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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934. For the quarterly period ended September 30, 2002.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934. For the transition period from ____________ to_____________
COMMISSION FILE NUMBER 0-23067
CONCORD COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2710876
(State of incorporation) (IRS Employer Identification Number)
600 NICKERSON ROAD
MARLBORO, MASSACHUSETTS 01752
(508) 460-4646
(Address and telephone of principal executive offices)
----------------
INDICATE BY CHECK MARK WHETHER REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO
BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS, AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS
FOR THE PAST 90 DAYS.
YES X NO
17,113,875 SHARES OF THE REGISTRANT'S COMMON STOCK, $0.01 PAR VALUE, WERE
OUTSTANDING AS OF OCTOBER 30, 2002.
THIS DOCUMENT CONTAINS 40 PAGES.
THE EXHIBIT INDEX IS ON PAGE 36.
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 2002
CONTENTS
PAGE
----
PART I: FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets:
September 30, 2002 and December 31, 2001 3
Condensed Consolidated Statements of Operations:
Three and nine months ended September 30, 2002
and September 30, 2001 4
Condensed Consolidated Statements of Cash Flows:
Nine months ended September 30, 2002
and September 30, 2001 5
Notes to Condensed Consolidated Financial Statements 6-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-26
Item 3. Quantitative and Qualitative Disclosures about Market Risk 27
Item 4. Controls and Procedures 28
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2. Changes in Securities and Use of Proceeds 29
Item 3. Defaults Upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 30
Item 6. Exhibits and Reports on Form 8-K 30
SIGNATURE 31
CERTIFICATIONS 32-35
EXHIBIT INDEX 36-37
2
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONCORD COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2002 2001
---- ----
ASSETS
Current Assets:
Cash and cash equivalents $ 8,680,564 $ 9,010,811
Marketable securities 62,809,802 59,333,068
Restricted cash 938,576 --
Accounts receivable, net of allowance of $1,369,295 and $1,409,835
at September 30, 2002 and December 31, 2001, respectively 18,697,277 16,537,131
Prepaid expenses and other current assets 2,650,452 3,057,797
------------ ------------
Total current assets 93,776,671 87,938,807
------------ ------------
Equipment and improvements, at cost:
Equipment 22,400,710 19,636,704
Leasehold improvements 6,081,378 5,956,710
------------ ------------
28,482,088 25,593,414
Less-- accumulated depreciation and amortization 19,341,448 14,798,688
------------ ------------
9,140,640 10,794,726
------------ ------------
Deferred tax asset 3,500,000 3,500,000
Other long-term assets 240,623 246,655
------------ ------------
3,740,623 3,746,655
------------ ------------
Total assets $106,657,934 $102,480,188
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 2,759,692 $ 3,553,417
Accrued expenses 12,852,274 13,278,825
Deferred revenue 24,644,888 22,141,078
------------ ------------
Total current liabilities 40,256,854 38,973,320
------------ ------------
Stockholders' Equity:
Common stock, $0.01 par value:
Authorized-- 50,000,000 shares
Issued and outstanding-- 17,111,903 and 16,901,193 shares
at September 30, 2002 and December 31, 2001, respectively 171,119 169,012
Additional paid-in capital 98,063,347 96,365,287
Deferred compensation (91,341) (241,547)
Accumulated other comprehensive income 1,488,091 1,892,264
Accumulated deficit (33,230,136) (34,678,148)
------------ ------------
Total stockholders' equity 66,401,080 63,506,868
------------ ------------
Total liabilities and stockholders' equity $106,657,934 $102,480,188
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
CONCORD COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
Revenues:
License revenues $12,201,638 $13,207,481 $38,520,251 $ 39,759,656
Service revenues 10,852,119 8,632,804 31,721,899 24,125,715
----------- ----------- ----------- ------------
Total revenues 23,053,757 21,840,285 70,242,150 63,885,371
Cost of Revenues
Cost of license revenues 469,322 381,332 1,430,071 1,660,901
Cost of service revenues 3,781,787 3,722,142 11,321,745 11,799,437
----------- ----------- ----------- ------------
Total cost of revenues 4,251,109 4,103,474 12,751,816 13,460,338
----------- ----------- ----------- ------------
Gross profit 18,802,648 17,736,811 57,490,334 50,425,033
----------- ----------- ----------- ------------
Operating Expenses:
Research and development 5,258,779 6,030,382 16,445,438 18,716,078
Sales and marketing 11,818,136 12,872,464 35,842,755 38,178,493
General and administrative 1,742,436 2,029,605 5,569,231 6,821,317
Stock-based compensation 25,289 41,360 84,997 281,790
----------- ----------- ----------- ------------
Total operating expenses 18,844,640 20,973,811 57,942,421 63,997,678
----------- ----------- ----------- ------------
Operating loss (41,992) (3,237,000) (452,087) (13,572,645)
Other Income (Expense)
Interest income 816,929 886,694 2,395,837 2,547,459
Other (expense) income (75,707) 4,171 (120,530) (45,745)
----------- ----------- ----------- ------------
Total other income, net 741,222 890,865 2,275,307 2,501,714
----------- ----------- ----------- ------------
Income (loss) before income taxes 699,230 (2,346,135) 1,823,220 (11,070,931)
Provision for income taxes 135,565 25,000 375,208 111,298
----------- ----------- ----------- ------------
Net income (loss) $ 563,665 $(2,371,135) $ 1,448,012 $(11,182,229)
=========== =========== =========== ============
Net income (loss) per common and potential common share:
Basic $ 0.03 $ (0.14) $ 0.09 $ (0.67)
=========== =========== =========== ============
Diluted $ 0.03 $ (0.14) $ 0.08 $ (0.67)
=========== =========== =========== ============
Weighted average common and potential common
shares outstanding:
Basic 17,104,224 16,699,679 17,017,611 16,644,181
=========== =========== =========== ============
Diluted 17,275,667 16,699,679 17,749,296 16,644,181
=========== =========== =========== ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
CONCORD COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
-----------------
SEPTEMBER 30, SEPTEMBER 30,
2002 2001
---- ----
Cash Flows from Operating Activities:
Net income (loss) $ 1,448,012 $(11,182,229)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 4,542,760 4,612,633
Stock-based compensation 84,997 281,790
Changes in current assets and liabilities:
Accounts receivable (2,160,146) 4,576,769
Prepaid expenses and other current assets 407,345 (660,458)
Accounts payable (793,725) 148,315
Accrued expenses (1,418,611) 3,010,043
Deferred revenue 2,503,810 5,041,563
------------ ------------
Net cash provided by operating activities 4,614,442 5,828,426
------------ ------------
Cash Flows from Investing Activities:
Purchases of equipment and improvements (2,888,674) (3,563,454)
Change in other assets 6,032 (13,160)
Investments in marketable securities (9,776,647) (14,922,327)
Deposit of restricted cash (938,576) --
Proceeds from sales of marketable securities 6,887,800 9,730,811
------------ ------------
Net cash used in investing activities (6,710,065) (8,768,130)
------------ ------------
Cash Flows from Financing Activities:
Proceeds from issuance of common stock 1,765,376 781,055
------------ ------------
Net cash provided by financing activities 1,765,376 781,055
------------ ------------
Net decrease in cash and cash equivalents (330,247) (2,158,649)
Cash and cash equivalents, beginning of period 9,010,811 10,725,265
------------ ------------
Cash and cash equivalents, end of period $ 8,680,564 $ 8,566,616
============ ============
Supplemental Disclosure of Cash Flow Information:
Cash paid for taxes $ 186,405 $ 245,602
============ ============
Supplemental Disclosure of Noncash Transactions:
Reversal of deferred compensation related to forfeitures
of stock options $ (65,209) $ (1,129,486)
============ ============
Retirement of fully depreciated assets $ -- $ 343,467
============ ============
Unrealized gain on available-for-sale securities $ 587,886 $ 2,089,097
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
CONCORD COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
FORM 10-Q, SEPTEMBER 30, 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation
The accompanying condensed consolidated financial statements have been
presented by Concord Communications, Inc. (the "Company" or "Concord") unaudited
(except the balance sheet information as of December 31, 2001 which has been
derived from audited financial statements) in accordance with accounting
principles generally accepted in the United States of America for interim
financial statements and with the instructions to Form 10-Q and Regulation S-X
pertaining to interim financial statements. Accordingly, these interim financial
statements do not include all information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. The financial statements reflect all adjustments and
accruals of a normal recurring nature, which management considers necessary for
a fair presentation of the Company's financial position as of September 30, 2002
and December 31, 2001, and the Company's results of operations for the three and
nine months ended September 30, 2002 and 2001. The results for the interim
periods presented are not necessarily indicative of results to be expected for
any future period. The financial statements should be read in conjunction with
the audited financial statements and the notes thereto included in the Company's
2001 Annual Report on Form 10-K filed with the Securities and Exchange
Commission in March 2002.
(b) Principles of Consolidation
The accompanying condensed consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All material
intercompany accounts and transactions have been eliminated in consolidation.
(c) Cash, Cash Equivalents and Marketable Securities
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 marketable securities as
available-for-sale and recorded them at fair value, with the unrealized gains
and losses reported as a separate component of stockholders' equity until
realized. The Company considers highly liquid investments, purchased with an
original maturity of 90 days or less, to be cash equivalents. Cash and cash
equivalents were $8,680,564 and $9,010,811 at September 30, 2002 and December
31, 2001, respectively, and consisted primarily of money market funds.
(d) Restricted Cash
Restricted cash totaling $938,576 at September 30, 2002 consists of money
market funds held in the Company's name and custodied with a major financial
institution. Such funds are being used as collateral under a letter of credit
arrangement with a Company supplier.
(e) Revenue Recognition
The Company's revenues consist of software license revenues and service
revenues. Software license revenues are recognized in accordance with the
American Institute of Certified Public Accountants' Statement of Position
("SOP") 97-2, Software Revenue Recognition, as modified by SOP 98-9,
Modification of SOP 97-2, Software Revenue Recognition with respect to Certain
Transactions. Under SOP 97-2, software license revenues are recognized upon
execution of a contract and delivery of software, provided that the license fee
is fixed or determinable, no significant production, modification or
customization of the software is required and collection is considered
reasonably assured by management. Revenues under multiple-element arrangements,
which typically
6
include software products, services and maintenance sold together, are allocated
to each element using the residual method in accordance with SOP 98-9. Under the
residual method, the fair value of the undelivered elements is deferred and
subsequently recognized when these elements are delivered. The Company has
established sufficient vendor specific objective evidence for professional
services, training, and maintenance and customer support services based on the
price charged when these elements are sold separately. Accordingly, software
license revenues are recognized under the residual method in arrangements in
which software is licensed with professional services, training, and maintenance
and customer support services.
Service revenues include professional services, training and maintenance
and customer support fees. Professional services are not essential to the
functionality of the other elements in an arrangement and are accounted for
separately. Service revenues are recognized as the services are performed.
Maintenance revenues, a component of service revenues, are derived from
customer support agreements generally entered into in connection with initial
software license sales and subsequent renewals. Maintenance and customer support
fees include the right to unspecified upgrades on a when-and-if-available basis
and ongoing technical support. Maintenance revenues are recognized ratably over
the term of the maintenance period. Payments for maintenance fees are generally
made in advance and are included in deferred revenue. As of September 30, 2002
and December 31, 2001, deferred revenue includes approximately $19.3 million and
$17.1 million, respectively, of deferred maintenance revenues.
(f) Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
(g) Financial Instruments, Concentration of Credit Risk and Significant
Customers
The Company has estimated the fair value of financial instruments using
available market information and appropriate valuation methodologies. The
carrying values of cash, cash equivalents, restricted cash, marketable
securities, accounts receivable, accounts payable, and accrued expenses
approximate fair market value due to the short-term nature of these financial
instruments. Financial instruments that potentially subject the Company to
concentrations of credit risk are principally cash, cash equivalents, restricted
cash, marketable securities and accounts receivable. The Company has no
significant off-balance-sheet or concentration of credit risk exposure such as
foreign exchange contracts or option contracts. The Company maintains its cash,
cash equivalents, restricted cash and marketable securities with established
financial institutions. Concentration of credit risk with respect to accounts
receivable is limited to certain customers to whom the Company makes substantial
sales. To reduce its credit risk, the Company routinely assesses the financial
strength of its customers. The Company maintains an allowance for potential
credit losses but historically has not experienced any significant losses
related to individual customers or groups of customers in any particular
industry or geographic area. No individual customer or reseller accounted for
more than 10% of revenues for the three and nine months ended September 30, 2002
or September 30, 2001. No one customer or reseller accounted for more than 10%
of accounts receivable as of September 30, 2002. One customer, a reseller in
South America, accounted for 13.4% of accounts receivable at December 31, 2001;
a total of 7.2% of the receivables from this customer was included in the
Company's deferred revenue at December 31, 2001. As of September 30, 2002, this
customer represented 3.0% of accounts receivable.
(h) Derivative Financial Instruments
The Company uses forward contracts to reduce its exposure to foreign
currency risk and variability in operating results due to fluctuations in
exchange rates underlying the value of accounts receivable denominated in
foreign currencies until such receivables are collected. A forward contract
obligates the Company to exchange predetermined amounts of specified foreign
currencies at specified exchange rates on specified dates. These foreign
currency forward exchange contracts are denominated in the same currency in
which the underlying foreign currency receivables are denominated and bear a
contract value and maturity date that approximate the value and
7
expected settlement date, respectively, of the underlying transactions. For
contracts that are designated and effective as hedges, unrealized gains and
losses on open contracts at the end of each accounting period, resulting from
changes in the fair value of these contracts, are recognized in earnings in the
same period as gains and losses on the underlying foreign denominated
receivables or payables are recognized and generally offset. Gains and losses on
forward contracts and foreign denominated receivables are included in other
income (expense), net. The Company does not enter into or hold derivatives for
trading or speculative purposes and only enters into contracts with highly rated
financial institutions.
At September 30, 2002, the Company had one forward contract outstanding,
which is presented in the table below. The notional exchange rate is quoted
using market conventions where the currency is expressed in currency units per
U.S. dollar.
Fair
Market
Maturity Notional Notional Value as of
Currency Position Date Amount Exchange Rate September 30, 2002
- -------- -------- ----- ------ ------------- ------------------
Euro Sell 10/28/02 $486,169 0.9715 $472,314
(i) Reclassifications
Certain amounts in the prior period's financial statements have been
reclassified to conform to the current period's presentation.
2. BASIC AND DILUTED INCOME/LOSS PER COMMON SHARE
The Company computes earnings per share following the provisions of SFAS
No. 128, Earnings per Share. SFAS No. 128 establishes standards for computing
and presenting earnings per share and applies to entities with publicly held
common stock or potential common stock. Basic net income (loss) per share is
computed using the weighted-average number of common shares outstanding for a
period. Diluted net income (loss) per share is computed using the
weighted-average number of common and dilutive common-equivalent shares
outstanding for the period. Diluted net loss per common share is the same as
basic net loss per common share for the three and nine months ended September
30, 2001, as the effects of potential common stock are antidilutive. Dilutive
common-equivalent shares primarily consist of employee stock options. The
dilutive effect of outstanding stock options is computed using the treasury
stock method. For the three and nine months ended September 30, 2002, employee
stock options to purchase 3,142,910 and 2,107,830 shares, respectively, were
outstanding but not included in the diluted weighted-average share calculation
as their effects would have been antidilutive. For the three and nine months
ended September 30, 2001, employee stock options to purchase 2,318,735 and
2,436,069 shares, respectively, were outstanding but not included in the diluted
weighted-average share calculation as the effect would have been antidilutive as
a result of the Company's reported loss for the periods.
Calculation of the basic and diluted net income (loss) per share and
potential common share are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Net income (loss) applicable to common stockholders $ 563,665 $(2,371,135) $ 1,448,012 $(11,182,229)
=========== =========== =========== ============
Weighted average common shares outstanding 17,104,224 16,699,679 17,017,611 16,644,181
Potential common shares pursuant to stock options 171,443 -- 731,685 --
----------- ----------- ----------- ------------
Diluted weighted average shares 17,275,667 16,699,679 17,749,296 16,644,181
=========== =========== =========== ============
Basic net income (loss) per common share 0.03 (0.14) 0.09 (0.67)
=========== =========== =========== ============
Diluted net income (loss) per common and potential common share 0.03 (0.14) 0.08 (0.67)
=========== =========== =========== ============
8
3. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) for the three and nine months ended September
30, 2002 and 2001 is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---------- ----------- ---------- ------------
Net income (loss) available to common stockholders $ 563,665 $(2,371,135) $1,448,012 $(11,182,229)
Unrealized gain on marketable securities 595,749 1,434,424 587,886 2,089,097
---------- ----------- ---------- ------------
Comprehensive income (loss) $1,159,414 $ (936,711) $2,035,898 $ (9,093,132)
========== =========== ========== ============
4. SEGMENT REPORTING AND INTERNATIONAL INFORMATION
The Company follows the provisions of SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. SFAS No. 131 establishes
standards for reporting information regarding operating segments in annual
financial statements and requires selected information for those segments to be
presented in interim financial reports issued to stockholders. SFAS No. 131 also
establishes standards for related disclosures about products and services and
geographic areas. Operating segments are identified as components of an
enterprise about which separate, discrete financial information is available for
evaluation by the chief operating decision maker, or decision making group, in
making decisions on how to allocate resources and assess performance. The
Company's chief decision making group, as defined under SFAS No. 131, is the
executive management committee which is comprised of the executive officers of
the Company.
The following table presents the approximate revenues by major
geographical regions:
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
United States $15,016,000 $12,951,000 $44,372,000 $39,545,000
Europe 4,634,000 6,197,000 15,533,000 15,234,000
Rest of the World 3,404,000 2,692,000 10,337,000 9,106,000
----------- ----------- ----------- -----------
Total $23,054,000 $21,840,000 $70,242,000 $63,885,000
=========== =========== =========== ===========
No one country, except the United States, accounts for greater than 10% of
total revenues. Substantially all of the Company's assets are located in the
United States.
The Company's reportable segments are determined by customer type: managed
service providers/telecommunications carriers (MSP/TC) and enterprise. The
accounting policies of the segments are the same as those described in Note 1.
The executive management committee evaluates segment performance based on
revenues. Accordingly, all expenses are considered corporate level activities
and are not allocated to segments. Also, the executive management committee does
not assign assets to these segments.
The table presents the approximate revenues by reportable segment:
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
MSP/TC $ 9,703,000 $10,461,000 $27,494,000 $29,393,000
Enterprise 13,351,000 11,379,000 42,748,000 34,492,000
----------- ----------- ----------- -----------
Total $23,054,000 $21,840,000 $70,242,000 $63,885,000
=========== =========== =========== ===========
9
5. RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets, which supersedes SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
SFAS No. 144 further refines the requirements of SFAS No. 121, which required
that companies (1) recognize an impairment loss only if the carrying amount of a
long-lived asset is not recoverable based on its undiscounted future cash flows
and (2) measure an impairment loss as the difference between the carrying amount
and fair value of the asset. In addition, SFAS No. 144 provides guidance on
accounting and disclosure issues surrounding long-lived assets to be disposed of
by sale. The Company adopted SFAS No. 144 beginning on January 1, 2002. The
adoption did not have any impact on the Company's consolidated financial
position, results of operations or cash flows.
In November 2001, the Emerging Issues Task Force issued EITF 01-14 relating
to the accounting for reimbursements received for out-of-pocket expenses. In
accordance with EITF 01-14, reimbursements received for out-of-pocket expenses
incurred should be characterized as revenues in the statement of operations. The
Company has historically accounted for reimbursements received for out-of-pocket
expenses incurred as a reduction to cost of service revenues in the statement of
operations to offset the costs incurred. The Company adopted EITF 01-14 on
January 1, 2002, and comparative financial statements for prior periods have
been reclassified to comply with the guidance in EITF 01-14. During the three
and nine months ended September 30, 2002, reimbursed out-of-pocket expenses
totaled $0 and $18,051, respectively. During the three and nine months ended
September 30, 2001, reimbursed out-of-pocket expenses totaled $18,822 and
$45,936, respectively. There was no impact on the gross profit as a percentage
of total revenues or gross margin for the three and nine month periods ended
September 30, 2002 or 2001.
10
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 2002
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Concord develops, markets and supports the eHealth(TM) Suite of scalable
information technology ("IT") infrastructure fault and performance management
software solutions. Concord's eHealth(TM) Suite integrates fault and performance
management of the systems, applications and networks that comprise today's IT
infrastructure. Concord's solutions optimize the performance and availability of
IT infrastructures on which enterprises, managed service providers and
telecommunication carriers depend for their day-to-day business and operational
success. Concord's software solutions monitor fault conditions throughout the
infrastructure in real time; test availability and responsiveness of critical
services; collect, consolidate, normalize and analyze a high volume of data from
the IT infrastructure; alert IT personnel to faults and potential outages,
maximize uptime of the IT infrastructure and automatically execute corrective
action to restore availability, if desired.
The information provided by Concord or statements made by our employees
may contain forward-looking statements. In particular, some statements contained
in this Form 10-Q for the quarterly period ended September 30, 2002 are not
historical statements including, but not limited to, statements concerning the
plan and objectives of management, increases in revenues (domestically and
internationally), increases in absolute dollars or decreases as a percentage of
revenues in sales and marketing, research and development and general and
administrative expenses (domestically and internationally), Concord's ability to
use deferred tax assets, Concord's success in competing in international
markets, Concord's expected future profitability and Concord's expected
liquidity and capital resources. This document contains forward-looking
statements. Any statements contained herein that do not describe historical
facts are forward-looking statements. The Company makes such forward-looking
statements under the provisions of the "safe harbor" section of the Private
Securities Litigation Reform Act of 1995.
The forward-looking statements contained herein are based on current
expectations but are subject to a number of risks and uncertainties. The facts
that could cause actual results to differ materially from current expectations
include the following: risks of intellectual property rights and litigation,
risks in technology development and commercialization, risks in product
development and market acceptance of and demand for the Company's products,
risks of downturns in economic conditions generally, and in the software,
networking and telecommunications industries specifically, risks associated with
competition and competitive pricing pressures, risks associated with
international sales, risks associated with a limited family of products and
other risks detailed in this Form 10-Q under the heading "Factors that Could
Affect Future Results" and elsewhere in the Company's filings with the
Securities and Exchange Commission.
11
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
financial data as percentages of the Company's total revenues:
UNAUDITED THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
Revenues:
License revenues 52.9% 60.5% 54.8% 62.2%
Service revenues 47.1% 39.5% 45.2% 37.8%
----- ----- ----- -----
Total revenues 100.0% 100.0% 100.0% 100.0%
Cost of Revenues
Cost of license revenues 2.0% 1.7% 2.0% 2.6%
Cost of service revenues 16.4% 17.0% 16.1% 18.5%
----- ----- ----- -----
Total cost of revenues 18.4% 18.8% 18.2% 21.1%
----- ----- ----- -----
Gross profit 81.6% 81.2% 81.8% 78.9%
----- ----- ----- -----
Operating Expenses:
Research and development 22.8% 27.6% 23.4% 29.3%
Sales and marketing 51.3% 58.9% 51.0% 59.8%
General and administrative 7.6% 9.3% 7.9% 10.7%
Stock-based compensation 0.1% 0.2% 0.1% 0.4%
----- ----- ----- -----
Total operating expenses 81.7% 96.0% 82.5% 100.2%
----- ----- ----- -----
Operating loss -0.1% -14.8% -0.6% -21.3%
Other income, net 3.2% 4.1% 3.2% 3.9%
----- ----- ----- -----
Income (loss) before taxes 3.1% -10.7% 2.6% -17.4%
Provision for income taxes 0.6% 0.1% 0.5% 0.2%
----- ----- ----- -----
Net income (loss) 2.5% -10.9% 2.1% -17.6%
----- ----- ----- -----
REVENUES. Concord's revenues consist of software license revenues and
service revenues. Software license revenues are recognized in accordance with
the American Institute of Certified Public Accountants' Statement of Position
("SOP") 97-2, Software Revenue Recognition, as modified by SOP 98-9,
Modification of SOP 97-2, Software Revenue Recognition with Respect to Certain
Transactions. Under SOP 97-2, software license revenues are recognized upon
execution of a contract and delivery of software, provided that the license fee
is fixed or determinable, no significant production, modification or
customization of the software is required and collection is considered
reasonably assured by management. Revenues under multiple-element arrangements,
which typically include software products and maintenance sold together, are
allocated to each element using the residual method in accordance with SOP 98-9.
Service revenues are recognized as the services are performed. Maintenance
revenues, a component of service revenues, are derived from customer support
agreements generally entered into in connection with initial license sales and
subsequent renewals. Maintenance revenues are recognized ratably over the term
of the maintenance period. Payments for maintenance fees are generally made in
advance.
TOTAL REVENUES. The Company's total revenues increased 5.6% to $23.1
million in the three months ended September 30, 2002 from $21.8 million in the
three months ended September 30, 2001. Total revenues increased 10.0% to $70.2
million in the nine months ended September 30, 2002 from $63.9 million in the
nine months ended September 30, 2001.
LICENSE REVENUES. Concord's license revenues are derived from the
licensing of software products. License revenues decreased 7.6% to $12.2
million, or 52.9% of total revenues, in the three months ended September 30,
2002 from $13.2 million, or 60.5% of total revenues, in the three months ended
September 30, 2001. License revenues decreased 3.1% to $38.5 million, or 54.8%
of total revenues, in the nine months ended September 30, 2002, from $39.8
million, or 62.2% of total revenues, in the nine months ended September 30,
2001. The decrease in license revenues for the three months and nine months
ended September 30, 2002 was due, in large part, to decreases in, or
postponements or cancellations of IT infrastructure purchases by some of our
customers due to worldwide economic uncertainty. In addition to the continuing
worldwide slowdown in the economy, political uncertainty resulting in financial
instability in Brazil, reduced spending by some telecommunication carriers on
their infrastructures and the announcement of accounting improprieties by a few
major U.S. based firms have also
12
negatively affected IT spending by our customers and potential customers. The
decrease in license revenues as a percent of total revenues was the result of a
significant increase in service revenues, consisting mainly of maintenance
revenues.
SERVICE REVENUES. Concord's service revenues consist of fees for
maintenance, training and professional services. Service revenues increased
25.7% to $10.9 million, or 47.1% of total revenues, in the three months ended
September 30, 2002 from $8.6 million, or 39.5% of total revenues, in the three
months ended September 30, 2001. Service revenues increased 31.5% to $31.7
million, or 45.2% of total revenues, in the nine months ended September 30, 2002
from $24.1 million, or 37.8% of total revenues, in the nine months ended
September 30, 2001. The increase in service revenues for the three months and
nine months ended September 30, 2002 was attributed to an increase in our
customer base and the resulting demand for services by these customers.
INTERNATIONAL REVENUES. Concord's international revenues decreased 9.6% to
$8.0 million, or 34.9% of total revenues, for the three months ended September
30, 2002 from $8.9 million, or 40.7% of total revenues, for the three months
ended September 30, 2001. International revenues increased 6.3% to $25.9
million, or 36.8% of total revenues, for the nine months ended September 30,
2002 from $24.3 million, or 38.1% of total revenues, for the nine months ended
September 30, 2001. International revenues are primarily driven by customers
based in Europe, as well as the continued expansion of the Company's operations
outside the United States.
SEGMENT REVENUES. Concord's reportable segments are determined by customer
type: managed service providers/telecommunications carriers ("MSP/TC") and
enterprise. Concord's MSP/TC revenues decreased 7.2% to $9.7 million, or 42.1%
of total revenues, for the three months ended September 30, 2002 from $10.5
million, or 47.9% of total revenues, for the three months ended September 30,
2001. MSP/TC revenues decreased 6.5% to $27.5 million, or 39.1% of total
revenues, for the nine months ended September 30, 2002 from $29.4 million, or
46.0% of total revenues, for the nine months ended September 30, 2001. The
decrease in MSP/TC revenues for the three months and nine months ended September
30, 2002 was due to the general reduced spending by major telecommunications
firms on IT infrastructure projects. The general slowdown of the economy in the
United States and abroad, the overcapacity in the telecommunications
infrastructure market and the bankruptcies of some major U.S. carriers have all
contributed to the lower spending by this segment. The decrease in MSP/TC
revenues as a percent of total revenues was the result of a significant increase
in enterprise revenues, including both new and existing customers.
Concord's enterprise revenues increased 17.3% to $13.4 million, or 57.9%
of total revenues, for the three months ended September 30, 2002 from $11.4
million, or 52.1% of total revenues, for the three months ended September 30,
2001. Enterprise revenues increased 23.9% to $42.7 million, or 60.9% of total
revenues, for the nine months ended September 30, 2002 from $34.5 million, or
54.0% of total revenues, for the nine months ended September 30, 2001. The
increase in enterprise revenues for the three and nine months ended September
30, 2002 was due to an increase in orders from new customers and repeat sales to
existing customers.
COST OF REVENUES. Cost of revenues includes cost of license revenues and
cost of service revenues. Cost of revenues increased 3.6% to $4.3 million, or
18.4% of total revenues, in the three months ended September 30, 2002 from $4.1
million, or 18.8% of total revenues, in the three months ended September 30,
2001, resulting in gross margins of 81.6% and 81.2% respectively. Cost of
revenues decreased 5.3% to $12.8 million, or 18.2% of total revenues, in the
nine months ended September 30, 2002, from $13.5 million, or 21.1% of total
revenues, in the nine months ended September 30, 2001. We expect to maintain our
cost of revenues as a percentage of total revenues; however, this will depend
upon our royalty costs and our revenue growth, among other factors. Accordingly,
there can be no assurance that we will be successful in maintaining our cost of
revenues as a percentage of total revenues.
COST OF LICENSE REVENUES. Cost of license revenues includes expenses
associated with royalty costs, production, fulfillment and product
documentation. The cost of license revenues increased 23.1% to $469,000, or 2.0%
of total revenues, in the three months ended September 30, 2002 from $381,000,
or 1.7% of total revenues, in the three months ended September 30, 2001. Cost of
license revenues decreased 13.9% to $1.4 million, or 2.0% of total revenues, in
the nine months ended September 30, 2002, from $1.7 million, or 2.6% of total
revenues, in the nine months ended September 30, 2001. The increase in cost of
license revenues for the three months ended September 30, 2002 is due to
increases in some royalty costs. The decrease in cost of license revenues for
the nine
13
months ended September 30, 2002 as a percent of total revenues was driven by
increased efficiencies and better management of expenses within the operations
organization.
COST OF SERVICE REVENUES. Cost of service revenues includes the personnel
costs associated with providing customer support in connection with maintenance,
training and professional service contracts. Cost of service revenues increased
1.6% to $3.8 million, or 16.4% of total revenues, in the three months ended
September 30, 2002 from $3.7 million, or 17.0% of total revenues, in the three
months ended September 30, 2001. Cost of service revenues decreased 4.0% to
$11.3 million, or 16.1% of total revenues, in the nine months ended September
30, 2002, from $11.8 million, or 18.5% of total revenues, in the nine months
ended September 30, 2001. The decrease in cost of service revenues for the nine
months ended September 30, 2002 was driven by increased efficiencies and better
management of expenses.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
consist primarily of personnel costs associated with software development.
Research and development expenses decreased 12.8% to $5.3 million, or 22.8% of
total revenues, in the three months ended September 30, 2002 from $6.0 million,
or 27.6% of total revenues, in the three months ended September 30, 2001.
Research and development expenses decreased 12.1% to $16.4 million, or 23.4% of
total revenues, in the nine months ended September 30, 2002 from $18.7 million,
or 29.3% of total revenues, in the nine months ended September 30, 2001. The
decrease in research and development expenses was primarily due to a decrease in
headcount in research and development from 145 to 130 people for the period from
September 30, 2001 to September 30, 2002 as well as a reduction of discretionary
expenses for the three and nine month periods ended September 30, 2002 compared
to September 30, 2001. We intend to decrease our research and development
expenses as a percentage of total revenues. Our ability to decrease these
expenses as a percentage of total revenues will depend upon our revenue growth,
among other factors. Accordingly, there can be no assurance that we will be
successful in decreasing our research and development expenses as a percentage
of total revenues.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of salaries, commissions to sales personnel and agents, travel,
tradeshow participation, public relations, advertising and other promotional
expenses. Sales and marketing expenses decreased 8.2% to $11.8 million, or 51.3%
of total revenues, in the three months ended September 30, 2002 from $12.9
million, or 58.9% of total revenues, in the three months ended September 30,
2001. Sales and marketing expenses decreased 6.1% to $35.8 million, or 51.0% of
total revenues, in the nine months ended September 30, 2002 from $38.2 million,
or 59.8% of total revenues, in the nine months ended September 30, 2002. The
decrease in sales and marketing expenses was primarily the result of a reduction
in sales bonuses and commissions due to the reduction in license revenues in
2002 as well as a reduction in headcount in sales and marketing from 195 to 172
people from September 30, 2001 to September 30, 2002. We intend to decrease our
sales and marketing expenses as a percentage of total revenues. Our ability to
decrease these expenses as a percentage of total revenues will depend upon our
revenue growth, among other factors. Accordingly, there can be no assurance that
we will be successful in decreasing our expenses as a percentage of total
revenues.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of salaries for financial, accounting, legal, investor
relations, human resources, administrative and management personnel. General and
administrative expenses decreased 14.1% to $1.7 million, or 7.6% of total
revenues, in the three months ended September 30, 2002 from $2.0 million, or
9.3% of total revenues, in the three months ended September 30, 2001. General
and administrative expenses decreased 18.4% to $5.6 million, or 7.9% of total
revenues, in the nine months ended September 30, 2002 from $6.8 million, or
10.7% of total revenues, in the nine months ended September 30, 2001. The
decrease in general and administrative expenses is due to a decrease in
headcount from 40 to 31 people from September 30, 2001 to September 30, 2002, a
decrease in bad debt expense for both the three and nine months ended September
30, 2002 and a reduction in discretionary expenses. We expect to decrease these
expenses as a percentage of total revenues, however, this will ultimately depend
upon our revenue growth, among other factors. Accordingly, there can be no
assurance that we will be successful in decreasing our expenses as a percentage
of total revenues.
STOCK-BASED COMPENSATION. Stock-based compensation relates to the issuance
of stock options with exercise prices below the deemed fair value of the
Company's common stock at the date of grant. Deferred stock-based compensation
resulted solely from the issuance of stock options to employees of FirstSense
Software, Inc. ("FirstSense") in connection with the Company's acquisition of
FirstSense on February 4, 2000 and is amortized
14
through charges to operations over the vesting period of the options, which is
generally four years. Stock-based compensation was approximately $25,000 and
$41,000 for the three months ended September 30, 2002 and 2001, respectively,
and was approximately $85,000 and $282,000 for the nine months ended September
30, 2002 and 2001, respectively. The Company recorded forfeitures of deferred
stock based compensation of approximately $65,000 and $1.1 million for the nine
months ended September 30, 2002 and 2001, respectively, related to forfeitures
of stock options by terminated employees. There were no forfeitures of deferred
stock compensation for the three months ended September 30, 2002 and 2001.
OTHER INCOME. Other income consists of interest earned on funds available
for investment, net of foreign currency exchange gains and losses and
miscellaneous foreign taxes. The Company had net other income of $741,000 and
$891,000 for the three months ended September 30, 2002 and 2001, respectively.
The Company had net other income of $2.3 million and $2.5 million for the nine
month periods ended September 30, 2002 and 2001.
PROVISION FOR INCOME TAXES. The Company recorded an income tax provision
of approximately $136,000 and $375,000 for the three and nine months ended
September 30, 2002, respectively. The Company recorded an income tax provision
of approximately $25,000 and $111,000 for the three and nine months ended
September 30, 2001, respectively. The income tax provisions for the three and
nine months ended September 30, 2002 and 2001 are mainly related to foreign
taxes resulting from the profitability of certain of the Company's foreign
operations.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2002, the Company had cash, cash equivalents and
marketable securities of $71.5 million, excluding restricted cash totaling
approximately $939,000. This represents an increase of $3.2 million from $68.3
million as of December 31, 2001. Concord had working capital of $53.5 million
and $49.0 million as of September 30, 2002 and December 31, 2001, respectively.
The increase in working capital was primarily attributable to an increase in
cash, cash equivalents and marketable securities due to income from continuing
operations during 2002.
Net cash provided by operating activities was $4.6 million for the nine
months ended September 30, 2002 and $5.8 million for the nine months ended
September 30, 2001. Accounts receivable increased $2.2 million primarily due to
slower collections particularly with international customers. Deferred revenue
increased $2.5 million mainly due to an increase in new and renewed maintenance
contracts.
Investing activities have consisted of the acquisition of property and
equipment, most notably computer and networking equipment to support the
corporate infrastructure, and also investments in marketable securities. The
Company manages its market risk on its investment securities by selecting
investment grade securities with the highest credit ratings of relatively short
duration that trade in highly liquid markets.
Financing activities consisted primarily of the issuance of common stock
from the exercise of stock options during the nine months ended September 30,
2002 and 2001.
As of September 30, 2002, the Company has future payments under facility
and certain equipment lease agreements expiring through June 2007 of $3.7
million, $6.6 million and $3.3 million in one year, one to three years, and
thereafter, respectively.
The Company has deferred tax assets of approximately $21.9 million, the
largest component of which represents net operating loss ("NOL") carryforwards
and research and development credits. The Company has significantly reserved for
these deferred tax assets by recording a valuation allowance of $18.4 million.
The resulting net deferred tax asset is based on the Company's estimate of NOL
carryforwards it expects to use in the future; all other tax assets have been
fully reserved. Pursuant to paragraphs 20 to 25 of SFAS No. 109, the Company
considered both positive and negative evidence in assessing the need for a
valuation allowance at September 30, 2002 and December 31, 2001. The factors
that weighed most heavily on the Company's decision to record a valuation
allowance were (i) the substantial restrictions on the use of certain of its
existing NOL and credit carryforwards and (ii) the uncertainty of future
profitability. In addition, the Company is subject to rapid technological
change, competition from substantially larger competitors, a limited family of
products and other related risks, as more thoroughly described in the "Risk
Factors" section of the Company's Form 10-K for the year ended December 31, 2001
and in the "Factors that Could Affect Future Results" section of this Form 10-Q.
As a result, the Company found the evidence
15
described above to be the most reliable objective evidence available in
determining that a valuation allowance against its tax assets would be
necessary.
Pursuant to the Tax Reform Act of 1986, the utilization of NOL
carryforwards for tax purposes may be subject to an annual limitation if a
cumulative change of ownership of more than 50% occurs over a three-year period.
At December 31, 2001, the utilization of approximately $2,309,000 of the
Company's NOL carryforwards are restricted to $330,000 per year as a result of
an ownership change that occurred in 1995. In addition, the utilization of
approximately $15,663,000 of NOL carryforwards that were acquired as a result of
the FirstSense acquisition is also restricted as a result of a prior ownership
change of FirstSense. Utilization of the FirstSense NOL carryforwards is limited
to $4.3 million per year.
As of December 31, 2001, the Company's NOL deferred tax asset includes
approximately $2.3 million pertaining to the benefit associated with the
exercise and subsequent disqualifying disposition of incentive stock options by
the Company's employees. When and if the Company realizes this asset, the
resulting change in the valuation allowance will be credited directly to
additional paid-in capital, pursuant to the provisions of SFAS No. 109.
As of September 30, 2002, Concord's principal sources of liquidity
included cash, cash equivalents and marketable securities. The Company believes
that its current cash, cash equivalents and marketable securities and cash
provided by future operations will be sufficient to meet the working capital and
anticipated capital expenditure requirements for at least the next 12 months.
Although operating activities may provide cash in certain periods, to the extent
Concord experiences growth in the future, its operating and investing activities
may require additional cash. Consequently, any such future growth may require
Concord to obtain additional equity or debt financing.
CRITICAL ACCOUNTING POLICIES
In December 2001, the SEC requested that all registrants list their three
to five most "critical accounting policies" in the Management Discussion and
Analysis section of their Annual Report on Form 10-K. The SEC indicated that a
"critical accounting policy" is one which is both important to the portrayal of
the company's financial condition and results and requires management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effect of matters that are inherently uncertain. We
believe that the following three accounting policies fit this definition:
Revenue Recognition, Accounts Receivable and Accounting for Income Taxes.
(a) Revenue Recognition Policy
We recognize revenue from the sale of software licenses when persuasive
evidence of an arrangement exists, the product has been delivered, the fee is
fixed or determinable and collection of the resulting receivable is reasonably
assured. Delivery generally occurs when product is delivered to a common carrier
and the delivery terms are FOB Concord. All revenues generated from our
worldwide operations are approved at our corporate headquarters, located in the
United States.
At the time of the transaction, we assess whether the fee associated with
our revenue transaction is fixed or determinable and whether or not collection
is reasonably assured. We assess whether the fee is fixed or determinable based
on the payment terms associated with the transaction. If a significant portion
of a fee is due after our normal payment terms, which are usually 30 to 60 days
from invoice date, we account for the fee as not being fixed or determinable. In
these cases, we usually recognize revenue when the fee is due.
We assess collection based on a number of factors, including past
transaction history with the customer and the credit-worthiness of the customer.
We do not request collateral from our customers. If we determine that collection
of a fee is not reasonably assured, we defer the fee and usually recognize
revenue upon receipt of cash.
For all sales, in the absence of a signed license agreement, we use either
a purchase order or purchase order equivalent as evidence of an arrangement. If
a signed license agreement is obtained, we use either the license agreement or
the license agreement and a purchase order as evidence of an arrangement. Sales
through our resellers
16
are usually evidenced by a master agreement governing the relationship together
with purchase orders on a transaction-by-transaction basis.
For arrangements with multiple obligations (for example, undelivered
maintenance and support), we allocate revenue to each component of the
arrangement using the residual value method based on the fair value of the
undelivered elements. This means that we defer revenue from the fee arrangement
equivalent to the fair values of the undelivered elements. We determine fair
values for ongoing maintenance and support obligations using our internal
pricing policies for maintenance and by referencing the prices at which we have
sold separate maintenance contract renewals to our customers. We determine fair
values of services, such as training or consulting, by referencing the prices at
which we have separately sold comparable services to our customers.
Our arrangements do not generally include clauses involving acceptance of
our products by our customers. However, if an arrangement includes an acceptance
provision, revenue recognition occurs upon the earlier of receipt of a written
customer acceptance or expiration of the acceptance period.
(b) Accounts Receivable Policy
We perform ongoing credit evaluations of our customers and adjust credit
limits based upon payment history and the customer's current credit worthiness,
as determined by our review of their current credit information. We continuously
monitor collections and payments from our customers and maintain a provision for
estimated credit losses based on a percentage of our accounts receivable, our
historical experience and any specific customer collection issues that we have
identified. While management believes such credit losses have historically been
within our expectations and appropriate reserves have been established, we
cannot guarantee that we will continue to experience the same credit loss rates
that we have experienced in the past.
(c) Accounting for Income Taxes Policy
As part of the process of preparing our consolidated financial statements
we are required to estimate our income taxes in each of the jurisdictions in
which we operate. To do this, we estimate our actual current tax liabilities,
while also assessing temporary differences resulting from differing treatment of
items, such as deferred revenue, for tax and accounting purposes. These
differences result in deferred tax assets and liabilities, which are included
within our consolidated balance sheet. We must then assess the likelihood that
our deferred tax assets will be recovered from future taxable income. To the
extent we believe that recovery is not likely, we must establish a valuation
allowance. To the extent we establish a valuation allowance or increase this
allowance in a period, we must include an expense within the tax provision in
the statement of operations.
Significant management judgment is required in determining our provision
for income taxes, our deferred tax assets and liabilities and any valuation
allowance recorded against our net deferred tax assets. We have recorded a
valuation allowance of $18.4 million as of September 30, 2002, due to
uncertainties related to our ability to utilize some of our deferred tax assets,
primarily consisting of the utilization of certain net operating loss
carryforwards from prior years. We are unsure whether we will have sufficient
future taxable income to allow us to use these net operating losses before they
expire. The valuation allowance is based on our estimates of taxable income by
jurisdiction in which we operate and the period over which our deferred tax
assets will be recoverable. In the event that actual results differ from these
estimates or we adjust these estimates in future periods we may need to
establish an additional valuation allowance. Establishing new or additional
valuation allowances could materially adversely impact our financial position
and results of operations.
Our net deferred tax assets as of September 30, 2002 were $3.5 million,
net of a valuation allowance of $18.4 million.
The above listing is not intended to be a comprehensive list of all of our
accounting policies. In many cases, the accounting treatment of a particular
transaction is specifically dictated by accounting principles generally accepted
in the United States, with no need for management's judgment in their
application. There are also areas in which the exercise of management's judgment
in selecting an available alternative would not produce a materially different
result. See our audited consolidated financial statements and notes thereto
which begin on page F-1 of the Annual Report on Form 10-K for the year ended
December, 31, 2001 and which contain accounting policies and other disclosures
required by generally accepted accounting principles.
17
FACTORS THAT COULD AFFECT FUTURE RESULTS
References in these risk factors to "we," "our," the "Company," "Concord,"
and "us" refer to Concord Communications, Inc., a Massachusetts corporation. Any
investment in our common stock involves a high degree of risk. If any of the
following risks actually occur, our business, results of operations and
financial condition would likely suffer.
This document contains forward-looking statements. Any statements
contained in this document that do not describe historical facts are
forward-looking statements. Concord makes such forward-looking statements under
the provisions of the "safe harbor" section of the Private Securities Litigation
Reform Act of 1995. In particular, statements contained in Management's
Discussion and Analysis of Financial Condition and Results of Operations, which
are not historical facts (including, but not limited to, statements concerning:
the plans and objectives of management; increases in absolute dollars or
decreases as a percentage of revenues in sales and marketing, research and
development, customer support and service, and general and administrative
expenses; expectations regarding increased competition and Concord's ability to
compete successfully; sustenance of revenue growth both domestically and
internationally; the size, scope and description of Concord's target customer
market; future product development, including but not limited to anticipated
expense levels to fund product development, acquisitions and the integration of
acquired companies; and our expected liquidity and capital resources) constitute
forward-looking statements. Forward-looking statements contained herein are
based on current expectations, but are subject to a number of risks and
uncertainties. Concord's actual future results may differ significantly from
those stated in any forward-looking statements. Factors that may cause such
differences include, but are not limited to, the factors discussed below.
OUR FUTURE OPERATING RESULTS ARE UNCERTAIN.
Prior to 2001, we marketed and sold our products primarily in the
performance management market. In 2001, our product functionality was expanded
to include both fault and performance management features to penetrate the fault
management market. While sales of our fault products were approximately 15% of
our license revenues for the quarter ended September 30, 2002, we still have a
limited operating history in this expanded market upon which we can evaluate our
business. As currently developed, our product is an integrated fault and
performance management tool that manages applications, systems and networks. The
integrated fault and performance market is highly competitive and rapidly
evolving. Additionally, many of our competitors in this new market have a longer
operating history and greater resources. Our limited operating history and an
economic climate which continues to look uncertain as of October 2002, makes the
prediction of future results of operations difficult or impossible. Our
prospects must be considered in light of the risks, costs, and difficulties
frequently encountered by emerging companies operating in the highly competitive
software industry.
WE CANNOT ENSURE THAT OUR REVENUES WILL GROW OR THAT WE WILL BE PROFITABLE.
As a company, we have expended considerable resources to develop
innovative products that have enabled us to penetrate new markets both in the
United States and internationally. As a result of these efforts, we achieved
revenue growth and profitability for the fiscal years ended 2000, 1999, and
1998. However, as the worldwide economy continued to weaken in 2001, our
revenues did not grow at expected levels. We operated at a net loss during the
first three quarters of 2001 and we cannot ensure that we can generate revenue
growth on a quarterly or annual basis, or that we can achieve or sustain any
revenue growth in the future. While quarterly revenues are up modestly in the
last two quarters of 2002, our annual revenues in 2002 may be lower than our
annual revenues in 2001.
In an effort to return to profitability, we reduced our operating expenses
for 2001 and have further limited our operating expenses in 2002. However,
competition in the marketplace may require us to increase our operating expenses
in the future in order to:
- fund higher levels of research and development;
- increase our sales and marketing efforts;
- develop new distribution channels;
18
- broaden our customer support capabilities;
- expand our administrative resources in anticipation of future
growth; and
- respond to unforeseeable economic or business circumstances.
To the extent that increases in our expenses precede or are not followed
by increased revenues, our profitability will be at risk. In addition, in view
of the rapidly evolving nature of our business and markets, the uncertain
economic and geopolitical landscape, and our limited operating history in our
current market, we believe that one should not rely on period-to-period
comparisons of our financial results as an indication of our future performance.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE.
We are likely to experience significant fluctuations in our quarterly
operating results caused by many factors, including, but not limited to:
- changes in the demand for our products by customers or groups of
customers;
- the timing, composition, and size of orders from our customers,
including the tendency for significant bookings to occur in the
final two weeks of each fiscal quarter;
- our customers' spending patterns and budgetary resources for fault
and performance management;
- geopolitical conditions in the world, with specific reference to the
current situation in the Middle East, Indonesia and Brazil;
- the success of our new customer generation activities;
- introductions or enhancements of products, or delays in the
introductions or enhancements of products, by us or our competitors;
- changes in our pricing policies or those of our competitors;
- changes in the distribution channels through which our products are
sold;
- our success in anticipating and effectively adapting to developing
markets and rapidly changing technologies;
- our success in attracting, retaining, and motivating qualified
personnel;
- the publication of opinions about us and our products, or our
competitors and their products, by industry analysts or others; and
- changes in general economic conditions.
Though our service revenues have been increasing as a percentage of total
revenues, we do not have a significant ongoing revenue stream that may mitigate
quarterly fluctuations in operating results, as do other software companies with
a longer history of operations. Increases in our revenues will also depend on
our successful implementation of our distribution strategy as we attempt to
expand our channels of distribution. Due to the buying patterns of certain of
our customers and also to our own sales incentive programs focused on annual
sales goals, revenues in our fourth quarter could be higher than revenues in our
first quarter of the following year. There also may be other factors, such as
seasonality and the timing of receipt and delivery of orders within a fiscal
quarter, that significantly affect our quarterly results, which are difficult to
predict given our limited operating history.
Our quarterly sales and operating results depend generally on:
- the volume and timing of orders within the quarter;
- the tendency of sales to occur late in fiscal quarters; and
- our fulfillment of orders received within the quarter.
19
A significant portion of our product sales occur in the final two weeks of
each fiscal quarter. Any delay in the shipment of products near the end of the
quarter may result in decreased revenues for the quarter. Additionally, intense
competition and budgetary constraints placed upon our customers typically
increase during the final two weeks of a fiscal quarter and may adversely affect
our revenues for that quarter. Weak economic conditions tend to exacerbate these
factors.
In addition, our expense levels are based in part on our expectations of
future orders and sales, which are extremely difficult to predict. A substantial
portion of our operating expenses is related to personnel, facilities and
equipment, and sales and marketing programs. Accordingly, we may not be able to
adjust our fixed expenses quickly enough to address any significant shortfall in
demand for our products in relation to our expectations.
Due to all of the foregoing factors, we believe that our quarterly
operating results are likely to vary significantly in the future. Therefore, in
some future quarter our results of operations may fall below the expectations of
securities analysts and investors. In such event, the trading price of our
common stock will likely suffer.
THE MARKET FOR INTEGRATED FAULT AND PERFORMANCE MANAGEMENT SOFTWARE IS EMERGING.
The market for our integrated fault and performance solution is still in
an early stage of development. Although the rapid expansion and increasing
complexity of computer applications, systems, and networks in recent years has
increased the demand for both fault and performance management software
products, the awareness of, and the demand for, an integrated fault and
performance solution is a recent development. The market for this solution is
only beginning to develop, and therefore it is difficult to assess:
- the size of this market;
- the appropriate features and prices for products to address this
market;
- the optimal distribution strategy; and
- the competitive environment that will develop.
The development of this market and our growth will depend significantly
upon the desire and success of telecommunication carriers, managed services
providers, and enterprises to integrate fault and performance management for
their applications, systems, and networks. Moreover, it will depend on the
willingness of telecommunication carriers, managed service providers, systems
integrators, and outsourcers to integrate fault and performance management
software into their product and service offerings. The market for integrated
fault and performance management software may not grow or we may fail to assess
and address the needs of this market.
THE MARKET FOR OUR PRODUCTS IS INTENSELY COMPETITIVE.
The market for our products is intensely competitive, rapidly evolving,
and subject to technological change. Our current and future competitors include:
- report toolset vendors;
- fault management software vendors;
- application performance software vendors;
- enterprise management software, framework and platform providers;
- large, well established management framework companies that have
developed network or application management platforms;
- developers of network element management solutions;
- probe vendors;
- telecommunications vendors;
20
- system agent vendors; and
- vendors who provide as a service some of the functionality of our
products.
We expect competition to persist, increase, and intensify in the future
with possible price competition developing in our markets. Many of our current
and potential competitors have longer operating histories and significantly
greater financial, technical and marketing resources and name recognition than
us. We do not believe our market will support a large number of competitors and
their products. If we do not provide products that achieve success in our market
in the short term, we could suffer an insurmountable loss in market share and
brand name acceptance. We cannot ensure that we will compete effectively with
current and future competitors.
THE MARKET FOR INTEGRATED PERFORMANCE AND FAULT MANAGEMENT OF SOFTWARE
APPLICATIONS, SYSTEMS AND NETWORKS IS BECOMING INCREASINGLY TARGETED BY LARGER
COMPANIES WITH SUBSTANTIALLY GREATER RESOURCES.
Our revenues are generated from sales of products that manage integrated
fault and performance aspects of software applications, systems and networks.
This market is very competitive and we are in direct competition with larger
companies with substantially greater resources. These larger companies are able
to devote considerable resources to the development of competitive products and
the creation and maintenance of direct and indirect sales channels. The
continued presence of these larger companies in this market may impact our
ability to retain or increase our market share.
MARKET ACCEPTANCE OF OUR EHEALTH(TM) PRODUCT FAMILY IS CRITICAL TO OUR SUCCESS.
We currently derive substantial product revenues from our eHealth(TM)
product family, and we expect that revenues from these products will continue to
account for almost all of our product revenues in the foreseeable future. Broad
market acceptance of these products is critical to our future success. We cannot
ensure that market acceptance of our eHealth(TM) Suite of products will increase
or even remain at current levels. Factors that may affect the market acceptance
of our integrated solution include:
- the availability and price of competing integrated solutions,
products and technologies;
- the demand for integrated, as opposed to stand-alone, solutions; and
- the success of our sales efforts and those of our marketing
partners.
Moreover, if demand for integrated fault and performance management
software products increases, we anticipate that our competitors will introduce
additional competitive products and new competitors could enter our market and
offer alternative products resulting in decreased market acceptance of our
products.
WE MAY NEED FUTURE CAPITAL FUNDING.
We plan to continue to expend substantial funds on the continued
development, marketing, and sale of the eHealth(TM) product family. While we
have approximately $72 million in short term investments (cash, cash equivalents
and marketable securities) as of September 30, 2002, we cannot ensure that our
existing capital resources and any funds that may be generated from future
operations together will be sufficient to finance our future operations or that
other sources of funding will be available on terms acceptable to us, if at all.
In addition, future sales of substantial amounts of our securities in the public
market could adversely affect prevailing market prices and could impair our
future ability to raise capital through the sale of our securities.
WE MUST INTRODUCE PRODUCT ENHANCEMENTS AND NEW PRODUCTS ON A TIMELY BASIS.
Because of rapid technological change in the software industry and
potential changes in the IT infrastructure, fault and performance management
software market, and changes in industry standards, the life cycle of versions
of our eHealth(TM) products is difficult to estimate. We cannot ensure that:
21
- we will successfully develop and market enhancements to our
eHealth(TM) products or successfully develop new products that
respond to technological changes, evolving industry standards or
customer requirements;
- we will not experience difficulties that could delay or prevent the
successful development, introduction and sale of such enhancements
or new products; or
- such enhancements or new products will adequately address the
requirements of the marketplace and achieve market acceptance.
THE NEED FOR OUR PRODUCTS MAY DECREASE IF MANUFACTURERS INCORPORATE OUR PRODUCT
FEATURES INTO THEIR PRODUCT OFFERINGS.
Our products manage the performance of computer applications, systems, and
networks. Presently, manufacturers of both hardware and software have not
implemented these management functions into their products in any significant
manner. These products typically include, but are not limited to, operating
systems, workstations, network devices, and software. If manufacturers begin to
incorporate these management functions into their products it may decrease the
value of our products and have a substantial impact on our business.
CONTINUING PUBLIC COMPANY ACCOUNTING IMPROPRIETIES MAY ADVERSELY IMPACT OUR
REVENUES.
The public's perception of accounting improprieties by public companies
has undermined confidence in the public markets, adding to economic uncertainty.
This economic uncertainty can affect customer demand for our products and
services, thus affecting our revenue. For example, the announcement by a large
American telecommunications firm near the end of our second fiscal quarter that
it had improperly accounted for some expenses created uncertainties for some of
our customers last quarter. Specifically, banks holding debt for this
telecommunications company reduced expenditures to mitigate the exposure created
by the telecommunications company's actions. Our revenues suffered in the final
weeks of the quarter ended June 30, 2002 as many of our customers considerably
decreased, postponed or potentially canceled IT infrastructure purchases due to
this uncertainty. It is likely that similar announcements by other companies
would impact the Company's future sales.
CURRENT GEOPOLITICAL INSTABILITY AND THE CONTINUING THREAT OF DOMESTIC AND
INTERNATIONAL TERRORIST ATTACKS MAY ADVERSELY IMPACT OUR REVENUES.
International tensions, exacerbated by the possibility of war in the
Middle East and recent events in Indonesia, contribute to an uncertain political
and economic climate, both in the United States and globally, which may affect
our ability to generate revenue on a predictable basis. In addition, recent
terrorist attacks internationally have contributed to continued international
tensions and uncertainty, while ongoing terrorist threats in the United States
have continued to fuel economic uncertainty in the wake of the tragic events of
September 11, 2001. As we sell products both in the United States and
internationally, the threat of future terrorist attacks may adversely affect our
business.
OUR SUCCESS IS DEPENDENT UPON SALES TO TELECOMMUNICATION CARRIERS, SERVICE
PROVIDERS, AND ENTERPRISE CUSTOMERS.
We derive and likely will continue to derive a significant portion of our
revenues from the sales of our products to telecommunication carriers, service
providers, and enterprise customers. These markets worldwide have suffered from
a turbulent economy during 2000, 2001 and the first nine months of 2002,
turbulence that has been exacerbated by the tragic events of September 11, 2001
and their aftermath, as well as heightened geopolitical tensions as we enter the
fourth quarter of 2002. We have been negatively affected by the general weakness
in capital spending within these markets. The volume of sales of our products
and services to telecommunication carriers, service providers, and enterprise
customers may increase slower than we expect or may decrease.
OUR COMMON STOCK PRICE COULD EXPERIENCE SIGNIFICANT VOLATILITY.
The market price of our common stock may be highly volatile and could be
subject to wide fluctuations in response to:
- variations in results of operations;
22
- announcements of technological innovations or new products by us or
our competitors;
- changes in financial estimates by securities analysts;
- announcements relating to financial improprieties by public
companies; or
- other events or factors.
In addition, the financial markets have experienced significant price and
volume fluctuations that have particularly affected the market prices of equity
securities of many high technology companies and that often have been unrelated
to the operating performance of such companies or have resulted from the failure
of the operating results of such companies to meet market expectations in a
particular quarter. Broad market fluctuations or any failure of our operating
results in a particular quarter to meet market expectations may adversely affect
the market price of our common stock leading to an increased risk of securities
class action litigation. Such litigation could result in substantial costs and a
diversion of our attention and resources.
OUR INDUSTRY IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE. OUR SUCCESS DEPENDS UPON
MAINTENANCE OF STANDARD PROTOCOLS.
The software industry is characterized by:
- rapid technological change;
- frequent introductions of new products;
- changes in customer demands; and
- evolving industry standards.
The introduction of products embodying new technologies and the emergence
of new industry standards can render existing products and integrated solutions
obsolete and unmarketable. Our eHealth(TM) - Network product's analysis and
reporting, as well as the quality of its reports, depends upon its utilization
of the industry-standard Simple Network Management Protocol ("SNMP") and the
data resident in conventional Management Information Bases ("MIBs"). Any change
in these industry standards, the development of vendor-specific proprietary MIB
technology, or the emergence of new network technologies could affect the
compatibility of our eHealth(TM) - Network products with these devices, which in
turn could affect its analysis and generation of comprehensive reports or the
quality of the reports. Similarly, our Live Health(TM) - Fault Manager product
receives only SNMP traps from failing devices, systems, and applications. Any
change in these industry standards could hinder the effectiveness of this
product. Furthermore, although our eHealth(TM) Suite of products currently runs
on industry-standard UNIX operating systems and Windows NT, any significant
change in industry-standard operating systems could affect the demand for, or
the pricing of, our products and solutions and those of our competitors.
WE HAVE CHANGED THE DATABASE WHICH IS SHIPPED WITH OUR PRODUCTS.
We have started shipping Oracle(R) software as the database on which the
eHealth(TM) Suite of products runs, which will eventually replace the Ingres(R)
database on which our eHealth(TM) Suite of products currently operates. While we
believe the switch to Oracle will make our products even more robust and we are
comfortable with the choice of Oracle as a database vendor, there is no
guarantee that our customers will readily accept this change. There also is no
guarantee that Oracle will be able to continue to deliver to us an acceptable
database solution, nor that the product Oracle delivers will continue to
interface effectively in conjunction with our eHealth(TM) Suite of products.
WE RELY ON STRATEGIC PARTNERS AND OTHER EVOLVING DISTRIBUTION CHANNELS.
Our distribution strategy is to develop multiple distribution channels,
including sales through:
- strategic marketing partners;
- value added resellers;
23
- system integrators;
- telecommunication carriers;
- original equipment manufacturers; and
- independent software vendors and international distributors.
We have developed a number of these relationships and intend to continue
to develop new "channel partner" relationships. Specifically, beginning in the
second half of 2002, we are focusing on identifying and developing our key
distribution partners worldwide. We intend to decrease the total number of
distributors selling our products, but increase the quality and focus of our
most valuable distributors. Our success will depend in large part on our
development of these more focused distribution relationships and on the
performance and success of these third parties, particularly telecommunication
carriers and other network service providers. We sell our products in the United
States through both direct sales to customers and indirect sales to customers
through our channel partners. Internationally, we sell our products almost
exclusively through indirect sales via our channel partners. Our international
channel partners are located in Europe, the Middle East, Africa, Asia, and North
and South America and are subject to local laws, regulations, and customs that
may make it difficult to accurately assess the potential revenues that can be
generated from a certain market. Our success depends upon our ability to attract
and retain valuable channel partners and to accurately assess the size and
vitality of the markets in which our products are sold. While we have
implemented policies and procedures to achieve this, we cannot predict the
extent to which we are able to attract and retain financially stable, motivated
channel partners. Additionally, our channel partners may not be successful in
marketing and selling our products. We may:
- fail to attract important and effective channel partners;
- fail to penetrate our targeted market segments through the use of
channel partners; or
- lose any of our channel partners, as a result of competitive
products offered by other companies, products developed internally
by these channel partners, their financial insolvency or otherwise.
WE MAY FAIL TO MANAGE SUCCESSFULLY THE GROWTH OR CONTRACTION OF OUR BUSINESS.
We have experienced reductions in our sales and operations personnel; our
products have become increasingly complex; and our product distribution channels
are being developed and expanded. The rapid evolution of our markets and the
increasing complexity of our products has placed, and is likely to continue to
place, significant strains on our administrative, operational, and financial
resources and increase demands on our internal systems, procedures, and controls
that may impact our ability to grow our business.
OUR SUCCESS DEPENDS ON OUR RETENTION OF KEY PERSONNEL.
Our performance depends substantially on the performance of our key
technical, senior management and sales and marketing personnel. We may lose the
services of any of such persons. We do not maintain key person life insurance
policies on any of our employees. Our success depends on our continuing ability
to identify, hire, train, motivate, and retain highly qualified management,
technical, and sales and marketing personnel. Despite current weak economic
conditions, we experience intense competition for such personnel and are
constantly exploring new avenues for attracting and retaining key personnel.
However, we cannot ensure that we will successfully attract, assimilate, or
retain highly qualified technical, managerial or sales and marketing personnel
in the future.
24
OUR FAILURE TO CONTINUE TO EXPAND INTO INTERNATIONAL MARKETS COULD HARM OUR
BUSINESS.
We intend to continue to expand our operations outside of the United
States and enter additional international markets, primarily through the
establishment of channel partner arrangements. As mentioned above, we have
concentrated recently on developing more focused relationships with fewer key
distributors. We expect to commit additional time and development resources to
customizing our products and services for selected international markets and to
developing international sales and support channels. We cannot ensure that such
efforts will be successful.
We face certain difficulties and risks inherent in doing business
internationally, including, but not limited to:
- costs of customizing products and services for international
markets;
- dependence on independent resellers;
- multiple and conflicting regulations;
- exchange controls;
- longer payment cycles;
- unexpected changes in regulatory requirements;
- import and export restrictions and tariffs;
- difficulties in staffing and managing international operations;
- greater difficulty or delay in accounts receivable collection;
- potentially adverse tax consequences;
- the burden of complying with a variety of laws outside the United
States;
- the impact of possible recessionary environments in economies
outside the United States;
- political and economic instability which continues to increase in
light of uncertainty in the Middle East; and
- exposure to foreign currency fluctuations.
Our successful expansion into certain countries will require additional
modification of our products, particularly national language support. Presently,
the majority of our current export sales are denominated in United States
dollars. To the extent that international sales continue to be denominated in
U.S. dollars, an increase in the value of the United States dollar relative to
other currencies could make our products and services more expensive and,
therefore, potentially less competitive in international markets. In certain
European Union countries, however, we have introduced pricing in Euros in 2002.
While we do maintain a foreign currency hedging program on accounts receivable,
to the extent that future international sales are denominated in foreign
currency, our operating results will be subject to risks associated with foreign
currency fluctuation. Additionally, as we increase our international sales,
seasonal fluctuations in revenue generation resulting from lower sales that
typically occur during the summer months in Europe and other parts of the world
may affect our total revenues.
OUR FAILURE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS MAY HARM OUR COMPETITIVE
POSITION.
Our success depends significantly upon our proprietary technology. We rely
on a combination of patent, copyright, trademark and trade secret laws,
non-disclosure agreements, and other contractual provisions to establish,
maintain, and protect our proprietary rights. These means afford only limited
protection.
We have nine issued and eleven pending U.S. patents, and various foreign
counterparts as of September 30, 2002. We cannot ensure that patents will issue
from our pending applications or from any future applications or that, if
issued, any claims allowed will be sufficiently broad to protect our technology.
In addition, we cannot ensure that
25
any patents that have been or may be issued will not be challenged, invalidated
or circumvented, or that any rights granted by those patents would protect our
proprietary rights. Failure of any patents to protect our technology may make it
easier for our competitors to offer equivalent or superior technology.
We have sought also to protect our intellectual property through the use
of copyright, trademark, and trade secret laws. Despite our efforts to protect
our proprietary rights, unauthorized parties may attempt to copy aspects of our
products or services, or to obtain and use information that we regard as
proprietary. Third parties may also independently develop similar technology
without breach of our proprietary rights.
In addition, the laws of some foreign countries do not protect proprietary
rights to as great an extent as do the laws of the United States. In addition,
many of our products are licensed under end user license agreements (also known
as "shrinkwrap" licenses) that are not signed by licensees. The law governing
the enforceability of shrinkwrap license agreements is not settled in most
jurisdictions. There can be no guarantee that we would achieve success in
enforcing one or more shrinkwrap license agreements if we sought to do so in a
court of law.
WE LICENSE CERTAIN TECHNOLOGIES FROM THIRD PARTIES.
We license from third parties, generally on a non-exclusive basis, certain
technologies used in our products. The termination of any such licenses, or the
failure of the third-party licensors to adequately maintain or update their
products, could result in delay in our shipment of certain of our products while
we seek to implement technology offered by alternative sources, and any required
replacement licenses could prove costly. While it may be necessary or desirable
in the future to obtain other licenses relating to one or more of our products
or relating to current or future technologies, we cannot ensure that we will be
successful in doing so on commercially reasonable terms or at all.
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS WOULD HARM OUR BUSINESS.
Although we do not believe that we are infringing upon the intellectual
property rights of others, claims of infringement are becoming increasingly
common as the software industry develops legal protections for software
products. Litigation may be necessary to protect our proprietary technology, and
third parties may assert infringement claims against us with respect to their
proprietary rights. Any claims or litigation can be time-consuming and expensive
regardless of their merit. Infringement claims against us can cause product
release delays, require us to redesign our products, or require us to enter into
royalty or license agreements, which agreements may not be available on terms
acceptable to us or at all.
PRODUCT DEFECTS COULD RESULT IN THE LOSS OF OR DELAY IN MARKET ACCEPTANCE OF OUR
PRODUCTS.
As a result of their complexity, software products may contain undetected
errors or failures when first introduced or as new versions are released. We
cannot ensure that, despite testing by us and testing and use by current and
potential customers, errors will not be found in new products we ship or, if
discovered, that we will successfully correct such errors in a timely manner or
at all. The occurrence of errors and failures in our products could result in
loss of, or delay in, market acceptance of our products, and alleviating such
errors and failures could require significant expenditure of capital and other
resources by us.
WE MAY NOT HAVE SUFFICIENT PROTECTION AGAINST PRODUCT LIABILITY CLAIMS.
Because our products are used by our customers to identify and predict
current and future application, system, and network problems and to avoid
failures of the network to support critical business functions, design defects,
software errors, misuse of our products, incorrect data from network elements,
or other potential problems, within or out of our control, may arise from the
use of our products and could result in financial or other damages to our
customers. While we do not maintain product liability insurance, our license
agreements with our customers typically contain provisions designed to limit our
exposure to potential claims as well as any liabilities arising from such
claims. As a matter of practice, our license agreements limit our liability in
regards to product liability claims, and in many agreements, our maximum
liability for product liability claims is limited to the equivalent of the cost
of the products licensed under that agreement. However, any litigation or
similar procedure related to a product liability claim may require considerable
resources to be expended that could adversely affect our business and financial
condition and decrease future revenues.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(a) Foreign Currency Exchange Rate Risk
We have international offices in Canada, England, France, Germany, Spain,
Sweden, Japan, Hong Kong, Singapore, South Africa, Australia, Mexico, Brazil and
the Netherlands. Approximately 36.8% of our revenues for the nine months ended
September 30, 2002 and 37.8% and 32.2% of our revenues for fiscal 2001 and 2000,
respectively, were from our operations outside the United States. At September
30, 2002 and December 31, 2001, the amount of total assets located at our
international subsidiaries was immaterial. These subsidiaries transact business
in predominantly local currency. Therefore, we are exposed to foreign currency
exchange risks and fluctuations in foreign currencies, along with economic and
political instability in the foreign countries in which we operate, all of which
could adversely impact our results of operations and financial condition.
We use forward contracts to reduce our exposure to foreign currency risk
due to fluctuations in exchange rates underlying the value of accounts
receivable denominated in foreign currencies held until such receivables are
collected. A forward contract obligates us to exchange predetermined amounts of
specified foreign currencies at specified exchange rates on specified dates.
These forward contracts, to qualify as hedges of existing assets, are
denominated in the same currency in which the underlying foreign currency
receivables are denominated and bear a contract value and maturity date that
approximate the value and expected settlement date, respectively, of the
underlying transactions. For contracts that are designated and effective as
hedges, unrealized gains and losses on open contracts at the end of each
accounting period, resulting from changes in the fair value of these contracts,
are recognized in earnings in the same period as gains and losses on the
underlying foreign denominated receivables are recognized and generally offset.
We do not enter into or hold derivatives for trading or speculative
purposes, and we only enter into contracts with highly-rated financial
institutions. At September 30, 2002, we had one forward contract outstanding,
which is presented in the table below. The notional exchange rate is quoted
using market conventions where the currency is expressed in currency units per
U.S. dollar.
Fair Market
Maturity Notional Notional Value as of
Currency Position Date Amount Exchange Rate September 30, 2002
-------- -------- -------- -------- -------------- ------------------
Euro Sell 10/28/02 $486,169 0.9715 $472,314
We plan to continue to utilize forward contracts and other instruments in
the future to reduce our exposure to exchange rate fluctuations from accounts
receivable denominated in foreign currencies, and we may not be able to do this
successfully. Accordingly, we may experience economic loss and a negative impact
on earnings and equity as a result of foreign currency exchange rate
fluctuations. Also, as we continue to expand our operations outside of the
United States, our exposure to fluctuations in currency exchange rates could
increase.
(b) Market and Interest Rate Risk
Most of the Company's current export sales are denominated in United
States dollars. To the extent that international sales continue to be
denominated in United States dollars, an increase in the value of the United
States dollar relative to other currencies could make the Company's products and
services more expensive and, therefore, potentially less competitive in
international markets.
All of the Company's investments are in investment grade securities with
high credit ratings of relatively short duration that trade in highly liquid
markets and are carried at fair value on the Company's books. Accordingly, the
Company has no quantitative information concerning the market risk of
participating in such investments. Due to the short-term nature of our
investments, we believe we have minimal market risk. The Company's investment
portfolio of cash equivalents and marketable securities is subject to interest
rate fluctuations, but the Company believes this risk is immaterial due to the
short-term nature of these investments.
27
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
Within the 90 days prior to the date of this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Company's President and Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures, as defined in
Exchange Act Rule 15d-14(c). Based upon that evaluation, the Company's President
and Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective in enabling the
Company to identify, process, and report information required to be included in
the Company's periodic SEC filings within the required time period.
(b) Changes in Internal Controls.
There were no significant changes in the Company's internal controls or to
our knowledge, in other factors that could significantly affect our disclosure
controls and procedures subsequent to the Evaluation Date.
28
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 2002
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not a party to any litigation that it believes could have a
material adverse effect on the business, results of operations or financial
condition of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Issuance of Securities
On February 4, 2000, the Company completed a merger with FirstSense
Software, Inc. The Company has reserved for issuance in connection with the
merger 1,940,000 shares of Concord Common Stock and has issued 1,799,000 of such
shares. The Company issued the shares in a private placement transaction
pursuant to Section 4(2) under the Securities Act of 1933, as amended. The
merger was accounted for as a pooling of interests. The Company filed a Form S-3
Registration Statement to cover the resale of the securities issued in the
merger.
(b) Use of Proceeds
On October 16, 1997, the Company commenced an initial public offering
("IPO") of 2,900,000 shares of common stock, par value $.01 per share (the
"Common Stock"), of the Company pursuant to the Company's final prospectus dated
October 15, 1997 (the "Prospectus"). The Prospectus was contained in the
Company's Registration Statement on Form S-1, which was declared effective by
the Securities and Exchange Commission (SEC File No. 333-33227) on October 15,
1997. Of the 2,900,000 shares of Common Stock offered, 2,300,000 shares were
offered and sold by the Company and 600,000 shares were offered and sold by
certain shareholders of the Company. As part of the IPO, the Company granted the
several underwriters an over allotment option to purchase up to an additional
435,000 shares of Common Stock (the "Underwriters' Option"). The IPO closed on
October 21, 1997 upon the sale of 2,900,000 shares of Common Stock to the
underwriters. On October 24, 1997, the Representatives, on behalf of the several
underwriters, exercised the Underwriters' Option, purchasing 435,000 additional
shares of Common Stock from the Company. The aggregate offering price of the
shares of Common stock in the IPO to the public was $40,600,000 (exclusive of
the Underwriters' Option), with proceeds to the Company and selling
shareholders, after deduction of the underwriting discount, of $29,946,000
(before deducting offering expenses payable by the Company) and $7,812,000
respectively. The aggregate offering price of the Underwriters' Option exercised
was $6,090,000, with proceeds to the Company, after deduction of the
underwriting discount, of $5,663,700 (before deducting offering expenses payable
by the Company). The aggregate amount of expenses incurred by the Company in
connection with the issuance and distribution of the shares of Common Stock
offered and sold in the IPO were approximately $3.6 million, including $2.7
million in underwriting discounts and commissions and $950,000 in other offering
expenses. The net proceeds to the Company from the IPO, after deducting
underwriting discounts and commissions and other offering expenses, were
approximately $34.7 million. To date, the Company has not utilized any of the
net proceeds from the IPO. The Company has invested all such net proceeds
primarily in US treasury obligations and other interest bearing investment grade
securities.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
29
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The exhibits listed in the accompanying Exhibit Index on page 36 and 37
are filed or incorporated by reference as part of this Report.
(b) Reports on Form 8-K
A report on Form 8-K was filed with the Commission on September 9, 2002 to
report that the Company's Vice President of Business Development resigned
effective as of September 30, 2002.
30
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 2002
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Concord Communications, Inc.
/s/ Melissa H. Cruz
---------------------
November 4, 2002 Name: Melissa H. Cruz
Title: Executive Vice President, Business
Services and Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
31
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Concord Communications, Inc. (the
"Company") on Form 10-Q for the period ending September 30, 2002 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
John A. Blaeser, President and Chief Executive Officer of the Company, certify,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/ John A. Blaeser
- -------------------
John A. Blaeser
President and Chief Executive Officer
November 4, 2002
32
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Concord Communications, Inc. (the
"Company") on Form 10-Q for the period ending September 30, 2002 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Melissa H. Cruz, Executive Vice President, Business Services and Chief Financial
Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of
my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/ Melissa H. Cruz
- -------------------
Melissa H. Cruz
Executive Vice President, Business Services and
Chief Financial Officer
November 4, 2002
33
STATEMENT OF PRINCIPAL EXECUTIVE OFFICER
I, John A. Blaeser, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Concord Communications,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of
Concord Communications, Inc. as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for Concord Communications, Inc. and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to Concord Communications, Inc., including its
consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of Concord Communications, Inc.'s
disclosure controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to Concord Communications, Inc.'s auditors and the audit
committee of Concord Communications, Inc.'s board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect Concord Communications, Inc.'s ability to
record, process, summarize and report financial data and have identified for
Concord Communications, Inc.'s auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in Concord Communications, Inc.'s internal
controls; and
6. Concord Communications, Inc.'s other certifying officers and I have indicated
in this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ John A. Blaeser
-------------------
John A. Blaeser
President and Chief Executive Officer
November 4, 2002
34
STATEMENT OF PRINCIPAL FINANCIAL OFFICER
I, Melissa H. Cruz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Concord Communications,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of
Concord Communications, Inc. as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for Concord Communications, Inc. and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to Concord Communications, Inc., including its
consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of Concord Communications, Inc.'s
disclosure controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to Concord Communications, Inc.'s auditors and the audit
committee of Concord Communications, Inc.'s board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect Concord Communications, Inc.'s ability to
record, process, summarize and report financial data and have identified for
Concord Communications, Inc.'s auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in Concord Communications, Inc.'s internal
controls; and
6. Concord Communications, Inc.'s other certifying officers and I have indicated
in this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ Melissa H. Cruz
-------------------
Melissa H. Cruz
Executive Vice President,
Business Services and Chief
Financial Officer
November 4, 2002
35
CONCORD COMMUNICATIONS, INC.
FORM 10-Q, SEPTEMBER 30, 2002
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION SEC DOCUMENT REFERENCE
----------- ----------- ----------------------
3.01 Restated Articles of Organization of the Company Exhibit No. 3.01 on Form 10-K, for
the period ended December 31, 1997
3.02 Restated By-laws of the Company Exhibit No. 3.02 on Form 10-K, for
the period ended December 31, 1998
10.01 Working Capital Loan Agreement between the Company and Exhibit No. 10.01 to Registration
Silicon Valley Bank dated April 3, 1997 Statement on Form S-1 (No.
333-33227)
10.02 Revolving Promissory Note made by the Company in favor of Exhibit No. 10.02 to Registration
Silicon Valley Bank Statement on Form S-1 (No.
333-33227)
10.03 Equipment Line of Credit Letter Agreement between the Exhibit No. 10.03 to Registration
Company and Fleet Bank dated as of June 9, 1997 Statement on Form S-1 (No.
333-33227)
10.04 1995 Stock Plan of the Company Exhibit No. 10.04 to Registration
Statement on Form S-1 (No.
333-33227)
10.05 1997 Stock Plan of the Company Exhibit No. 10.01 on Form 10-Q, for
the period ended June 30, 1998
10.06 1997 Stock Plan of the Company, as amended on March 12, Exhibit No. 10.06 on Form 10-K, for
1998, March 1, 1999, May 15, 1999 and March 8, 2000 the period ended December 31, 2000
10.07 1997 Employee Stock Purchase Plan of the Company Exhibit No. 10.06 to Registration
Statement on Form S-1 (No.
333-33227)
10.08 1997 Non-Employee Director Stock Option Plan as amended on Exhibit No. 10.08 on Form 10-Q
March 12, 1998, March 8, 2000, April 25, 2001 and filed on August 13, 2002
February 6, 2002
10.09 The Profit Sharing/401(K) Plan of the Company Exhibit No. 10.08 to Registration
Statement on Form S-1 (No.
333-33227)
10.10 Lease Agreement between the Company and John Hancock Mutual Exhibit No. 10.09 to Registration
Life Insurance Company dated March 17, 1994, as amended on Statement on Form S-1 (No.
March 25, 1997 333-33227)
10.11 First Amendment to Lease Agreement between the Company and Exhibit No. 10.10 to Registration
John Hancock Mutual Life Insurance Company dated March 25, Statement on Form S-1 (No.
1997 333-33227)
10.12 Form of Indemnification Agreement for directors and Exhibit No. 10.11 to Registration
officers of the Company Statement on Form S-1 (No.
333-33227)
10.13 Restated Common Stock Registration Rights Agreement between Exhibit No. 10.12 to Registration
the Company and certain investors dated August 7, 1986 Statement on Form S-1 (No.
333-33227)
10.14 Amended and Restated Registration Rights Agreement between Exhibit No. 10.13 to Registration
the Company and certain investors dated December 28, 1995 Statement on Form S-1 (No.
333-33227)
10.15 Management Change in Control Agreement between the Company Exhibit No. 10.14 to Registration
and John A. Blaeser dated as of August 7, 1997 Statement on Form S-1 (No.
333-33227)
10.16 Management Change in Control Agreement between the Company Exhibit No. 10.15 to Registration
and Kevin J. Conklin dated as of July 23, 1997 Statement on Form S-1 (No.
333-33227)
10.17 Management Change in Control Agreement between the Company Exhibit No. 10.16 to Registration
and Ferdinand Engel dated as of July 23, 1997 Statement on Form S-1 (No.
333-33227)
10.18 Management Change in Control Agreement between the Company Exhibit No. 10.17 to Registration
and Gary E. Haroian dated as of July 23, 1997 Statement on Form S-1 (No.
333-33227)
10.19 Management Change in Control Agreement between the Company Exhibit No. 10.18 on Form 10-Q
and Melissa H. Cruz dated as of June 12, 2000 filed on August 14, 2000
10.20 Management Change in Control Agreement between the Company Exhibit No. 10.18 to Registration
and Daniel D. Phillips, Jr. dated as of July 23, 1997 Statement on Form S-1 (No.
333-33227)
10.21 Stock Option Agreement dated January 1, 1996 between the Exhibit No. 10.19 to Registration
Company and John A. Blaeser Statement on Form S-1 (No.
333-33227)
10.22 Stock Option Agreement dated January 1, 1996 between the Exhibit No. 10.20 to Registration
Company and John A. Blaeser Statement on Form S-1 (No.
333-33227)
10.23 Letter Agreement between the Company and Silicon Valley Exhibit No. 10.21 to Registration
Bank dated March 25, 1996 together with the Loan Statement on Form S-1 (No.
Modification Agreement dated November 14, 1996 333-33227)
10.24 Form of Shrink-Wrap License Exhibit No. 10.22 to Registration
Statement on Form S-1 (No.
333-33227)
10.25 Agreement and Plan of Reorganization dated as of October Exhibit No. 2.1 on Form 8-K filed
19, 1999 by and among Concord Communications, Inc., E on November 12, 1999
Acquisition Corp., Empire Technologies, Inc. and the
stockholders of Empire Technologies, Inc.
10.26 Agreement and Plan of Reorganization dated as of January Exhibit No. 2.1 on Form 8-K filed
20, 2000 by and among Concord Communications, Inc., F on February 10, 2000
Acquisition Corp., and FirstSense Software, Inc.
10.27 Registration Rights Agreement dated as of February 4, 2000 Exhibit No. 99.1 on Form 8-K filed
by and among Concord Communications, Inc. and Timothy on February 10, 2000
Barrows, as Securityholder Agent
10.28 2000 Non-Executive Employee Equity Incentive Plan Exhibit 10.28 on Form 10-K, for the
period ended December 31, 2000
36
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION SEC DOCUMENT REFERENCE
----------- ----------- ----------------------
10.29 Management Change in Control Agreement between the Company Exhibit No. 10.29 on Form 10-Q
and Ellen Kokos dated as of February 2, 2001 filed on May 9, 2001
10.30 Management Change in Control Agreement between the Company Exhibit No. 10.30 on Form 10-Q
and John F. Hamilton dated as of April 16, 2001 filed July 31, 2001
10.31 2001 Non-Executive Employee Stock Purchase Plan Exhibit No. 10.31 on Form 10-Q
filed on November 5, 2001
10.32 Management Agreement between the Company and John Hamilton Exhibit No. 10.32 on Form 10-Q
dated May 6, 2002 filed on August 13, 2002
*10.33 Management Agreement between the Company and Kevin Conklin Exhibit No. 10.33 to Current Report
dated September 9, 2002 on Form 10-Q
- ----------
* filed herewith
37