UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended September 30, 2004.

OR

Commission File Number: 0-23067

CONCORD COMMUNICATIONS, INC.

600 Nickerson Road
Marlborough, 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES [X] NO [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES [X] NO [  ]

     18,308,575 shares of the registrant’s common stock were outstanding as of October 29, 2004.

CONCORD COMMUNICATIONS, INC.

FORM 10-Q, September 30, 2004

TABLE OF CONTENTS

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PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONCORD COMMUNICATIONS, INC.

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CONCORD COMMUNICATIONS, INC.

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CONCORD COMMUNICATIONS, INC.

     The accompanying notes are an integral part of these condensed consolidated financial statements.

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CONCORD COMMUNICATIONS, INC.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements have been prepared by Concord Communications, Inc. (the “Company” or “Concord”) in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) 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. These 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, 2004 and December 31, 2003, and the Company’s results of operations for the three and nine months ended September 30, 2004 and 2003. 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 consolidated financial statements and the notes thereto included in the Company’s 2003 Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on March 15, 2004.

(b) Financial Instruments, Concentration of Credit Risk and Significant 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 accounted for more than 10% of revenues for either the three or nine months ended September 30, 2004 or 2003. One customer, located in the United States, accounted for 10.2% of the Company’s accounts receivable at September 30, 2004. No individual customer accounted for more than 10% of the Company’s accounts receivable at December 31, 2003.

(c) 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 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. 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, 2004, the Company did not have any forward contracts outstanding.

(d) Stock-Based Compensation

     The Company accounts for employee stock-based compensation arrangements under the provisions of Accounting Principles Board (“APB”) Opinion No. 25 and related interpretations. Statement of Financial Accounting Standards (“SFAS”) No. 123 permits the use of either a fair-value based method or the intrinsic value method under APB No. 25 to account for employee stock-based compensation arrangements. Companies that elect to use the intrinsic value method provided in APB No. 25 are required to disclose the pro forma net income (loss) and net income (loss) per share that would have resulted from the use of the fair value method. The Company has provided below the pro forma disclosures of the effect on net income (loss) and net income (loss) per share as if SFAS No. 123, as amended by SFAS No. 148, had been applied in measuring compensation expense for all periods presented.

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(e) Restricted Cash

     Restricted cash totaling $65,000 and $194,000 at September 30, 2004 and December 31, 2003, respectively, consists of money market funds held in the Company’s name with a major financial institution. The balance as of September 30, 2004 is being used as collateral for a lease of one of the Company’s facilities and will expire in May 2005. The December 31, 2003 balance was being used as collateral under a letter of credit arrangement with a Company supplier and expired in May 2004.

(f) Reclassifications

     Certain amounts in the 2003 condensed consolidated financial statements have been reclassified to conform to the 2004 presentation.

2. ACQUISITION OF NETVIZ CORPORATION

     On July 17, 2003, the Company completed the acquisition of netViz Corporation (“netViz”). netViz’s software enables users to visualize business processes and allows them to map relationships within the supporting technology infrastructure through data-driven icons. The integration of netViz’s technologies with Concord’s eHealth® Suite will provide a new, more automated means of application service optimization. This integration will enable enterprises and service providers to employ data-driven icons to visualize and take action on the critical relationships between business processes, application services, and network and system infrastructures. Furthermore, this will allow customers to measure the performance and availability of application services, map the dependencies between business processes, and manage the complete application service. We believe that integrating netViz technologies will further increase the eHealth® Suite’s value proposition by capturing the business context of information and delivering IT knowledge.

     The results of operations of the acquired business have been included in the financial statements of the Company since the date of acquisition.

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     The following table reflects unaudited pro forma results of operations of the Company assuming that the netViz acquisition had occurred on January 1, 2003:

     The unaudited pro forma results of operations are not necessarily indicative of the actual results that would have occurred had the transaction actually taken place at the beginning of these periods.

3. GOODWILL AND OTHER INTANGIBLE ASSETS

     All of the Company’s goodwill resulted from the acquisition of netViz (see Note 2). The goodwill is tested for impairment on June 30th of each year and whenever changes in circumstances indicate goodwill could be impaired. As of June 30, 2004, the Company performed its annual test for impairment on the carrying value of goodwill of its MSP/TC and Enterprise reporting units. The Company compared the fair value of each reporting unit to which goodwill has been allocated to its book value and determined that no impairment existed at that date.

     Other intangible assets as of September 30, 2004 consist of the following:

Aggregate amortization expense for the three and nine months ended September 30, 2004 was $0.2 million and $0.6 million, respectively. Aggregate amortization for the three and nine months ended September 30, 2003, was $0.2 million and $0.2 million, respectively. For each period, approximately 66% of the aggregate expense was included in costs of revenues and the remainder was included in operating expenses.

4. IN-PROCESS RESEARCH AND DEVELOPMENT

     On July 11, 2003, Concord entered into a license agreement with Tavve Software Company (“Tavve”) whereby Concord licensed components of Tavve’s technology. Concord has licensed Tavve’s root cause analysis and discovery of layer 2 and 3 network topology to build upon Concord’s current position in optimizing application availability and performance across networks and systems. The transaction included two different purchases of Tavve technology. The first purchase, valued at $1.2 million, included $0.2 million of prepaid maintenance and $1.0 million of in-process research and development. This was accounted for as in-process research and development as an integrated product had not reached technological feasibility and had no alternative future use. This purchase of in-process research and development was expensed during the three months ended September 30, 2003.

     During the three months ended June 30, 2004, the Company made a second purchase for additional source code for which the Company paid $0.1 million. This was also accounted for as in-process-research-and-development as an integrated product has not reached technological feasibility and has no alternative future use.

     Technological feasibility is established when either of two sets of criteria is met:

     a) the detail program design has been completed, documented, and traced to product specifications and its high-risk development issues have been resolved; or

     b) a working model of the product has been finished and determined to be complete and consistent with the product design.

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     Upon acquiring the licensed components of Tavve’s technology, Concord did not have a completed product design at the time of the purchase as it had not completed, documented, and traced the detail program design to product specifications. Concord did not have the high-risk development issues resolved.

     A working model is defined as an operative version of the computer software product that is completed in the same software language as the product to be ultimately marketed, performs all the major functions planned for the product, and is ready for initial customer testing (usually identified as beta testing). Upon acquiring the licensed components of Tavve’s technology, Concord did not have a working model as defined.

     In addition, the purchased source code has no alternative future use, i.e., Concord will not use the source code for any other purpose than described above.

     The detail program design for the integration of Tavve’s technology into Concord eHealth® Suite of products has not been completed as of September 30, 2004; thus, the exact costs and efforts required for completion of this integration has not been determined. Based on management’s initial estimates, an integrated product based on Tavve’s technology will be introduced in the next one to three years. However, as with any major software development project, the timing of actual introduction may vary. Failure to successfully market and sell the integrated product may adversely impact the Company’s business.

5. COMMITMENTS AND CONTINGENCIES

(a) Indemnifications

     As permitted under Massachusetts law, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was serving, at the Company’s request in such capacity. The term of the indemnification period is for the officer or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a Director and Officer insurance policy pursuant to which the Company may recover all or a portion of amounts it pays to directors or officers under their indemnification agreements. As a result of its insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements is minimal.

     The Company warrants that its software products will perform in all material respects in accordance with its standard published specifications in effect at the time of delivery of the licensed products to the customer for a period of 90 days. Additionally, the Company warrants that its maintenance services will be performed consistent with its maintenance policy in effect at the time those services are delivered. The Company believes its maintenance policy is consistent with generally accepted industry standards. If necessary, the Company would provide for the estimated cost of product and service warranties based on specific warranty claims and claim history; however, the Company has never incurred significant expense under product or services warranties. As a result, the Company believes the estimated liability of these warranties is minimal.

     The Company enters into standard indemnification agreements in the ordinary course of its business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally its business partners or customers, in connection with any patent, copyright, trademark, trade secret or other intellectual property infringement claim by any third party with respect to the Company’s products. The term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is often capped at a dollar figure. The Company has never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, the Company believes the estimated liability of these agreements is minimal.

     When, as part of an acquisition, the Company acquires all of the stock or all or a portion of the assets and/or liabilities of a company, it may assume liability for certain events or occurrences that took place prior to the date of acquisition. The maximum potential amount of future payments it could be required to make for such obligations is undeterminable at this time. The Company has no liabilities recorded for these exposures as of September 30, 2004.

     The Company has entered into separate registration rights agreements with Vo Tran, a major shareholder of netViz, and with Bear, Stearns & Co. Inc. Pursuant to these agreements, the Company indemnifies and holds harmless the indemnified parties under the

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agreements in connection with any material misstatements or omissions by the Company in its filings with the SEC or, with respect to the agreement entered into with Vo Tran, the violation by the Company of any applicable securities law or regulation. The term of the indemnification provisions in these agreements is perpetual. The Company has never incurred costs to defend lawsuits or settle claims related to these agreements. As a result, the Company believes the estimated liability of these agreements is minimal.

(b) Claims

     On April 30, 2004, the Company received a letter from LMS Technology Distributions SDN BHD (“LMS”) of Malaysia that demands that the Company reimburse LMS for approximately $4.65 million in alleged losses arising out of the Company’s purported wrongful termination of a Concord Authorized Reseller Agreement (the “CAR Agreement”) with LMS. The Company disputes that the CAR Agreement was wrongfully terminated or that LMS is owed any of the amounts claimed, and the Company intends to defend vigorously against the demand. It is not possible to predict or determine the outcome of these demands or to provide ranges of losses that may arise, if any.

     In November 2003, Concord received notice from a former sales employee in France, stating that he was wrongfully dismissed in July 2003. The former employee filed a wrongful termination lawsuit against Concord claiming approximately $0.4 million in damages. Concord disputes that the former employee was wrongfully terminated and intends to vigorously defend against this claim. However, Concord has determined, in the three month period ending September 30, 2004, that the amount of the loss was probable and could be estimated as defined by SFAS No. 5, Accounting for Contingencies; thus, an amount of $0.12 million has been accrued.

6. NET INCOME PER SHARE

     The Company computes earnings per share following the provisions of SFAS No. 128, Earnings per Share. Basic net income per share is computed using the weighted-average number of common shares outstanding for a period. Diluted net income per share is computed using the weighted-average number of common and dilutive potential common shares outstanding for the period. Diluted net income per share is computed using the weighted-average number of common shares outstanding for a period.

     For both the three and nine months ended September 30, 2004 and 2003, dilutive potential common shares outstanding consisted of stock options. The dilutive effect of outstanding stock options is computed using the treasury stock method. The dilutive effect of senior convertible notes is computed using the if-converted method.

     Calculations of the basic and diluted net income per common share and potential common share are as follows:

     For the three months ended September 30, 2004 and 2003 and for the nine months ended September 30, 2004 and 2003, diluted weighted average shares outstanding does not include 3,169,030; 1,828,568; 2,823,729 and 2,441,742 potential common shares, respectively, as their effect would have been anti-dilutive.

     For the period ended September 30, 2004, common stock reserved for issuance upon conversion of the convertible senior notes in the amount of 3,209,776 shares were not included in diluted earnings per share because the conversion criteria had not been met. Pursuant to a recently issued accounting standard (see Note 10), the Company must consider the effect of such conversion on diluted earnings per share, without regard to whether the conversion criteria have been met, beginning in the fourth quarter of 2004. Accordingly,

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3,209,776 shares will be included in the diluted weighted average common shares outstanding and equivalents for the net income per share calculation, excluding interest expense for the period, if the effect of adding these shares is dilutive.

7. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) is defined as the change in net assets of the Company during a period from transactions generated from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.

Comprehensive income (loss) for the three and nine months ended September 30, 2004 and 2003 is as follows:

8. 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:

     For the three and nine months ended September 30, 2004, no one country, except the United States, accounted for greater than 10% of total revenues. For the three months ended September 30, 2003, no one country, except the United States and Germany, accounted for greater than 10% of total revenues. For the nine months ended September 30, 2003, no one country, except the United States and the United Kingdom, accounted 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 for the Company on a consolidated basis. 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.

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     The following table presents the approximate revenues by reportable segment:

The Company currently does not provide revenues by product or product family, as it is impractical due to the nature of its single suite of products. Some components of the suite could be included in more than one product family. In addition, categorization and classification of the Company’s components into product families is changing in nature; changes in packaging, licensing and product categorization occur on a frequent basis.

9. PURCHASE FOR CASH OF CERTAIN OUTSTANDING OPTIONS

In October 2004, Concord consummated an offer to purchase any and all outstanding options to purchase shares of its common stock with an exercise price per share of $25.00 or more granted under its 1997 Stock Plan (the “Option Repurchase”). In connection with the Option Repurchase, Concord incurred compensation expense of approximately $3.3 million, excluding fees and expenses, in the three month period ending December 31, 2004. A total of 965,242 options were purchased; these shares will be returned to the pool of options available for new grants under the Concord’s 1997 Stock Plan.

10. RECENT ACCOUNTING PRONOUNCEMENTS

At the September 2004 meeting, the Emerging Issues Task Force (EITF) reached a final consensus on Issue 04-8, Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share. The issue under consideration concerned whether the dilutive effect of contingently convertible debt with a market price trigger should be included in diluted earnings per share. The EITF determined that these securities should be treated as convertible securities and included in a dilutive earnings per share calculation (if dilutive), regardless of whether the market price trigger has been met. The effective date for this consensus will be the same as the effective date for the revised version of SFAS No. 128, Earnings per Share, yet to be issued by the Board. The Board’s most recent discussion on the effective date for SFAS No. 128R indicates that it will be effective for reporting periods ending after December 15, 2004. In the period of adoption, previously reported earnings per share will be retroactively restated While the Company’s convertible senior notes fall within the scope of EITF 04-8, the Company believes that the adoption of this standard will not have a material impact on its diluted earnings per share as the inclusion of the convertible senior notes is expected to be anti-dilutive.

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CONCORD COMMUNICATIONS, INC.
FORM 10-Q, September 30, 2004

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

     We are a software company that provides a solution to enterprise customers, managed service providers and telecommunication carriers. We serve the Business Service Management (BSM) market with our solution, the eHealth® Suite of products, which maps Information Technology (IT) services to business needs, measures the actual end user experience and manages application, system and network infrastructure.

     We sell our products worldwide through a direct sales force, channel partners and other resellers. We have sales offices in 18 countries, including the United States and we have customers in 63 countries.

     Our products are generally sold on a perpetual license basis. On an initial purchase, customers will usually buy a license to our eHealth® Console and a certain number of software elements, which is dependent on the number of components of the IT services to be managed. As a customer’s IT services management requirements expands, they will order additional modules and elements. We believe that our significant installed base provides an opportunity to sell additional software elements and other products to our existing customer accounts. Most of our customers purchase maintenance upon the initial licensing of our software. In addition, the majority of these customers renew their maintenance agreements annually. For an annual maintenance fee, a customer receives telephone, email and web-based support, as well as updated product releases. In additional to on-going technical support, we also offer professional and education services to our customers.

     Our total revenues are generated from license revenue and service revenue. License revenues are usually generated by the purchase of a license to our product. Concord’s service revenues consist of fees for maintenance, training and professional services. For the three month and nine month periods ending September 30, 2004, our total revenues increased year over year. For the three month and nine month periods ending September 30, 2004, our profitability decreased year over year due, in part, to the interest payable on Company’s 3.0% Senior Convertible Notes issued in December 2003. For the three month period ending September 30, 2004, total revenues were $26.9 million, up 1.3% from $26.6 million for the three month period ending September 30, 2003. For the nine-month period ending September 30, 2004, total revenues were $77.4 million, up 1.5% from $76.3 million for the nine month period ending September 30, 2003. Our diluted earnings per share decreased to $0.01 per share for the three-month period ending September 30, 2004 compared to $0.03 per share for the corresponding prior year period. Our diluted earnings per share decreased to $0.00 per share for the nine-month period ending September 30, 2004 compared to $0.14 per share for the corresponding prior year period. We generated $3.3 million in operating cash during the nine-month period ending September 30, 2004 and finished the quarter with $163.4 million of cash, cash equivalents, marketable securities and restricted cash.

     In October 2004, we consummated an offer to purchase any and all outstanding options to purchase shares of our common stock with an exercise price per share of $25.00 or more granted under our 1997 Stock Plan (the “Option Repurchase”). In connection with the Option Repurchase, we incurred compensation expense of approximately $3.3 million, excluding fees and expenses, in the three month period ending December 31, 2004. A total of 965,242 options were purchased; these shares will be returned to the pool of options available for new grants under the Concord’s 1997 Stock Plan.

Critical Accounting Policies, Significant Estimates and Judgments

     The accompanying discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with US GAAP. The preparation of consolidated financial statements

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requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. However, future events are subject to change and the best estimates and judgments routinely require adjustment. US GAAP requires us to make estimates and judgments in several areas. If actual results differ significantly from management’s estimates and projections, there could be a material effect on our financial statements. See our audited consolidated financial statements and notes thereto in our Annual Report on Form 10-K and which contain accounting policies and other disclosures required by US GAAP.

     We believe that the policies, significant estimates and judgments discussed below are the most critical to our financial statements and the understanding of our financial condition and results of operations because their application places the most significant demands on management’s judgment.

     (a) Revenue Recognition

     Our 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. Software license revenues are recognized when persuasive evidence of an arrangement exists and delivery of the software has occurred, provided that the license fee is fixed or determinable, collection is considered reasonably assured and no customer acceptance clauses exist. If an arrangement includes an acceptance provision, revenue recognition occurs upon the earlier of a receipt of a written customer acceptance or expiration of the acceptance period. If an arrangement includes a right of return for the possibility that the software does not meet published specifications during the warranty period, which is typically 90 days, revenue is recognized upon shipment if all other criteria are met, as the company’s product is mature and we have not experienced returns of our products. If the fee is determined not to be fixed or determinable, revenue is recognized when the fees become due. If collection is not considered reasonably assured, revenue is recognized upon the receipt of cash. Revenues under multiple-element arrangements, which typically include software products, services, maintenance and sometimes undelivered specified software upgrades 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 remainder of the arrangement consideration is allocated to the software. We have established sufficient vendor specific objective evidence for professional services, training, maintenance, customer support services and specified software upgrades 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, maintenance, customer support services and specified software upgrades.

     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, provided evidence of an arrangement exists, fees are fixed or determinable, and collection is considered reasonably assured.

     We license our software to end-users, resellers and OEM’s. Revenue recognition is centralized at our corporate headquarters, located in the United States. Our arrangements with customers do not generally include provisions involving acceptance of our products by our customers. However, if a customer arrangement includes an acceptance provision, revenue recognition occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period. With respect to revenues from our channel partners and other resellers, we recognize revenue upon delivery of our software to the channel partner or reseller. We do not offer any right of return, price protection or similar rights to our channel partners and other resellers.

     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 to resellers are usually evidenced by a master agreement governing the relationship together with purchase orders on a transaction-by-transaction basis. Sales to OEM’s are usually evidenced by a master agreement governing the relationship together with a shipping report on a transaction-by-transaction basis.

     Delivery generally occurs when product is delivered to a common carrier and the delivery terms are FOB Concord. In the case of arrangements with resellers or OEMs, revenue is recognized upon delivery to the reseller or OEM. Most of these arrangements involve a sell-through by the reseller or OEM to an end user. For a reseller, evidence usually comes in the form of a purchase order typically identifying the end-user. For an OEM, evidence of sell-through usually comes in the form of a shipping report, which usually identifies the “ship to” location.

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     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, depending upon the region, we account for the fee as not being fixed or determinable. In these cases, we recognize revenue when the fees become 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 recognize revenue upon receipt of cash. Concord’s channel partners and other resellers are responsible to the Company upon delivery.

     For arrangements with multiple elements (for example, undelivered maintenance and support or undelivered specified software upgrades), 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 value 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 value of services, such as training or consulting, by referencing the prices at which we have separately sold comparable services to our customers. For specified undelivered software upgrades, we determine fair value of these upgrades by referencing the prices at which we sell upgrades separately to our customers.

     The majority of our sales transactions are completed using standard terms and conditions; however, there are agreements that contain non-standard terms and conditions. As a result, significant contract interpretation is sometimes required to determine the appropriate accounting, including whether the deliverables specified in a multiple obligations arrangement should be treated as separate units of accounting for revenue recognition purposes, and if so, how the price should be allocated among the deliverable elements and when to recognize the revenue for each element. Changes in the allocation of the sales price between deliverable elements might impact the timing of revenue recognition, but would not change the total revenue recognized for the transaction.

     (b) Accounts Receivable

     We record our trade accounts receivable at the invoiced amount; these accounts do not bear interest. 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 our historical experience and any specific customer collection issues that we have identified. We review our allowance for doubtful accounts on a monthly basis. We review all past due balances over 60 days individually for collectibility. We charge account balances against the allowance when we feel it is probable the receivable will not be recovered. We do not have any off-balance-sheet credit exposure to our customers.

     While 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. Thus, if the financial condition of our customers were to deteriorate, our actual losses may exceed our estimates, and additional allowances would be required.

     (c) Accounting for Income Taxes

     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 and expense accruals, 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. To the extent we reverse any portion of the valuation allowance, we must recognize a benefit within the tax provision in the statement of operations or to additional paid-in capital for the benefit of deductions for stock option exercises.

     Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities

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and any valuation allowance recorded against our net deferred tax assets. The Company has reserved for a portion of its deferred tax assets by recording a valuation allowance. The resulting net deferred tax asset is based on the Company’s estimate of future taxable income it expects to generate; all other tax assets have been reserved. The remaining valuation allowance of $2.3 million 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. This amount relates primarily to stock option deductions and will be credited to additional paid-in capital when released. If we are sufficiently profitable in 2004, the reserve will be released in 2004. 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.

     (d) Accounting for Acquisitions and Acquired In-process Research and Development

     We have completed our acquisition of netViz (“netViz”), which was accounted for under the purchase method of accounting, which has resulted in recording significant goodwill and other intangible asset balances. The purchase price has been allocated to the assets acquired and liabilities assumed at their estimated fair values on the date of acquisition, as determined by management and, with respect to the identifiable intangible assets, an appraisal. Our accounting for the netViz acquisition involves significant judgments and estimates regarding primarily, but not limited to: the fair value of acquired intangible assets, which are based on projections of future revenues and cash flows, assumptions regarding discount factors, royalty rates, tax rates, amortization methodologies and related useful lives, as well as the fair value of other acquired assets and assumed liabilities, including potential contingencies and deferred income taxes. The completed technology (software), reseller relationships, maintenance relationships and trade name/trademarks will be amortized at the greater of (a) the ratio that current revenues bear to the total of current and anticipated future revenues or (b) the straight-line method over their respective remaining useful lives. The contractor agreements will be amortized using the straight-line method over their useful lives. The values of the completed technology, reseller relationships, maintenance relationships, contractor agreements and trade name/trademarks were determined using the income approach. The income approach requires a projection of revenues and expenses specifically attributed to the intangible assets. The discounted cash flow (“DCF”) method is then applied to the potential income streams after making necessary adjustments with respect to such factors as the wasting nature of the identifiable intangible assets and the allowance of a fair return on the net tangible assets and other intangible assets employed. There are several variations on the income approach, including the relief-from-royalty method, the avoided cost method and the lost profits method.

     The relief-from-royalty method was used to value the trade name/trademarks. The relief-from-royalty method is used to estimate the cost savings that accrue to the owner of the intangible assets that would otherwise have to pay royalties or licensee fees on revenues earned through the use of the asset. The royalty rate used in the analysis is based on an analysis of empirical, market-derived royalty rates for guideline intangible assets. Typically, revenue is projected over the expected remaining useful life of the intangible asset. The market-derived royalty rate is then applied to estimate the royalty savings. The key assumptions used in valuing the trade name/trademarks are as follows: royalty rate 1%, discount rate 21%, tax rate 40% and estimated average economic life of 3 years.

     The avoided cost method was used to value the reseller relationships and contractor agreements. The avoided cost method considers the concept of avoided cost as an indicator of value. The avoided cost method is appropriate for estimating the fair value of an asset where reliable data for sales of comparable property are not available and where the property does not directly produce an income stream. The key assumptions used in valuing the reseller relationships are as follows: tax rate 40% and estimated average economic life of 5 years. The key assumptions used in valuing the contractor agreements are as follows: tax rate 40% and estimated average economic life of 4 years.

     The completed technology (software) was valued using the income approach without variation. The key assumptions used in valuing the completed technology are as follows: discount rate 21%, tax rate 40% and estimated life of 4 years. The key assumptions used in valuing the maintenance relationship are as follows: discount rate 21%, tax rate 40% and estimated average economic life of 5 years.

     Deferred income taxes and any valuation allowances are based in part on future estimated profitability of the Company. As a direct result of the netViz acquisition, the Company has estimated that future profitability will increase and therefore released $0.75 million of the valuation allowance.

     We have also completed our accounting of the license agreement with Tavve whereby Concord licensed components of Tavve’s technology. Our accounting for the Tavve license as in-process research & development involved significant judgments and estimates regarding primarily, but not limited to: assessing if the acquired technology has reached technological feasibility and if the acquired technology has no alternative future use.

     Technological feasibility is established when either of two sets of criteria is met:

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     a) the detail program design has been completed, documented, and traced to product specifications and its high-risk development issues have been resolved; or

     b) a working model of the product has been finished and determined to be complete and consistent with the product design.

     Upon acquiring the licensed components of Tavve’s technology, Concord did not have a completed product design at the time of the purchase as it had not completed, documented, and traced the detail program design to product specifications. Concord also did not have the high-risk development issues resolved.

     A working model is defined as an operative version of the computer software product that is completed in the same software language as the product to be ultimately marketed, performs all the major functions planned for the product, and is ready for initial customer testing (usually identified as beta testing). Upon acquiring the licensed components of Tavve’s technology, Concord did not have a working model as defined.

     In addition, the purchased source code has no alternative future use, i.e., Concord will not use the source code for any other purpose than described above.

     The detail program design for the integration of Tavve’s technology into Concord eHealth® Suite of products has not been completed as of September 30, 2004; thus, the exact costs and efforts required for completion of this integration has not been determined. Based on management’s initial estimates, an integrated product based on Tavve’s technology will be introduced in the next one to three years. However, as with any major software development project, the timing of actual introduction may vary. Failure to successfully market and sell our integrated product may adversely impact our business.

     (e) Valuation of Long-Lived Tangible and Intangible Assets and Goodwill

     We have significant long-lived tangible and intangible assets and goodwill, which are susceptible to valuation adjustments as a result of changes in various factors or conditions. The long-lived tangible assets are fixed assets, which are depreciated over their estimated useful lives. The long-lived intangible assets are completed technology (software), reseller relationships, maintenance relationships, contractor agreements, and trade name / trademarks which are amortized over their estimated useful lives following the greater of the pattern in which the expected benefits will be consumed or otherwise used up or on a straight-line basis. Goodwill is not amortized.

     At each quarter-end, the carrying value of the completed technology (software) is compared to its net realizable value (“NRV”). NRV is the estimated future gross revenues from products that incorporate the software reduced by the estimated future costs of disposal. If NRV is less than the carrying value, the excess is written-off and the then current NRV becomes the new carrying value of the software. We assess the potential impairment of other identifiable intangible assets and fixed assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important, which could trigger an impairment of such assets, include the following:

	•		Significant underperformance relative to historical or projected future operating results;
	•		Significant changes in the manner of or use of the acquired assets or the strategy for our overall business;
	•		Significant negative industry or economic trends;
	•		Significant decline in our stock price for a sustained period; and
	•		A decline in our market capitalization below net book value.

     Future adverse changes in these or other unforeseeable factors could result in an impairment charge that would impact future results of operations and financial position in the reporting period identified.

     Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, or SFAS 142, requires goodwill to be tested for impairment using a two-step process. The first step compares the fair value of the reporting unit with the unit’s carrying value, including goodwill. When the carrying value of the reporting unit is greater than fair value, the unit’s goodwill may be impaired, and the second step must be completed to measure the amount of the goodwill impairment charge, if any. In the second step,

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the implied fair value of the reporting unit’s goodwill is compared with the carrying amount of the unit’s goodwill. If the carrying amount is greater than the implied fair value, the carrying value of the goodwill must be written down to its implied fair value. We operate in one reporting unit and, therefore, will conduct future goodwill impairment test on an enterprise-wide level. Goodwill is required to be tested for impairment at least annually, or more frequently when events and circumstances occur indicating that the recorded goodwill might be impaired. We plan to perform the annual assessment at June 30 of each fiscal year. Factors we consider important, which could trigger an impairment of goodwill, include the following:

	•		Significant underperformance relative to historical or projected future operating results;
	•		Significant negative industry or economic trends;
	•		Significant decline in our stock price for a sustained period; and
	•		A decline in our market capitalization below net book value.

     Future adverse changes in these or other unforeseeable factors could result in an impairment charge that would impact future results of operations and financial position in the reporting period identified.

     Significant judgments and estimates are involved in determining the useful lives of our intangible assets, determining what reporting units exist and assessing when events or circumstances would require an interim impairment analysis of goodwill or other long-lived assets to be performed. Changes in events or circumstances, including but not limited to technological advances or competition which could result in shorter useful lives, additional reporting units which may require alternative methods of estimating fair value, or economic or market conditions which may affect previous assumptions and estimates, could have a significant impact on our results of operations or financial position through accelerated amortization expense or impairment charges.

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RESULTS OF OPERATIONS

     The following table sets forth, for the periods indicated, certain financial data as percentages of the Company’s total revenues:

Total Revenues

     Concord’s total revenues are generated from license revenue and service revenue.

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License Revenues

     Concord’s license revenues are derived from the licensing of software products.

Third Quarter 2004 Compared to Third Quarter 2003:

     The decrease in license revenues in both absolute dollars and percentage of revenues was driven by lower demand for our products in Europe and Asia. This decrease was partially offset by $0.4 million increase of license revenues generated by netViz, a company which was acquired by Concord in July 2003.

First Nine Months 2004 Compared to First Nine Months 2003:

     The decrease in license revenues in both absolute dollars and percentage of revenues was due to lower international license sales. In the first nine months of 2003, we completed several large transactions with European-based managed service providers. Sales to this segment in Europe were lower in the first nine months of 2004 as demand for our products was not as robust as compared to the nine months ended September 30, 2003. The decrease of license revenues in the first nine months of 2004 was partially offset by $1.6 million increase of license revenues generated by netViz.

     The continuing decrease of license revenues as a percent of total revenues in the three and nine months ended September 30, 2004 as compared to the three and nine months ended September, 2003 was the result of a significant increase in service revenues combined with a decrease of the license revenues.

     There were no material price increases for products during the first nine months of 2004 and inflation did not have a significant impact on our revenues or income during the first nine months of 2004.

New eHealth customer accounts

     License revenues are partially dependent on our ability to sell to new eHealth customer accounts. New eHealth customer accounts represent the number of new customer accounts that purchase software from the Concord eHealth® Suite of products. NetViz new customer accounts are excluded from this count as these products are not considered key drivers of our primary business. Due to the nature of netViz® products, customers that purchase netViz® products do not generate significant revenue for the initial or subsequent purchase.

Third Quarter 2004 Compared to Third Quarter 2003:

     The number of sales to new eHealth customer accounts in the three months ended September 30, 2004 is comparable to the number of transactions completed in the three month period ended September 30, 2003.

First Nine Months 2004 Compared to First Nine Months 2003:

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     The decrease in the number of sales to new eHealth customer accounts in the nine months ended September 30, 2004 as compared to the corresponding prior year period was due, primarily, to sales and marketing execution issues in the first quarter of 2004, as our sales teams focused their efforts on our large install base in the first two quarters of 2004. However, the number of new eHealth customer accounts increased substantially in the three month period ended September 30, 2004 as compared to the number of sales to new customers in the each of the first two quarters of 2004. Internal initiatives, implemented in the third quarter of 2004, such as targeted marketing programs and specific sales incentives, helped improve our effectiveness in the three months ended September 30, 2004.

Transactions over $100,000

     License revenues can also be dependent on the number of transactions over $100,000 that we are able to close during the period.

Third Quarter 2004 Compared to Third Quarter 2003 and First Nine Months 2004 Compared to First Nine Months 2003:

     The number of transactions greater than $100,000 recorded in the three and nine months ended September 30, 2004 is comparable to the number of transactions recorded in the three and nine months ended September 30, 2003. We believe that the solution selling training offered to our new sales employees combined with on going business oriented sales training, will improve our ability to increase the number of transactions greater than $100,000. However, there can be no assurance that we will be successful in meeting this estimate.

Service Revenues

     Concord’s service revenues consist of fees for maintenance, training and professional services.

Third Quarter 2004 Compared to Third Quarter 2003 and First Nine Months 2004 Compared to First Nine Months 2003:

     The increase in service revenues in both absolute dollars and percentage of revenues in the three and nine month ended September 30, 2004 as compared to the corresponding prior year periods was due to an increase in maintenance revenues, which are generated from new and renewed maintenance contracts, and the maintenance generated by netViz. Maintenance generated by netViz contributed approximately $0.5 million and $1.3 million, respectively, in service revenue in the three and nine months ended September 30, 2004. Increased service revenues from new and renewed maintenance contracts primarily drove the balance of the increase in service revenues.

     Maintenance revenues represent fees earned by granting our customers rights to technical support, software product upgrades and maintenance patches during the support period, which is usually one year. The majority of our license customers purchase maintenance upon the initial licensing of our software. In addition, the majority of these customers renew their maintenance agreements annually. An increase in the number of the Company’s customers and the resulting demand for these services further helped drive the increase in service revenues in the three and nine months ended September 30, 2004 as compared to the three and nine months ended September 30, 2003.

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Direct and Indirect Revenues

     Concord markets its products in the United States primarily through a direct sales force. Internationally, Concord markets primarily through indirect channels, which include channel partners and other resellers.

Third Quarter 2004 Compared to Third Quarter 2003 and First Nine Months 2004 Compared to First Nine Months 2003:

     The increase in direct sales for the three month and nine month periods ending September 30, 2004 in both absolute dollars and percentage of revenue is due to improved performance by the domestic sales force due to our continued investment in sales training. The decrease in indirect sales for the same period is due to lower sales in Europe and Asia.

Segment Revenues

     Concord’s reportable segments are determined by customer type: managed service providers/telecommunications carriers (“MSP/TC”) and enterprise.

Third Quarter 2004 Compared to Third Quarter 2003:

     The increase in MSP/TC revenues in both absolute dollars and percentage of revenues was driven by several large telecommunication carriers orders. Many of the orders with MSP/TC customers had license transactions greater than $100,000 in the three months ended September 30, 2004. The number of transactions greater than $100,000 can be concentrated in a specific segment in a given quarter due to unpredictable buying patterns and this variability can lead to quarterly fluctuation in the relative percentage of revenues of both Enterprise and MSP/TC customers.

First Nine Months 2004 Compared to First Nine Months 2003:

     The increase in Enterprise revenues in both absolute dollars and percentage of revenues was driven by a combination of repeat sales to existing customers and many orders with license transactions greater than $100,000. These were mainly in the United States. This concentration of transactions with Enterprise customers explains, in part, the decrease of MSP/TC revenue in both absolute dollars and percentage of revenues. In the first quarter of 2003, we completed a certain number of transactions over $100,000 with European managed service providers; this explains the higher percentage of MSP/TC in the nine months ended September 30, 2003 as

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compared to the nine months ended September 30, 2004.

     Although MSP/TC revenues in both absolute dollars and percentage of revenues decreased in the nine month period ended September 30, 2004 as compared to the corresponding period ended September 30, 2003, we expect that MSP/TC revenue will be 40% to 50% of total revenues; however, there can be no assurance that we will be successful in meeting this estimate.

International Revenues

     Concord has fourteen international subsidiaries and three international branch offices. Concord has customers in 63 countries.

Third Quarter 2004 Compared to Third Quarter 2003 and First Nine Months 2004 Compared to First Nine Months 2003:

     The decrease in international revenues in both absolute dollars and percentage of revenues for the three and nine month periods ending September 30, 2004 was due mainly to strong demand by European managed service providers in Germany and the UK in 2003. Sales to these segments in Europe were lower for the three and nine months of 2004 as demand for our products was not as robust as compared to the corresponding prior year periods.

     Although international revenues decreased year over year, we expect revenue from international customers will be 40% to 50% of total revenues. We continue to commit additional time, training and development resources to customizing our products and services for selected international markets and this will improve our ability to meet our international sales targets. We believe that continued growth and profitability will require further expansion of our sales, marketing and customer service functions in international markets. However, there can be no assurance that we will be successful in meeting this estimate.

Revenues Recognized in Connection With Third Party Software

     Concord bundles third party software in some of its products when it determines that bundling such software is cost-effective or increases the effectiveness of Concord’s products. In some instances, Concord has determined that it can be cost prohibitive to develop such software applications, especially if such applications are already available in the marketplace. In addition, bundling third party software allows Concord, in certain instances, to accelerate the delivery of increased functionality within a short timeframe.

     Revenues generated by Concord products that included third party software were:

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Third Quarter 2004 Compared to Third Quarter 2003 and First Nine Months 2004 Compared to First Nine Months of 2003:

     The increase of revenues from third party software in the three and nine months ended September 30, 2004 as compared to the three and nine months ended September 30, 2003 in both absolute dollars and percentage of revenues was mostly driven by increased demand for Oracle® database software that is integrated into our product offering. Demand for the Oracle® database product is also driven by the transition of our large installed base from the Ingres database to the Oracle® database. In 2002, we integrated the Oracle® database software into our product offering; this enabled us to replace the Ingres database we used previously with the Oracle® product and to offer one single database solution to our customers.

Cost of Revenues

     Cost of revenues includes cost of license revenues and cost of service revenues.

Cost of License Revenues

     Cost of license revenues includes expenses associated with royalty fees, production, fulfillment of orders, product documentation and amortization expense associated with the completed technology intangible asset. Royalty costs are composed of third party software costs.

Third Quarter 2004 Compared to Third Quarter 2003:

     The increase of cost of license revenues in both absolute dollars and percentage of revenues was mainly driven by higher royalty costs, which are fees paid to third party software companies.

First Nine Months 2004 Compared to First Nine Months 2003:

     The increase of cost of license revenues in both absolute dollars and percentage of revenues was driven by higher royalty costs and amortization expense relating to the acquisition of netViz. Royalty costs and amortization expense contributed approximately 36% and 56%, respectively, to the increase in the cost of license revenues.

Expenses Recognized in Connection With Third Party Software

     Royalty costs are comprised of third party software costs. The Company bundles third party software in some of its products when it determines that bundling such software is cost-effective or increases the effectiveness of Concord’s products. Costs associated with revenues generated by Concord products that included third party software were:

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