,180 102 45,051 (4,493) (354) -- -- -- 40,306
Issuance of common stock in
connection with acquisitions 727 7 10,351 -- -- -- -- -- 10,358
Sale of common stock under the
Employee Stock Purchase Plan 9 -- 93 -- -- -- -- -- 93
Exercise of common stock options 92 1 142 -- -- -- -- -- 143
Purchase of treasury stock -- -- -- -- -- -- (258) (1,634) (1,634)
Cumulative translation adjustment -- -- -- -- -- 88 -- 88
Net loss -- -- -- (15,861) -- -- -- (15,861)
--------------------------------------------------------------------------------------------------
Balance, December 31, 1996 11,008 110 $ 55,637 $(20,354) $ (354)$ 88 (258) $ (1,634) $ 33,493
==================================================================================================
The accompanying notes are an integral part of these consolidated financial
statements.
30
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
------------------------------------------------
1996 1995 1994
------------ ------------ ------------
Cash Flows from Operating Activities:
Net (loss) income $ (15,861) $ 3,672 $ (4,099)
Adjustment to reconcile net (loss) income
to net (used in) provided by operating activities
Charge for purchased incomplete research and 13,285 --- 4,700
Non-cash charge for restructuring 3,048 --- ---
Depreciation and amortization 3,217 1,880 837
Retirements of property and equipment --- --- 48
Change in direct marketing costs (1,074) (842) (712)
Change in net deferred income taxes (481) --- ---
Changes in assets and liabilities, net of
Accounts receivable (3,211) (1,953) (2,382)
Inventories 524 (2,030) (94)
Prepaid expenses and other current assets (1,440) (785) (160)
Accounts payable 1,823 (91) 1,859
Accrued expenses (11) (311) 1,387
Reserve for distributor inventories (730) (279) 1,213
Deferred revenue 255 474 (1,427)
---------- --------- ---------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (656) (265) 1,170
---------- --------- ---------
Cash Flows from Investing Activities:
Escrow receivable --- 625 (625)
Change in other assets and deposits (27) 4 (92)
Purchase of property and equipment, net (4,476) (1,240) (374)
Purchase of DaVinci Systems Corporation,
net of cash acquired --- --- (4,976)
Purchase of Leprechaun Software International, Ltd.,
net of cash acquired (628) --- ---
Purchase of technology from neTrend Corporation (2,260) --- ---
Purchase of certain assets from Technocom, plc (1,963) --- ---
---------- --------- ---------
NET CASH USED IN INVESTING ACTIVITIES (9,354) (611) (6,067)
---------- --------- ---------
Cash Flows from Financing Activities:
Proceeds from sale of redeemable convertible preferred stock --- --- 8,475
Exercise of stock options 143 152 2
Sale of stock under the Employee Stock Purchase Plan 93 --- ---
Tax benefit from stock options --- 486 ---
Purchase of treasury stock (1,634) --- ---
Principal repayments on obligation under capital lease (1,168) (869) (280)
Net proceeds from sale of common stock --- 31,647 ---
Borrowings under line of credit and demand note payable --- --- 562
Repayments on line of credit and demand note payable --- --- (1,165)
---------- --------- ---------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (2,566) 31,416 7,594
---------- --------- ---------
Effect of exchange rates on cash and cash equivalents 12 --- ---
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (12,564) 30,540 2,697
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 33,338 2,798 101
---------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 20,774 $ 33,338 $ 2,798
========== ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
31
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS-(CONTINUED)
(DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
1996 1995 1994
----------------- ---------------- -----------------
SUPPLEMENTAL DISCLOSURE OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Accretion of preferred stock dividends $ --- $ 447 $ 483
================= ================= =================
Conversion of preferred stock into common stock $ --- $ 12,635 $ ---
================= ================= =================
Acquisition of equipment under capital leases $ 91 $ 2,124 $ 1,233
================= ================= =================
Cashless exercise of stock option $ --- $ --- $ 22
================= ================= =================
ACQUISITION OF DAVINCI SYSTEMS CORPORATION
Fair value of assets acquired $ --- $ --- 6,655
Liabilities assumed --- --- (1,479)
Cash acquired --- --- (200)
----------------- ----------------- ------------------
Cash paid for acquisition and direct costs
net of cash acquired $ --- $ --- 4,976
================= ================= =================
ACQUISITION OF LEPRECHAUN SOFTWARE INTERNATIONAL, LTD.
Fair value of assets acquired $ 1,158 $ --- $ ---
Fair value of stock issued (158) --- ---
Liabilities assumed (370) --- ---
Cash acquired (2) --- ---
----------------- ----------------- ------------------
Cash paid for acquisition and direct costs
net of cash acquired $ 628 $ --- $ ---
================= ================== ==================
ACQUISITION OF INTANGIBLE ASSETS FROM
NETREND CORPORATION AND VIMAL VAIDYA
Fair value of assets acquired $ 12,460 $ --- $ ---
Fair value of stock issued (10,200) --- ---
----------------- ----------------- ------------------
Cash paid for acquisition and direct costs $ 2,260 $ --- $ ---
================= ================== ==================
ACQUISITION OF TECHNOCOM PLC.
Fair value of assets acquired $ 1,963 $ --- $ ---
================= ================== ==================
Cash paid for acquisition and direct costs $ 1,963 $ --- $ ---
================= ================== ==================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for-
Interest $ 205 $ 271 $ 94
================= ================== ==================
Income taxes $ 1,302 $ 657 $ ---
================= ================== ==================
The accompanying notes are on integral part of these consolidated financial
statements.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
ON Technology Corporation and its Subsidiaries (the "Company") are engaged
in the development, marketing, sales support, and distribution of software for
local area networks.
In 1994, the Company acquired all of the outstanding stock of DaVinci
Systems Corporation (DaVinci), a company engaged in the development and
marketing of software. This transaction was accounted for as a purchase in
accordance with Accounting Principles Board (APB) No. 16 (see Note 2).
During 1996, the Company completed three acquisitions. The Company acquired
all of the assets and assumed certain liabilities of Leprechaun Software
International, Ltd., certain technology of neTrend Corporation and certain
intangible assets of Technocom plc. These acquisitions were accounted for as the
purchase of business combinations in accordance with APB No. 16 (see Note 3).
The accompanying consolidated financial statements reflect the application
of certain significant accounting policies as described below and elsewhere in
the notes to the consolidated financial statements.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
Management Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expense during the
reporting period. Actual results could differ from those estimates.
Revenue Recognition
Revenue from software product sales is recognized upon shipment of the
product to customers where the Company has no significant vendor obligations.
Revenue from the sale of advertising space in the Company's marketing catalog is
recognized upon shipment of the catalog. The deferred revenue balance at
December 31, 1996 and 1995 relates primarily to revenue on software maintenance
contracts, which is recognized ratably as it is earned. The reserve for
distributor inventories balance at December 31, 1996, 1995 and 1994 relates to
sales to distributors for which the Company has accrued its estimate of future
distributor returns when the product was shipped. In addition, the Company
accrues the costs associated with providing telephone support related to certain
products.
Cash and Cash Equivalents
The Company follows the provisions of Statement of Financial Accounting
Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity
Securities. The Company has classified its cash equivalents as held-to-maturity
and recorded them at amortized cost, which approximates market value. The
Company considers all highly liquid cash investments with maturates of three
months or less at the date of acquisition to be cash equivalents. Cash
equivalents consisted of commercial paper and money market funds at December 31,
1996 and 1995.
33
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
Fair Value of Financial Instruments
SFAS No. 107, Disclosure About Fair Value of Financial Instruments,
requires disclosure of an estimate of the fair value of certain financial
instruments. The Company's financial instruments consist of cash equivalents,
accounts receivable and capital leases. The estimated fair value of these
financial instruments approximates their carrying value at December 31, 1996 and
1995. The estimated fair values have been determined through information
obtained from market sources and management estimates.
Direct Marketing Costs
The Company sells its products through various channels, including free
trial marketing. The Company incurs substantial costs in advance of a free trial
campaign, including the rental of mailing lists, postage and printing. The
Company capitalizes such costs in accordance with the American Institute of
Certified Public Accountants' (AICPA) Statement of Position 93-7, Reporting on
Advertising Costs. The Company amortizes such costs over a three-month period,
which approximates the period of expected revenues. The Company has recorded
$1,067 and $1,554 of net capitalized direct marketing costs in the accompanying
consolidated balance sheets at December 31, 1996 and 1995, respectively. The
Company recorded $7,387, $7,291 and $3,032 of direct marketing expense for the
years ended December 31, 1996, 1995 and 1994, respectively.
Inventories
The Company values inventories at the lower of cost (first-in, first-out)
or market. Inventories consist principally of computer software disks, computer
hardware, packaging costs and other related purchased computer peripheral items.
The components of inventories are as follows:
1996 1995
------------ ------------
Raw Materials.......................... $ 637 $ 444
Finished Goods......................... 1,686 2,390
------------ ------------
$ 2,323 $ 2,834
============ ============
Depreciation
The Company provides for depreciation by charges to operations in amounts
estimated to allocate the cost of the assets over their estimated useful lives,
using the straight-line method, as follows:
ESTIMATED
ASSET CLASSIFICATION USEFUL LIFE
-------------------- -----------
Computers and equipment............................... 3-7 Years
Equipment acquired under capital leases............... Life of lease
Furniture and fixtures................................ 5-7 Years
34
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
The Company accounts for its long-term assets in accordance with SFAS No. 121,
Accounting for the Impairment of Long -lived Assets and for Long- lived Assets
to be Disposed of. Under SFAS No. 121, the Company is required to assess the
valuation of its long-lived assets, including cost in excess of net assets
acquired, based on the estimated future cash flows to be generated by such
assets. At each balance sheet date, the Company evaluated the realizability of
goodwill based on profitability expectations, using the undiscounted cash flow
method, for each subsidiary having a material goodwill balance. Based on it's
most recent analysis, the Company believes that no impairment of goodwill exists
at December 31, 1996.
Software Development Costs
Costs incurred in the development of computer software to be sold have been
expensed as research and development costs in the accompanying consolidated
statements of operations, in accordance with SFAS No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed. SFAS No. 86
requires that costs incurred in creating a computer software product be charged
to research and development expense until technological feasibility has been
established for the product. The costs incurred subsequent to the attainment of
technological feasibility in 1994, 1995 and 1996 are insignificant. The Company
has recorded charges for purchased incomplete research and development related
to the acquisitions discussed in Notes 2 and 3. In each case, the Company
determined that technological feasibility of the in-process purchased technology
acquired had not been established and that the technology had no alternative
future use.
Foreign Currency Translation
The Company translates the assets and liabilities of its foreign
subsidiaries at the exchange rates in effect at fiscal year-end in accordance
with SFAS No. 52, Foreign Currency Translation. Revenues and expenses are
translated using exchange rates in effect during each period. The cumulative
translation adjustment component of stockholders' equity relates primarily to
the Company's European operation which was established in 1996.
Postretirement Benefits
The Company has no obligations for postretirement benefits.
Concentration of Credit Risk
SFAS No. 105, Disclosure of Information about Financial Instruments with
Off-balance-sheet Risk and Financial Instruments with Concentrations of Credit
Risk, requires disclosure of any significant off-balance sheet and credit risk
concentrations. The Company has no significant off-balance-sheet concentrations
of credit risk such as foreign exchange contracts, option contracts or other
foreign hedging arrangements. The Company's financial instruments that subject
the Company to credit risk consist of cash and cash equivalents and accounts
receivable. The Company maintains the majority of cash balances with four
financial institutions. The Company's accounts receivable credit risk is not
concentrated within any geographic area, and no single customer accounts for
greater than 10% of revenues or represents a significant credit risk to the
Company.
35
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
Pro Forma Net (Loss) Income per Common and Common Equivalent Share
For the three years ended December 31, 1996, pro forma net (loss) income
per common and common equivalent share was based on the weighted average number
of common and common equivalent shares outstanding during the period, computed
in accordance with the treasury stock method. Pro forma net (loss) income per
common equivalent shares for the years ended December 31, 1995 and 1994 was
computed using the pro forma weighted average number of common shares assuming
that all series of redeemable convertible preferred stock had been converted to
common stock as of the original issuance dates. Other shares of stock issuable
pursuant to stock options have been included when their effect is dilutive.
Export Revenue
Export revenue as a percentage of total revenue for the years ended
December 31, 1996, 1995 and 1994 was 18%, 14% and 10%, respectively.
(2) ACQUISITION OF DAVINCI
On June 1, 1994, the Company acquired all of the outstanding stock of
DaVinci. As consideration, the Company paid $3,532 to DaVinci's shareholders,
assumed $1,479 of liabilities and paid off $900 of DaVinci's notes payable to
certain investors. This transaction was accounted for as a purchase, and
accordingly, the results of DaVinci since June 1, 1994, are included in the
accompanying consolidated statements of operations. The aggregate purchase price
of $6,655 (which consisted of $4,432 in cash, including $900 paid to certain
investors who held notes payable, $1,479 of assumed liabilities, and $744 of
direct acquisitions costs) was allocated based on the fair value of the tangible
and intangible assets as follows:
Current assets............................................ $1,014
Property and equipment.................................... 153
Purchased intangible assets, including acquired technology 788
Purchased incomplete research and development............. 4,700
---------
$6,655
=========
Included in purchased intangible assets are amounts related to trade names,
customer lists and acquired technologies including acquired software products.
These intangibles have been fully amortized as of December 31, 1996. The portion
of the purchase price allocated to incomplete research and development projects
that had not yet reached technological feasibility and did not have a future
alternative use, totaling $4,700, was charged to expense as of the acquisition
date. The amount allocated to incomplete research and development projects
represents the estimated fair value related to these projects determined by an
independent appraisal. Proven valuation procedures and techniques were utilized
in determining the fair value of each intangible asset. To bring these projects
to technological feasibility, high risk developmental and testing issues needed
to be resolved which required substantial additional effort and testing.
36
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(3) ACQUISITIONS IN 1996
Acquisition of Leprechaun Software International, Ltd.
On March 6, 1996, the Company acquired substantially all the assets and
assumed certain liabilities of Leprechaun Software International, Ltd., a
company engaged in the development of an antivirus software product. The
aggregate purchase price including direct acquisition costs of $1,158 was
allocated based on fair value of the tangible and intangible assets acquired as
follows:
Current assets................................................ $ 51
Property and equipment........................................ 13
Purchased intangible assets, including acquired technology.... 157
Purchased incomplete research and development................. 937
----------
$1,158
==========
As consideration, the Company paid $330 in cash, $200 in notes, issued
9,471 shares of common stock of the Company with a fair value of $16.68 per
share, assumed $370 in liabilities and incurred $100 in direct acquisition
costs. This transaction was accounted for as a purchase and, accordingly, the
results since March 6, 1996 are included in the accompanying consolidated
financial statements. Included in purchased intangible assets are amounts
related to acquired technology and goodwill.
Acquisition of Intangible Assets from neTrend Corporation and Vimal Vaidya
On January 30, 1996, the Company acquired certain intangible assets,
consisting primarily of incomplete firewall software technology from Vimal
Vaidya and acquired technology from neTrend Corporation, a development stage
company wholly owned by Vimal Vaidya, which, together with Vimal Vaidya,
developed the firewall software technology. The aggregate purchase price
including direct acquisition costs of $12,460 was allocated based on fair value
of the intangible assets acquired as follows:
Acquired technology.......................... $ 676
Purchased incomplete research and development 11,784
----------
$12,460
==========
As consideration, the Company paid $2,000 in cash, issued 717,300 shares of
common stock with a fair value of $14.22 per share and incurred $260 in direct
acquisition costs.
Acquisition of Technocom plc.
On March 29, 1996 the Company acquired certain assets of Technocom plc's
LAN software distribution business. The aggregate purchase price including
direct acquisition costs of $1,963 was allocated based on the fair value of the
tangible and intangible assets acquired as follows:
Property and equipment....................................... $ 110
Purchased intangible assets, including acquired technology... 1,289
Purchased incomplete research and development................ 564
---------
$1,963
=========
37
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(3) ACQUISITIONS IN 1996- (CONTINUED)
As consideration, the Company paid $1,803 in cash and incurred $160 in
direct acquisition costs. Also, included in cost of product revenue for the year
ended December 31, 1996 is a $571 charge for the elimination of profit for
inventory previously sold to Technocom plc. This transaction was accounted for
as a purchase and, accordingly, the results since March 29, 1996 are included in
the accompanying consolidated financial statements. Included in purchased
intangible assets are amounts related to acquired technology, goodwill, trade
names and customer lists.
These intangible assets are being amortized on a straight line basis over
the estimated useful life not to exceed three years. The portion of the purchase
price allocated to incomplete research and development projects that had not yet
reached technological feasibility and did not have any future alternative use
was expensed as purchased incomplete research and development as of the
acquisition dates. The amounts allocated to incomplete research and development
projects represents the estimated fair value related to these projects
determined by an independent appraisal. Proven valuation procedures and
techniques were utilized in determining the fair value of the purchased
intangible assets. To bring these projects to technological feasibility, high
risk development and testing issues needed to be resolved which required
substantial additional effort and testing.
(4) CHARGE FOR RESTRUCTURING.
On August 6, 1996, the Company announced that it had implemented a
reorganization of its operations and a restructuring plan (the "Plan"). The Plan
included write-offs and writedowns of certain assets, including accruing the
costs related to a significant reduction in the Company's work force, primarily
in the technical support and sales and marketing departments, and the de-
emphasis of certain product lines, resulting in a non-recurring charge of
$5,415. Included in the Plan was an additional inventory writedown of $2,026
which is included in cost of product revenue in accordance with Emerging Issues
Task Force (EITF) 96-9, Classification of Inventory Markdowns and Other Costs
Associated with a Restructuring.
The following are the significant components of the $5,415 charge for
restructuring:
Employee severance, benefits and related costs $1,531
Write-off and writedown of assets to net realizable value excluding inventory 3,522
Provision for lease loss and related costs in closing facility 362
------
$5,415
======
The total cash impact of the restructuring amounted to $2,367 which had been
paid as of December 31, 1996.
38
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(5) INCOME TAXES
The Company provides for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes. Under the liability method specified by SFAS No.
109, a deferred tax asset or liability is determined based on the difference
between the financial statement and tax basis of assets and liabilities, as
measured by the enacted tax rates assumed to be in effect when these differences
reverse. The income tax provision for the years ended December 31, 1996 and
1995 was calculated based on the Company's effective tax rate giving benefit to
available net operating loss and research and development credit carryforwards
and by recognizing a portion of the Company's deferred tax asset in the year
ended December 31, 1996. The income tax provision for the year ended December
31, 1994 consists of federal alternative minimum and minimum state income taxes
payable.
The components of the provision for income taxes are as follows:
1996 1995 1994
--------- --------- -------
Current
Federal.......... $ 735 $ 1,092 $ 7
State............ 444 530 4
--------- --------- -------
1,179 1,622 11
Deferred
Federal.......... (675) --- ---
State............ (407) --- ---
--------- --------- ------
(1,082) --- ---
--------- --------- ------
$ 97 $ 1,622 $ 11
========= ========= ======
In the year ended December 31, 1996, the Company incurred a significant
operating loss. However, included in the book changes were amounts not currently
deductible for income taxes. The 1996 tax provision includes the amount
currently payable with an offsetting deferred tax benefit to record a portion of
the Company's deferred tax asset. The Company provides deferred income taxes
for temporary differences between assets and liabilities recognized for
financial reporting and income tax purposes. The income tax effects of these
temporary differences are as follows:
1996 1995
---------- ----------
Deferred tax asset ---
Accounts receivable allowance....................... $ 479 $ 218
Inventory reserve................................... 1,215 322
Purchased intangibles............................... 5,910 680
Reserve for distributor inventories................. 82 336
Other temporary differences......................... 461 187
Net operating loss and tax credit carryforwards..... 571 482
----------- ------------
8,718 2,225
----------- ------------
Deferred tax liability---
Direct marketing costs and prepaid expenses......... (535) (308)
----------- ------------
Valuation allowance..................................... (7,702) (1,917)
----------- ------------
$ 481 $ ---
=========== ============
39
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(5) INCOME TAXES - (CONTINUED)
The Company has placed a significant valuation allowance against its net
deferred tax asset. The valuation allowance increased during 1996 by $5,785
since the Company believes it is "more likely than not" that it will not be able
to utilize it's deferred tax asset. The Company has recorded a deferred tax
asset for that portion to which it will "more likely than not" benefit.
As of December 31, 1996, the Company has available net operating loss
carryforwards of $1,023. These carryforwards expire through 2008 and are
subject to review and possible adjustment by the Internal Revenue Service. The
Tax Reform Act of 1986 contains provisions that may limit the amount of net
operating loss and credit carryforwards that the Company may utilize in any one
year in the event of certain cumulative changes in ownership over a three-year
period in excess of 50%, as defined, therein.
A reconciliation of the federal statutory rate to the Company's effective
tax rate is as follows:
1996 1995 1994
---------- ----------- -----------
Federal Statutory Rate.................................................... (34.0%) 34.0% (34.0%)
State taxes, net of federal benefit....................................... (6.2%) 6.6% (5.1%)
Recognition of net operating loss carryforwards and deferred provision.... 39.6% (10.0%) 38.9%
---------- ----------- -----------
Effective tax rate........................................................ 0.6% 30.6% 0.2%
========== =========== ===========
(6) LINE OF CREDIT
The Company has a $10,000 line of credit (the "Line") that allows the
Company to borrow up to the lesser of $10,000 or 80% of qualified eligible
accounts receivable, as defined, plus 40% of foreign qualified receivables, as
defined. Borrowings bear interest at the bank's prime rate (8.25% at December
31, 1996). The Line expires on April 1, 1998, at which time all outstanding
borrowings must be repaid. The Company has pledged all accounts receivable as
collateral. The Line requires the Company to meet certain financial covenants,
as defined in the Line. At December 31, 1996, the Company was in compliance
with all of these covenants. As of December 31, 1996, no amounts were
outstanding.
(7) LONG-TERM OBLIGATIONS AND COMMITMENTS
Leases
The Company conducts its operations in leased facilities and leases certain
equipment under operating and capital leases expiring at various times through
2001.
The Company has a master lease agreement, as modified, that allows the
Company to enter into up to $3,000 in fair market value equipment leases.
Borrowings under both lease agreements are payable in monthly installments
ranging from $1 to $9, including interest ranging from 7.01 % to 24.49% with
terms ranging between 36 and 50 months. As of December 31, 1996, the Company had
the ability to borrow up to $3,000 under this master lease agreement.
40
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(7) LONG-TERM OBLIGATIONS AND COMMITMENTS -(CONTINUED)
The approximate minimum annual lease payments under both the operating and
capital leases are as follows:
OPERATING CAPITAL
LEASES LEASES
------------- ----------
1997.......................................... $ 1,670 $ 1,164
1998.......................................... 1,513 503
1999.......................................... 1,165 28
2000.......................................... 326 0
Thereafter.................................... 976 0
------------- ----------
$ 5,650 1,695
============
Less --- Amount representing interest......... 122
----------
Present value of minimum lease payments....... 1,573
Less --- Current portion...................... 1,063
----------
$ 510
==========
Total rental expense included in the accompanying consolidated statements
of operations for the years ended December 31, 1996, 1995 and 1994 was $1,418,
$846 and $486, respectively.
The amount of equipment under capital lease and the related accumulated
amortization are as follows:
1996 1995
----------- ---------
Equipment acquired under capital lease.... $ 3,895 $ 3,804
Accumulated amortization.................. (2,559) (1,300)
----------- ---------
Net equipment acquired under capital lease $ 1,336 $ 2,504
=========== =========
Total amortization expense included in the accompanying consolidated
statements of operations for the years ended December 31, 1996, 1995 and 1994 is
$1,259, $1,001 and $273 , respectively.
Royalties
The Company has entered into several software license agreements. These
agreements provide the Company with exclusive worldwide licenses to distribute
certain software products. The Company is required to pay royalties on all
related sales, subject to the following aggregate royalty targets. If the
royalty targets for any specific product are not met by the Company, then the
Company may lose the exclusive distribution rights to that software product.
1997.................................. $ 2,105
1998.................................. 3,050
1999.................................. 3,900
2000.................................. 500
2001.................................. 500
Thereafter............................ 2,000
----------
$ 12,055
==========
Total royalty expense included in the accompanying consolidated statements
of operations for the years ended December 31, 1996, 1995 and 1994 was $2,178,
$2,333 and $1,184, respectively.
41
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(8) STOCKHOLDERS' EQUITY
Initial Public Offering
In August of 1995, the Company completed an initial public offering (the
"IPO") of 2,360,000 shares of its common stock for $15.00 per share. The sale
of common stock resulted in net proceeds to the company of $31,647, after
deducting all expenses related to the IPO. In connection with the Company's
initial public offering, the redeemable convertible preferred shares were
automatically converted into 3,841,632 shares of common stock.
Common Stock
The Company has 20,000,000 authorized shares of common stock $.01 par
value, of which 11,008,243 shares were issued and outstanding at December 31,
1996.
Preferred Stock
The Company has an authorized class of Preferred Stock consisting of
2,000,000 shares, which may be issued from time to time in one or more series.
The Company's Board of Directors has authority to issue the shares of Preferred
Stock in one or more series, to establish the number of shares to be included in
each series and to fix the designation, powers preferences and rights of the
shares of each series and the qualifications, limitations or restrictions
thereof, without any further vote or action by the stockholders. The issuance
of Preferred Stock could decrease the amount of earnings and assets available
for distribution to holders of Common Stock, and may have the effect of
delaying, deferring or preventing a change in control of the Company. The
Company had not issued any shares of Preferred Stock as of December 31, 1996.
Reserved Shares of Stock
The Company had reserved 2,726,614 shares of common stock at December 31,
1996 for the exercise of stock options under the 1992 Employee and Consultant
Stock Option Plan, 1995 Directors Stock Option Plan and 1995 Employee Stock
Purchase Plan.
Stock Split
On May 18, 1995, the Board of Directors approved a one-for-six reverse
stock split. Accordingly, all shares of common stock and the conversion ratio of
preferred stock have been retroactively adjusted in the accompanying
consolidated financial statements for all periods presented to reflect the
split.
(9) STOCK OPTION PLANS
In July 1992, the Company adopted the 1992 Employee and Consultant Stock
Option Plan, as amended (the "Plan"). Pursuant to the Plan, the Company may
grant to employees and consultants of the Company statutory and nonstatutory
stock options to purchase up to 2,550,000 shares of common stock.
The Company's 1995 Directors Stock Option Plan ( the "Director's Plan") was
adopted on May 18, 1995 and provides for the granting of options to purchase up
to 100,000 shares of Common Stock to directors who are not employees of the
Company.
42
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(9) STOCK OPTION PLANS-(CONTINUED)
Stock option activity for the option plans was as follows:
WGHT AVG
NUMBER EXERCISE
OF EXERCISE PRICE PRICE
SHARES RANGE PER SHARE PER SHARE
------ --------------- ----------
Outstanding, December 31, 1993 1,009,099 $ .0307 - $ 1.2600 $ .2259
Granted....................... 638,502 .5040 - 2.4600 2.1185
Exercised..................... (376,874) .0307 - .9600 .0349
Terminated.................... (192,286) .5040 - 2.4600 1.7355
------------ -----------------------------------------
Outstanding, December 31, 1994 1,078,441 .0307 - 2.4600 1.1685
Granted....................... 308,607 2.4600 - 17.5000 10.7900
Exercised..................... (444,878) .0307 - 9.0000 .3412
Terminated.................... (318,446) .5040 - 16.1250 2.0496
------------ -----------------------------------------
Outstanding, December 31, 1995 623,724 .0307 - 17.5000 5.6373
Granted....................... 603,217 5.1250 - 16.7500 8.8626
Exercised..................... (91,795) .5040 - 9.0000 1.5642
Terminated.................... (112,240) .5040 - 16.1250 8.6597
------------ -----------------------------------------
Outstanding, December 31, 1996.... 1,022,906 $ .0307 $ 17.5000 $ 7.5710
============ =========================================
Exercisable, December 31, 1996.... 186,721 $ .0307 $ 17.5000 $ 5.2891
============ =========================================
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123 Accounting for Stock Based Compensation, which requires the measurement of
the fair value of stock options or warrants to be included in the statement of
operations or disclosed in the notes to the financial statements. The Company
has determined that it will continue to account for stock-based compensation for
employees under Accounting Principles Board Opinion No. 25 and elect the
disclosure-only alternative under SFAS No. 123 for options granted in 1996 and
1995 using the Black-Scholes option pricing model prescribed by SFAS No. 123.
The weighted average assumptions are as follows:
1996 1995
----------- -----------
Risk-free interest rate................ 6.34% 6.50%
Expected dividend yield................ --- ---
Expected lives......................... 7 7
Expected volatility.................... 73.56% 73.56%
Had compensation cost for these plans been determined consistent with SFAS
No. 123, the Company's net (loss) income and pro forma net (loss) income per
share would have been reduced to the following pro forma amounts:
1996 1995
----------- ---------
Net (Loss) Income..............As Reported (15,861) 3,672
Pro Forma (16,846) 3,378
Net (Loss) Income Per Share....As Reported (1.46) 0.40
Pro Forma (1.55) .37
43
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(9) STOCK OPTION PLANS-(CONTINUED)
Because the method prescribed by SFAS No. 123 has not been applied to
options granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.
Employee Stock Purchase Plan
On May 18, 1995, the Company adopted the 1995 Employee Stock Purchase plan
pursuant to which up to 1,000,000 shares of common stock may be issued. The
plan consists of semiannual offerings commencing on the first day the Company's
common stock was publicly traded and each subsequent offering commencing on
January 1 and July 1 of each year. The maximum number of shares of common stock
that may be purchased by an employee is determined on the first day of each
offering period, as defined in the Plan. The price at which the shares are
purchased is the lower of 85% of the closing price on the first or last day of
the offering period.
(10) 401 (K) PLAN
In 1994, the Company established a plan under Section 401 (k) of the
Internal Revenue Code (the "401 (k) Plan") covering all eligible employees, as
defined. Participants in the 401 (k) Plan may not contribute more than the
lesser of the specified statutory amount or 15% of his or her pretax total
compensation. The 401 (k) Plan permits, but does not require, additional
contributions to the 401(k) Plan by the Company. The Company made no
contributions during 1996, 1995 or 1994.
(11) ACCRUED EXPENSES
Accrued expenses consisted of the following:
1996 1995
--------- ---------
Payroll and payroll related $ 691 $ 564
Royalties.................. 240 511
Other...................... 1,321 1,190
-------- ---------
$ 2,252 $ 2,265
======== =========
(12) SUBSEQUENT EVENTS
On January 24, 1997, the Company acquired the stock of Purview
Technologies, Inc. , a development stage company engaged in Internet usage
monitoring software development. The Company paid $1,000 in cash and issued
205,712 shares of its common stock. The aggregate purchase price including
estimated direct acquisition costs was $2,292. This transaction will be
accounted for as a purchase in accordance with APB No. 16.
On January 28, 1997, the Company acquired the stock of csd Software GmbH ,
a German developer and marketer of PC Desktop Software Management Tools. The
Company paid $5,000 in cash and issued 1,315,790 shares of its common stock. The
aggregate purchase price including estimated direct acquisition costs was
$15,623. This transaction will be accounted for as a purchase in accordance with
APB No. 16.
For each of these acquisitions, the Company is in the process of obtaining
independent appraisals to value the intangible assets acquired including
incomplete purchased research and development. The Company anticipates that a
substantial portion of the purchase price for these two acquisitions will be
charged to operations as purchased incomplete research and development.
44
ARTHUR
ANDERSEN
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To ON Technology Corporation and Subsidiaries:
We have audited in accordance with generally accepted standards, the
consolidated financial statements of On Technology Corporation and Subsidiaries
included in this Form 10-K and have issued our reporting thereon dated January
21, 1997 (except for the matters discussed in Note 12 as to which the dates are
January 24, 1997 and January 28, 1997, respectively). Our audit was made for
the purpose of forming an opinion on the basic consolidated financial statements
taken as a whole. The schedule listed in Item 14 of this Form 10-K is presented
for purposes of complying with the Securities and Exchange Commission's rules
and is not part of the basic consolidated financial statements. This schedule
has been subjected to the auditing procedures applied in the audit of the basic
consolidated financial statements and, in our opinion, fairly states in all
material respects, the financial data required to be set forth therein, in
relation to the basic consolidated financial statements taken as a whole.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 21, 1997
45
SCHEDULE II
ON TECHNOLOGY CORPORATION AND SUBSIDIARIES
Valuation and Qualifying Accounts
For the years Ended December 31, 1994, 1995 and 1996
(dollars in thousands)
BALANCE OTHER BALANCE,
BEGINNING OF CHARGED TO ADDITIONS TO END
YEAR EXPENSE ALLOWANCE(1) WRITE-OFFS OF YEAR
Allowance for doubtful accounts
- -------------------------------
Year ended December 31, 1994 $ 61 $395 $173 $195 $ 434
Year ended December 31, 1995 $434 $256 --- $ 85 $ 605
Year ended December 31, 1996 $605 $639 --- $ 53 $1,191
(1) Additions arising through the acquisition of DaVinci Systems Corporation in
1994.
46
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) 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/ Christopher A. Risley
____________________________________
Date: March 31, 1997 Name: Christopher A. Risley
Title: Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated.
/s/ John M. Bogdan
_____________________________________
Date: March 31, 1997 Name: John M. Bogdan
Title: Vice President of Finance
and Chief Financial Officer
/s/ Brian T. Horey
_____________________________________
Date: March 31, 1997 Name: Brian T. Horey
Title: Director
/s/ William C. Hulley
_____________________________________
Date: March 31, 1997 Name: William C. Hulley
Title: Director
/s/ Allan L. Wallack
_____________________________________
Date: March 31, 1997 Name: Allan L. Wallack
Title: Director
/s/ Michael J. Zak
_____________________________________
Date: March 31, 1997 Name: Michael J. Zak
Title: Director
/s/ R. Stephen Cheheyl
_____________________________________
Date: March 31, 1997 Name: R. Stephen Cheheyl
Title: Director
47
INDEX TO EXHIBITS
Sequentially
Numbered
Exhibit No. Exhibit Title Pages
- ----------- ------------- -----
3.1.+ Fourth Amended and Restated Certificate of Incorporation of ON
Technology Corporation, incorporated by reference to exhibit 3.1
to the Company's Registration Statement on Form S-1 (Reg. No. 33-
92562).
3.2.+ Amended and Restated By-Laws of ON Technology Corporation,
incorporated by reference to exhibit 3.2 to the Company's
Registration Statement on Form S-1 (Reg. No. 33-92562).
10.1.*+ 1992 Employee and Consultant Stock Option Plan, as amended.
10.2.*+ 1995 Directors Stock Option Plan, incorporated by reference to
exhibit 10.2 to the Company's Registration Statement on Form S-1
(Reg. No. 33-92562).
10.3.*+ 1995 Employee Stock Purchase Plan, as amended.
10.4.+ Second Restated Registration Rights Agreement dated June 1, 1994
by and among ON Technology Corporation and the holders of its
Series A, B and C Convertible Preferred Stock and First Amendment
thereto dated January 12, 1995, incorporated by reference to
exhibit 10.4 to the Company's Registration Statement on Form S-1
(Reg. No. 33-92562).
10.5.*+ Employment Agreement dated May 18, 1995 by and between ON
Technology Corporation and Christopher A. Risley, incorporated by
reference to exhibit 10.5 to the Company's Registration Statement
on Form S-1 (Reg. No. 33-92562).
10.6.*+ Employment Agreement dated May 18, 1995 by and between ON
Technology Corporation and John A. Rizzi, incorporated by
reference to exhibit 10.6 to the Company's Registration Statement
on Form S-1 (Reg. No. 33-92562).
10.7.*+ Employment Agreement dated May 18, 1995 by and between ON
Technology Corporation and Loren K. Platzman, incorporated by
reference to exhibit 10.7 to the Company's Registration Statement
on Form S-1 (Reg. No. 33-92562).
10.8.*+ Employment Agreement dated May 18, 1995 by and between ON
Technology Corporation and Ivan J. O'Sullivan, incorporated by
reference to exhibit 10.8 to the Company's Registration Statement
on Form S-1 (Reg. No. 33-92562).
10.9.*+ Employment Agreement dated May 18, 1995 by and between ON
Technology Corporation and John M. Bogdan, incorporated by
reference to exhibit 10.9 to the Company's Registration Statement
on Form S-1 (Reg. No. 33-92562).
10.10.*+ Employment Agreement dated May 18, 1995 by and between ON
Technology Corporation and James A. Batson, incorporated by
reference to exhibit 10.10 to the Company's Registration
Statement on Form S-1 (Reg. No. 33-92562).
10.11.*+ Form of Indemnity Agreement by and between ON Technology and its
directors and executive offices, incorporated by reference to
exhibit 10.11 to the Company's Registration Statement on Form S-1
(Reg. No. 33-92562).
10.12.+ Lease dated July 9, 1993 by and between ON Technology Corporation
and Boston Properties, incorporated by reference to exhibit 10.12
to the Company's Registration Statement on Form S-1 (Reg. No. 33-
92562).
10.13.+ Sublease dated October 7, 1994 by and between On Technology
Corporation and RSTAR Corporation, incorporated by reference to
exhibit 10.13 to the Company's Registration Statement on Form S-1
(Reg. No. 33-92562).
10.14.+ Lease entered into in August 1994 by and between ON Technology
Corporation and Perimeter Park West, incorporated by reference to
exhibit 10.14 to the Company's Registration Statement on Form S-1
(Reg. No. 33-92562).
10.15.+ Letter Agreement dated April 1, 1996 between Fleet Bank of
Massachusetts, N.A. and ON Technology Corporation, incorporated
by reference to exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1996.
48
Statement on Form S-1 (Reg. No. 33-92562).
10.16.+ Software License Agreement among ON Technology Corporation and e.g.
Software, Inc. dated July 1, 1994, incorporated by reference to
exhibit 10.16 to the Company's Registration Statement on Form S-1
(Reg. No. 33-92562).
10.17.+ Software License Agreement among ON Technology Corporation,
Integrity Software, Inc. and Integrity Software, Ltd. dated December
20, 1993, incorporated by reference to exhibit 10.17 to the
Company's Registration Statement on Form S-1 (Reg. No. 33-92562).
10.18+ Agreement by and between Database America Information Systems, Inc.
and ON Technology Corporation dated July 6, 1995, incorporation by
reference to exhibit 10.18 to Amendment No. 1 to the Company's
Registration Statement on Form S-1 (Reg. No. 33-92562).
10.19.*+ Directors and officers liability insurance policies issued by
SteadFast Insurance Company and Evanston Insurance Company
incorporated by reference to Exhibit 10.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 1995.
11.0. Computation of net income per share.
21.0. Subsidiaries of the registrant.
23.1. Consent of Arthur Andersen LLP.
27.0 Financial Data Schedule
* Management contracts or compensatory plans or arrangments covering executive
officers or directors of ON Technology Corporation.
+ Previously filed with the Securities and Exchange Commission and incorporated
by reference.
49