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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
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 000-29335
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WITNESS SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 23-2518693
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
300 COLONIAL CENTER PARKWAY ROSWELL, GEORGIA 30076
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code 770-754-1900
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Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, par value $.01 per share NASDAQ
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
At March 16, 2001, the registrant had 22,145,633 shares of common stock,
par value $.01 per share, outstanding, and the aggregate market value of the
outstanding shares of voting stock held by non-affiliates of the registrant on
such date was approximately $85 million based on the closing price of $6.19 per
share of such common stock on such date.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for its annual
meeting of stockholders, scheduled for May 21, 2001, are incorporated by
reference in Part III of this report.
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PART I
ITEM 1. BUSINESS
OVERVIEW
We provide business-driven multimedia recording, analysis and electronic
learning software that enables companies to enhance their customer interactions
across multiple communications media. Our software is designed to enable
companies to optimize their customer relationship management ("CRM"). As a
result, we believe our customers are able to generate additional revenue
opportunities, improve profitability, enhance customer retention, reduce
employee turnover and achieve greater customer intimacy.
Our eQuality software is designed to enable customer contact centers within
a company to record and evaluate complete customer interactions through multiple
media, such as telephone, e-mail and Web chat, identify performance gaps and
then apply targeted electronic learning for continuous performance improvement.
The eQuality software records a customer sales/service representative's ("CSR"s)
voice interactions with a customer as well as the CSR's corresponding computer
desktop activities, such as data entry, screen navigation and data retrieval. By
capturing both voice and computer desktop activity and synchronizing them during
replay, a company can observe and analyze complete customer interactions as they
actually occurred. Supporting the need for Web-based customer interactions
driven by the growth of the Internet and eCommerce, eQuality enables companies
to also capture, evaluate and analyze e-mail, Web chat and guided browser
sessions. In addition, eQuality allows companies to selectively record and
analyze customer interactions on any of these mediums based on business criteria
which they define, such as key customers, important marketing campaigns, new
product introductions and selected CSR criteria.
The most recent addition to the eQuality software suite is an integrated
electronic learning management solution designed specifically for the
Internet-enabled call center market. eQuality Now(TM) helps companies achieve
greater customer loyalty through continuous performance improvement. This is a
result of the software's ability to deliver ongoing, personalized training to
CSRs at their desktops. The training is focused on specific areas that impact
performance.
Historically, analyzing CSR performance and then devising personalized
training programs to target areas for improving skills has been a manual
process. The eQuality Now solution was introduced to provide a continuous
assessment of the skill level of contact center CSRs and the effectiveness of
current training, as well as to identify any knowledge gaps in the contact
center and areas that need improvement.
Performance scores stored in the eQuality Evaluation(TM) software trigger
the need for learning events. With eQuality Now, targeted training is assigned,
prioritized and delivered to an agent's desktop based on their evaluation
results. Finally, eQuality Now enables a closed performance loop for learning by
highlighting post-learning customer interactions. Once CSRs take a course, the
software can monitor subsequent multimedia contacts to confirm that the training
has been successful and the new skills can be applied in the real world.
We currently provide software to an extensive base of large companies with
multiple contact centers, including American Airlines, American Century Mutual
Funds, AT&T, Bank of America, EDS, J.P. Morgan Chase & Co., USAA, Verizon
Wireless and WorldCom. As of December 31, 2000, we had licensed our software
to over 237 customers at over 593 sites.
INDUSTRY BACKGROUND
Developing and maintaining long-term customer relationships is critical to
the success of businesses operating in a competitive global marketplace. The
rapid growth of the Internet and eCommerce has increased the importance
companies place on their customer relationships. Because the Internet enables
consumers to easily evaluate products and prices from a wide range of
geographically dispersed vendors and quickly change vendors at relatively low
cost, it is becoming more difficult for businesses to develop long-term
relationships with their customers. As the use of the Internet expands as a
business platform, the need for personal contact is essential to enabling a
higher quality customer experience. The integration and optimization of customer
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contacts across all communications media is, therefore, becoming both a
strategic and tactical business requirement.
In response to these trends, companies are adopting CRM initiatives seeking
to increase the longevity and profitability of their customer relationships. To
affect these initiatives, companies have developed software applications to
automate and evaluate key sales, marketing and customer service processes and
improve the effectiveness of their customer interactions. According to META
Group, CRM will be among the "safest" technology sectors overall-with spending
rates growing on a year-over-year basis at approximately 30+%. AMR Research
projects that the CRM software market should increase 44% to $9.8 billion this
year (2001). AMR also projects that 87% of companies will maintain or grow
investments in e-business initiatives, with top focus on customer and supplier
management. Historically, the focus of CRM applications has been on improving
the companies' internal sales, marketing and customer service processes.
Competitive pressures resulting from the emergence of the Internet and
eCommerce have required companies to shift the focus of their CRM initiatives
from improving their internal operations to meeting the needs of their
customers. Companies are developing a new set of business principles that place
a greater value on improving customer satisfaction and enhancing employee skills
to foster customer relationships and increase customer intimacy. We believe that
companies, with a better understanding of the characteristics and preferences of
their customers, will be able to more effectively customize product and service
offerings that result in increased customer retention. In addition, these
companies will be able to better identify opportunities to sell complementary or
higher-end products and to more accurately forecast customer demand.
To understand and improve customer relationships, a company must first
improve its specific business processes that involve a high degree of direct
customer interaction. Today, many of a company's direct customer interactions
occur through call centers. These call centers are generally staffed by
telephone operators, often referred to as CSRs, who process a steady flow of
outbound or inbound telephone calls relating to the company's products and
services. Call centers generally consist of supervisor and agent workstations
linked to a central telephone switch and a common computer system. Companies
have increased their focus on developing and improving the efficiency of their
call center operations.
Historically, call centers have had the ability to handle only limited
telephone and other voice interactions. These call centers have generally
focused on either conducting outbound calls, for functions such as collections
and product sales, or on managing inbound calls, for purposes such as product
support, order processing or customer service. The growth of the Internet and
the increased focus of businesses on optimizing relationships with their
customers have contributed to the evolution of traditional single-function,
telephone-based call centers into multi-functional, multi-channel customer
interaction centers, or contact centers. The emergence of multi-channel customer
contact centers has generally increased the volume and complexity of tasks that
CSRs are required to perform. As a result, traditional single-function CSRs must
now assume more valuable, multi-function customer service responsibilities.
Companies are now attempting to apply the best practices from the call center
industry to the rapid, electronic, high-volume customer interactions associated
with the Internet.
CSRs are now required to effectively handle multiple tasks that involve
interaction across a growing number of customer touch points, including
telephone, the electronic exchange of text messages over the Internet, commonly
referred to as Web chat, and e-mail. For example, certain Web-based consumers
may have the option to select a "call me now" button which initiates a Web chat
or direct telephone interaction with a CSR. While Web-based customer
interactions are expected to continue to grow rapidly, Jupiter Communications
estimates that 90% of all online customers still prefer human interaction. In
addition, companies have discovered that the success of their marketing
initiatives depends on their ability to rapidly make adjustments to these
campaigns as they progress. We believe these adjustments are best effected at
the direct point of customer contact, which is increasingly occurring through
the contact center. The increasing importance of developing long-term customer
relationships, the growing complexity of the CSR's job and the opportunity to
manage marketing initiatives through the customer contact center have combined
to dramatically increase the need for companies to provide an effective means to
record, evaluate and analyze their customer interactions.
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A number of applications have emerged to attempt to address the need to
better manage these interactions. However, we believe that most solutions
currently available do not adequately address the importance of optimizing
customer interactions through recording at the point of contact, evaluation of
the customer contact, analysis of CSR performance, and applying organizational
learning through an integrated electronic learning management software solution.
For example, current solutions require companies to record every call center
telephone call and store these calls on large-scale proprietary hardware
systems. These solutions do not allow a company to selectively record, retrieve,
evaluate and analyze specific customer interactions based on criteria selected
by the company. Consequently, companies who employ these existing solutions have
only a limited ability to actively evaluate and improve their customer
interactions, which in turn limits their ability to attract and retain
customers. Further, without an integrated e-learning solution, these existing
programs cannot effectively train and develop the CSRs who serve a company's
customers. As a result, we believe that there is a significant opportunity in
the marketplace for a comprehensive, integrated multimedia solution, which
optimizes a company's customer interactions.
THE EQUALITY SOLUTION
We provide business-driven multimedia recording and analysis software that
enables companies to enhance their customer interactions. As a result, we
believe our customers are able to generate additional revenue opportunities,
improve profitability, reduce employee turnover and enhance customer retention.
We believe our software and services provide the following key business
benefits:
- Increases revenue opportunities. The eQuality software enables companies
to analyze customer interactions, incorporating data from their existing
databases and systems. As a result, companies are able to customize their
sales and marketing efforts to individual customer preferences or
tendencies, improve the selling techniques of their CSRs and sell
additional complementary or higher-end products and services to their
existing customers. Consequently, we believe companies utilizing our
software can generate additional revenue opportunities.
- Enables improved profitability. Because the eQuality solution improves
the overall quality of companies' interactions with their customers,
costs associated with customer turnover are reduced. By providing CSRs
with better training, companies can improve the efficiency of CSRs by
reducing their average "talk time," which results in decreased total
telephone charges and a reduced total number of CSRs needed to handle the
same volume of customer interactions.
- Reduces employee turnover. Because the eQuality software enables the
evaluation of individual CSR performance, companies can customize
incentives to reward CSRs. We believe these customized incentives,
together with effective feedback and training, leads to increased CSR job
satisfaction, retention of high quality CSRs and reduced costs related to
CSR turnover. According to International Data Corporation, the turnover
rate in call centers ranges from 15% to 80% annually (the industry
average is 26%), and the average cost to acquire a CSR is $6,400. This
data, combined with the estimates from PELORUS Group, translates into an
aggregate CSR turnover cost of approximately $5.5 billion.
- Enhances customer retention. Using the eQuality software, companies can
develop more intimate knowledge of their customers, which should improve
the overall quality of products and services being delivered to
customers. We believe that the growth in Internet-related commerce and
services will increase the importance customers place on high-quality and
consistent customer service. It is imperative that companies retain these
costly new customers to capitalize on their investment. As a result, we
believe that companies who deliver excellent service to their customers
will develop longer-term, more profitable customer relationships.
We believe that we are able to provide these key business benefits through
the innovative features of our software solution, which include the following:
- Enables synchronized replay of voice and computer desktop data. The
eQuality software records a CSR's voice interaction with a customer, as
well as the CSR's corresponding computer desktop
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activities, such as data entry, screen navigation and data retrieval. By
capturing both voice and computer desktop activity and synchronizing them during
replay, companies can observe and analyze complete customer interactions as they
actually occurred. This enables companies to not only evaluate the
behavior of their CSRs, but also to determine whether the necessary
technology resources for customer support are readily available to them
and whether they are making effective and efficient use of available
technology resources.
- Captures customer interactions across multiple communications media. The
eQuality software captures customer interactions from a variety of
communications media, including telephone, Web chat and e-mail. This
multimedia capability allows companies to deliver consistent, high
quality customer service regardless of the communication channel.
- Records based on company-selected criteria. Companies using the eQuality
software can record customer interactions based on selected criteria,
which we refer to as business-driven recording. This enables companies to
define specific business criteria to trigger recording and analysis of
information, such as key customers, important marketing campaigns, new
product introductions and selected CSRs. Further, companies can define
critical business events to trigger the capture of the interaction, such
as customer problems that have reached a certain severity level.
Companies can then use this information to quickly evaluate the
performance of targeted business initiatives and to adjust those
initiatives for higher market impact.
- Provides performance analysis and feedback. The eQuality Evaluation
software facilitates the review, evaluation and scoring of CSRs,
providing an immediate performance summary. Using the eQuality Analysis
software, a user can combine important data derived from eQuality
Evaluation with data derived from many other business applications, such
as CRM and enterprise resource planning software and integrated telephony
applications. For instance, a company can evaluate quality scores
obtained from eQuality Evaluation with sales achievement data received
from a sales tracking system to ensure CSRs are not compromising the
quality of their customer interactions to sell new products. The
resulting information, which is presented in easy-to-use formats, such as
reports, graphs and tables, allows companies to provide more meaningful
feedback to CSRs on their performance and better analyze the overall
operation of the contact center.
- Enables an integrated, closed-loop environment for applying
organizational learning. eQuality Now(TM) delivers ongoing training
tailored to CSR competencies, which helps companies build customer
loyalty though a more highly skilled and motivated workforce. According
to PriceWaterhouseCoopers, 70% of Fortune 1,000 companies cite lack of
trained employees as their number one barrier to sustaining growth.
Companies are turning to e-learning in response to the urgency of
delivering and reinforcing training to improve CSRs' skills, as well as
to provide a means to support their career paths. Studies conducted by
Corporate University Xchange indicate that 40% of corporate training will
take place electronically by 2003. Our eQuality Now product addresses
this market trend by focusing on e-learning opportunities in the contact
center, such as new product and service introductions; upselling and
cross-selling techniques; and tips for managing customer communications
through newer communications channels, such as e-mail and collaborative
Web chat.
- Integrates with third-party software and hardware. The eQuality software
is designed to integrate with a variety of third-party software, such as
CRM applications, from providers such as Siebel Systems, Clarify, Cisco,
Genesys, eShare, Kana, eGain, Quintus, Peoplesoft, Servicesoft, Remedy,
Pivotol and Synchrony. In addition, the eQuality software is designed to
integrate or be compatible with a company's existing telephony and
computer network hardware and software such as telephone switches,
automated telephone dialers and computer-telephony integration systems.
This allows companies to capitalize on their existing infrastructure and
gain the benefits of our software with minimal additional investment.
- Provides an open architecture that scales to support small to large
installations. The eQuality software operates on the Windows NT platform
and is compatible with standard voice cards and databases. Also, the
software can capture and record computer screen activity from CSR
workstations
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that are running any of a variety of operating systems. By utilizing
off-the-shelf hardware and software, our customers are able to implement
and support our products at a relatively low cost. Because the software
is scalable, it can support the needs of a small single site as well as
large multi-site installations. For example, the eQuality software is
currently being used at a customer installation with approximately 7,000
CSRs. In addition, it can be expanded to accommodate an increasing number
of CSRs with minimal hardware and software investment.
- Enables rapid deployment. Because of the software's features, extensive
third-party integration, open architecture and implementation process, we
can typically implement our software at a customer's initial site within
30 to 60 days from the date the software agreement is signed by a new
customer. We ordinarily complete the actual software installation within
three to five days. Since the detailed project planning occurs during
installation at the first site, we can typically implement our software
at additional sites in five to seven days. Most of our target market
consists of large corporations with many customer contact centers, and we
have significant experience with customers purchasing our software for
multiple sites. As a result, rapid deployment is important in that it
allows those customers to quickly implement and begin realizing the
benefits of the eQuality software.
STRATEGY
Our objective is to be a leading provider of software that enables
companies to optimize their customer interactions across multiple communications
media, including telephone, Web chat, eCommerce, Internet self-service and
e-mail. Key elements of our strategy include the following:
- Extend the breadth and depth of product offerings. We intend to continue
to invest in research and development to enhance our current software and
build new software to address the growing needs of companies that seek to
better manage their customer relationships across multiple communications
media. We also intend to extend our Web-based capabilities, such as the
recording and analyzing of integrated eCommerce, e-mail and voice
interactions. Additionally, we plan to expand the number of third-party
applications with which our software can integrate.
- Increase sales to existing and new customers. A majority of our existing
customers are large companies that have multiple contact centers. While
we have been successful in penetrating these customers and installing our
software at more than one contact center, we have not yet installed our
software at a majority of their contact centers. We intend to capitalize
on the success of our initial installations, by using our direct sales
force and emphasizing the scalability and rapid deployment of our
software to increase the number of installations at existing customer
sites, which have not yet installed our software. We also plan to
continue pursuing new customer accounts with multiple contact centers
through our existing sales force and our network of strategic
relationships.
- Expand the network of application software and Internet infrastructure
business alliances. We intend to expand our network of business
alliances with complementary application software and Internet
infrastructure providers to increase the number of products with which
our software is compatible. We believe the demand for our software will
increase as it becomes compatible with an increasing number of CRM,
enterprise resource planning and Internet infrastructure applications. In
addition, expanding this network of business alliances will enable us to
generate new sales leads as our business alliances recommend our products
to their customers. Currently, we have business alliances with the
following application and Internet infrastructure providers: Siebel
Systems, Clarify, Cisco, Genesys, eShare, Kana, eGain, Quintus,
Peoplesoft, Servicesoft, Remedy, Pivotol, Synchrony and Davox.
- Expand international presence. We currently maintain small direct sales
forces in the United Kingdom, Canada, Sweden, the Netherlands, Mexico,
Australia, and Japan. We plan to expand our direct and indirect sales
channels in these regions, with particular attention to areas that are
actively adopting CRM solutions.
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PRODUCTS
The eQuality software initiates recording of customer interactions based on
criteria selected by companies and facilitates retrieval and analysis of the
recorded information, as well as targeted electronic learning events based on
skill gaps identified using the evaluation software. It records a CSR's voice
interaction with a customer as well as the CSR's corresponding computer desktop
activities, such as data entry, screen navigation and data retrieval. The voice
and data are captured and stored on a computer disk for synchronized evaluation
and analysis. By capturing both voice and desktop activity and synchronizing
them during replay, a company can observe and analyze complete customer
interactions as they actually occurred. The captured interactions can then be
selectively retrieved, combined with information from a company's other business
systems, such as CRM and enterprise resource planning software, analyzed and
presented in a number of summary or detailed formats. The eQuality software thus
enables companies to evaluate the effectiveness of its CSRs, improve contact
center performance and profile their customers' characteristics and preferences
to create customized product and service offerings. By recording customer
interactions, evaluating CSR performance, and then using eQuality Now to
prioritize training, companies have an integrated, closed-loop solution for
applying organizational learning. The result is an effective environment for
continuous performance improvement that helps companies ensure their customers
receive consistent service across all touch points.
An integral feature of eQuality is business-driven recording, which allows
a company to record specific customer interactions based on criteria that it
selects. Using eQuality, a company can define business rules that trigger
recording of selective customer interactions that are particularly critical to
its operating performance. For example, a company may use eQuality to record
customer interactions based on a number of criteria, including:
- Key customers. The eQuality software can selectively record all calls
from specific classes or groups of customers having common traits or
characteristics. Examples include customers with certain sales or asset
levels or customers having a particular importance to the company.
- Important marketing campaigns. All calls associated with particular
marketing campaigns can be recorded so that the effectiveness of the
campaign can be evaluated while the initiative is in process.
Consequently, adjustments can be made proactively to optimize performance
of the campaign.
- Target products. Interactions that relate to targeted products can be
identified and recorded to allow businesses to evaluate product design,
installation and service issues. Examples include selected calls related
to new product introductions, key revenue-producing products and
particularly profitable products.
- Selected CSR considerations. Calls that are handled by specific CSRs can
be sampled so that supervisors can more effectively monitor and train
CSRs. Examples include newly hired CSRs, CSRs that are not achieving
desired performance levels, and CSRs working with a new medium, such as
e-mail or Web chat.
By recording only critical customer interactions based on business rules,
companies have fewer interactions to store and therefore significantly lower
storage requirements. Further, the software's data capture technique allows
companies to utilize minimal network bandwidth by sending across the network
only the changed areas of a CSR's computer desktop screen. The result is a lower
total cost of ownership.
In addition, the eQuality software is designed to integrate or be
compatible with a company's existing telephony and computer network hardware and
software. The software is designed to run on a server that employs the Windows
NT operating system. In addition, it can capture and record computer screen
activity from CSR workstations that are running any of a variety of operating
systems, including Windows 3.1, Windows 95/98, Windows NT, OS/2, Sun Solaris,
HP(UX)3270 and AS/400, and thin client operating systems, such as Citrix
application server software.
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The eQuality suite of products is comprised of the following modules:
eQuality Balance. eQuality Balance records a CSR's voice interaction with
a customer and the CSR's corresponding computer desktop activities, such as data
entry, screen navigation and data retrieval. The captured voice and desktop
activity can then be synchronized during replay, allowing companies to observe
and analyze complete customer interactions as they actually occurred. This
enables companies to evaluate the performance of CSRs, determine whether the
necessary technology resources for customer support are available to the CSRs
and ascertain whether the CSRs are making effective and efficient use of these
resources. Supervisors can use this information to train CSRs, improve company
systems and resources designed to support CSRs and enhance the quality of the
services being delivered to customers.
eQuality Interactive and eQuality Response. The eQuality Interactive and
eQuality Response applications allow a company to record Internet interactions,
including Web chat, instant messaging, guided browser sessions and e-mail, based
on user-defined business rules. These applications enable companies to gauge the
effectiveness of their CSRs' Internet skills, refine newly implemented Internet
processes and optimize the effectiveness of their Web technology deployments. In
combination with eQuality Balance, companies are able to deliver consistently
high standards of service regardless of the medium.
eQuality Evaluation. The eQuality Evaluation application facilitates the
review, evaluation and scoring of CSRs, providing an immediate summary of a
CSR's performance. Using eQuality Evaluation, CSR supervisors can build custom
evaluation forms that are designed to collect information about aspects of a
CSR's performance that are most important to them. Supervisors and others can
input information regarding a CSR's performance into the form, which is then
collected in a database. The collected information can be retrieved, presented
in a summary format, analyzed and ultimately used to measure and improve a CSR's
performance. eQuality Evaluation can reveal problem areas, issues, trends and
opportunities. Supervisors and others with access to eQuality Evaluation can
review CSRs' performance and determine opportunities to increase their skill
levels through training. Supervisors can compare CSRs' performance to current
goals and provide more realistic future goals.
eQuality Analysis. The eQuality Analysis application provides a more
comprehensive analysis of customer interaction and CSR performance by bridging
the disparate information systems of a company. Using eQuality Analysis, a
company can combine data derived from eQuality Evaluation with data derived from
information obtained from a company's other business systems, such as CRM and
enterprise resource planning software and integrated telephony applications.
Combining multiple sources of data from within the company into a common
analysis and reporting system allows for a more thorough evaluation of CSR and
overall contact center performance. Recognizing the importance of multi-channel
contact centers, we have designed eQuality Analysis to integrate with business
systems that collect data from a broad range of communications media.
eQuality Now. The eQuality Now application delivers ongoing training
tailored to CSR competencies, which helps companies build customer loyalty
though a more highly skilled and motivated workforce. The e-learning management
software integrates with leading on-line learning products focused on CSR soft
and hard skills. By recording customer interactions, evaluating CSR performance,
and then using eQuality Now to prioritize training, contact centers have an
integrated, closed-loop solution for applying organizational learning. The
result is an effective environment for continuous performance improvement that
helps companies ensure their customers receive consistent service across all
touch points. In November 2000, eQuality Now became generally available.
eQuality Connect. The eQuality Connect application serves as the
foundation to integrate eQuality with Web-enabled contact center and eCRM
applications, including e-mail response management, collaborative Web chat and
customer information systems. As the underlying integration component of the
eQuality suite, eQuality Connect is an open, scalable software solution that
leverages strategic events and data gathered from external solutions to initiate
recordings. Companies can implement eQuality Connect as the integration layer
within their eQuality multimedia recording and analysis software, or as a
standalone solution that integrates eQuality with other applications, such as
internally developed customer information systems.
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Historically and at present, eQuality Balance was and is licensed together
with the eQuality Evaluation software. Through December 31, 2000, we derived
most of our license revenues from the sale of these two products. During 2000,
approximately 19% of our orders included more than one module of the eQuality
application suite, including eQuality Analysis, Response, Interactive, and
Connect.
PROFESSIONAL SERVICES
Our professional services group plays an integral role in installing our
software and training and supporting our customers. Specifically, we provide the
expertise, professional consulting staff and technology tools to install our
software and provide ongoing support to our customers. Our experienced
installation professionals work with the customer to build a solid technical
infrastructure that supports the software's applications.
An initial implementation engagement is typically completed within 30 to 60
days from the date the software agreement is signed by a new customer, and
involves the planning, configuration, testing and installation of our software.
Generally, the actual software installation takes three to five days. We believe
these installation projects allow our consultants and systems engineers to gain
industry-specific knowledge that can be used in future projects and products.
In addition to installing the software and supporting customers, the
professional services team works closely with the internal research and
development organization to help enhance software solutions. Experience gained
by the professional services group through ongoing software installation is
regularly conveyed to the development staff. Our research and development
organization then capitalizes on this experience to design enhancements to the
software. The services staff also maintains a technical support hotline.
CUSTOMERS
Our current customers include companies in a number of industries having at
least one contact center. As of December 31, 2000, we had licensed our software
to over 237 customers at over 593 sites. To date, customer installations have
ranged from as small as one contact center having 25 CSRs, to customers with 32
contact centers having an aggregate of approximately 16,000 CSRs.
BANKING & FINANCE APAC Customer Services Verizon Wireless
American Century Investments CheckFree Vodafone
American Express Compaq WorldCom
Bank of America EDS
BB&T Fingerhut TRAVEL & HOSPITALITY
Capital One IBM American Airlines
Citicorp Interim Customer Care Solutions Carlson Wagonlit Travel
Discover Financial Services Minacs Worldwide Continental Airlines
First Data Corporation Precision Response Corporation Delta Air Lines
J.P. Morgan Chase & Co. Sony Hilton Reservations Worldwide
PNC TransCom USA Hyatt Hotels
VISA West Teleservices Promus Hotels
Wells Fargo Xerox Premiere Cruise Lines
Renaissance Cruises
INSURANCE TELECOMMUNICATIONS & CABLE Sabre Holdings Corporation
AARP ALLTEL Travelocity.com
AXA Royal Belge AT&T US Airways
GEICO Direct BellSouth Wyndham Hotels & Resorts
Liberty Mutual Cable & Wireless
New York Life Comcast Cable UTILITIES
Pan American Life Global Crossing Alliant Energy
USAA McLeod USA Atlanta Gas Light Company
Nokia First Energy
OUTSOURCERS & TECHNOLOGY Sprint Niagra Mohawk Power Corporation
7C Ltd Telstra Northeast Utilities
ADP TCI (AT&T Broadband) Southern California Edison
Aegis Southern Company
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GENERAL BUSINESS EDS/Saturn McKessonHBOC
Abbott Laboratories Federal Express Merck-Medco
Accenture Federated Department Stores Next Retail
Barnes & Noble.com Georgia-Pacific PepsiCo
CompUSA International Paper The Timberland Company
DaimlerChrysler Maytag Victoria's Secret
Deloitte & Touche
In 1999 and 2000, no customer accounted for 10% or more of our revenues.
Two customers accounted for 27% of our revenues in 1998.
SALES AND MARKETING
We sell our software primarily through a combination of a direct sales
force and resellers. As of December 31, 2000, we had 16 sales offices in the
United States and offices in Canada, the United Kingdom, the Netherlands,
Sweden, Australia, Mexico, and Japan. Our sales and marketing organization
consisted of 89 employees worldwide.
To date, substantially all of our revenues have been generated through our
direct sales force, which consisted of 62 sales people in 23 locations as of
December 31, 2000. The direct sales force consists of account executives,
solutions consultants, and regional sales directors. In addition to qualified
leads generated internally, the direct sales force also pursues qualified leads
provided by companies with whom we have formal or informal referral agreements.
These agreements are not exclusive and may be terminated by either party.
We develop strategic marketing alliances with leading companies in our
industry to expand the coverage and support of our direct sales force. These
relationships may include joint marketing campaigns and selling strategies.
Separate from the direct sales force, our business development personnel are
responsible for the initiation, negotiation and completion of these
partnerships. We currently have such relationships with Siebel Systems, Clarify,
Cisco, Genesys, eShare, Kana, eGain, Accenture, Quintus, Peoplesoft,
Servicesoft, Remedy, Pivotol and Synchrony.
In addition to the direct sales force, we have agreements with a variety of
CRM and contact center companies under which they can resell our software. To
support this indirect sales channel, our business development personnel provide
information and training to these companies' sales personnel so that they are
better able to educate potential customers about the benefits of our software
and services. Our agreements with the resellers are not exclusive and may be
terminated by either party.
Our direct sales cycle typically begins with the qualification of a sales
lead or the request for a proposal from a prospective customer. The sales lead,
or request for a proposal, is followed by the qualification of the lead or
prospect, an assessment of the customer's requirements, a formal proposal,
presentations and product demonstrations, site visits to an existing customer
using the software and contract negotiation. The sales cycle can vary
substantially from customer to customer but typically lasts three to six months,
and is considered completed with the signing of the contract. Historically, most
of our customers have expanded their use of the software's solutions to expand
the number of CSRs at existing sites and to license additional contact centers,
with a minimal incremental sales effort on our behalf.
We use a variety of marketing programs to build brand name awareness, as
well as to attract potential customers. These programs include market research,
product and strategy updates with industry analysts, public relations
activities, direct mail and relationship marketing programs, seminars, trade
shows, speaking engagements and Web site marketing. To support sales efforts,
the marketing organization also produces marketing materials that include
brochures, data sheets and other technical descriptions, presentations and
demonstrations.
The market for business software has experienced seasonal fluctuations in
demand. The first and third quarters of the year have been typically
characterized by lower levels of revenues. As our revenues grow, seasonal
fluctuations in our revenues may become more evident.
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RESEARCH AND DEVELOPMENT
We believe our software development capabilities are essential to our
strategy of enhancing our core technology, developing additional applications
incorporating that technology and maintaining the competitiveness of our
software. We devote a substantial portion of our resources to developing new
software and features, extending and improving our software technology and
researching new technological initiatives in our market. We believe that our
future success depends in part upon our ability to continue to enhance existing
software, respond to changing customer requirements and develop and introduce
new or enhanced software that incorporates new technological developments and
emerging industry standards.
Research and development expenditures for the years ended December 31,
2000, 1999, and 1998 were $10.4 million, $5.8 million, and $3.5 million,
respectively. We intend to continue to increase our investment in research and
development in the future. As of December 31, 2000, we had 59 employees engaged
in research and development and software maintenance activities.
COMPETITION
Our software and services compete in the emerging market for products that
record and analyze customer interactions and provide electronic learning
applications. This market is intensely competitive and experiences rapid changes
in technology. We believe that we compete effectively and that we enjoy a
competitive advantage based upon (1) the functionality and quality of our
products, (2) the ease of use and ability of our products to operate with a
variety of hardware and software products, (3) our ability to implement our
products quickly, (4) the responsiveness of our customer support, and (5) our
competitive pricing. However, many current and potential competitors may have
longer operating histories, more established business relationships, larger
customer bases, a broader range of products and services, greater name
recognition and substantially greater financial, technical, marketing,
personnel, management, service, support and other resources than us. This could
allow our current and potential competitors to respond more quickly than we can
to new or emerging technologies and changes in customer requirements, take
better advantage of acquisitions and other opportunities, devote greater
resources to the marketing and sale of their products and services, and adopt
more aggressive pricing policies. In addition, many competitors market their
products through resellers and companies that integrate their technology and
products with those of the competitor. These resellers and technology partners
of competitors often have strong business relationships with our customers and
potential customers. Our competitors may use these business relationships to
market and sell their products and compete for customers with us. We cannot
assure that our competitors will not offer or develop products and services that
are superior to ours, or that achieve a greater market acceptance. Our
competitors include:
- quality monitoring suppliers to the call and contact center industry,
which historically have been companies that develop voice-only recording
software;
- traditional call logging vendors that have historically focused on
providing products that record all phone conversations made by or to the
user, including emergency services, such as 911, and verification and
liability users, such as trading floors and stockbrokers;
- systems integrators and consulting firms which design and develop custom
systems and perform custom integration; and
- new, larger and more established entities that may acquire, invest in or
form joint ventures with providers of recording or performance enhancing
software solutions, such as vendors of CRM products, computer telephony
companies and computer hardware, software and networking companies.
In addition, we have developed, and intend to continue to develop,
relationships with companies that resell our software, companies that integrate
the software with their technology and products and companies that provide us
with customer referrals or leads. Some of these companies have similar, and
often more established, relationships with our competitors, and may recommend
the products and services of competitors to customers instead of our software
and services. In addition, through their relationships with us, these companies
could learn about our software and the market for our software and services and
could develop and sell competing products and services.
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The principal competitive factors in our market include:
- product performance, reliability and features;
- user scalability and open architecture;
- third-party integration;
- quality and speed of product implementation;
- ease-of-use for customers;
- analytic capabilities of the product;
- how quickly new products and product enhancements can be brought to
market;
- customer support; and
- pricing of products and services.
Our success will depend on our ability to compete effectively based on
these factors. Further, we expect that competition will increase as other
established and emerging companies enter our market and as new products,
services and technologies are introduced. Increased competition may result in
price reductions, lower gross margins and loss of market share. This could
materially and adversely affect our business, financial condition and results of
operations.
PROPRIETARY RIGHTS
General. Our success depends to a significant degree on the legal
protection of our software and other proprietary technology rights. We rely on a
combination of patent, trade secret, copyright and trademark laws and
confidentiality and non-disclosure agreements with employees and third parties
to establish and protect our proprietary rights. These measures may not be
sufficient to protect proprietary rights, and we cannot be certain that third
parties will not misappropriate our technology and use it for their own benefit.
Also, most of these protections do not preclude our competitors from
independently developing products with functionality or features substantially
equivalent or superior to our software. Any failure to protect our intellectual
property could have a material adverse effect on our business.
Licenses. Our licenses are designed to prohibit unauthorized use, copying
and disclosure of our software technology. When we license our software to
customers, we require license agreements containing confidentiality terms
customary in the industry in order to protect our proprietary rights in the
software. These agreements generally warrant that the software will materially
comply with written documentation and is free of viruses and other illicit code.
We also warrant that we own the software we distribute and have not violated the
intellectual property rights of others. We license our products in a format that
does not permit the users to change the software code. In addition, because we
treat the source code for our products as a trade secret, all employees and
third parties who require access to the source code are first required to sign
non-disclosure agreements.
Patents. We have received a patent generally relating to our technology
that enables the recording of a CSR's computer desktop activities and the
synchronization of certain of these activities with the CSR's voice
interactions. The patent also relates to the data capture technique that records
only particular changed regions of a CSR's computer screen. The patent was
granted on May 31, 1996 and will expire on May 30, 2016. We also have two patent
applications pending with the United States Patent and Trademark Office. There
is no guarantee that the pending applications will result in issued patents or,
if issued, will provide us with any competitive advantages.
Trademarks and service marks. We have U.S. trademark registrations on the
mark WITNESS, on our logo and on one additional mark, and have pending U.S.
trademark applications for the marks eQuality and Bringing eQuality to
eBusiness. We also claim common law protections for other marks it uses in our
business. Competitors of ours and others could adopt similar marks, or try to
prevent us from using our marks, consequently impeding our ability to build
brand identity and possibly leading to customer confusion.
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13
We are aware of certain uses, U.S. trademark registrations, and U.S.
trademark applications for the trademark "equality" and its variations that
predate our use of, and U.S. trademark application for, our trademarks eQuality
and Bringing eQuality to eBusiness. It is possible that the U.S. Patent and
Trademark Office will deny the U.S. trademark applications. In addition, it is
possible that the owner of legal rights resulting from one or more of these
prior uses, U.S. trademark registrations, or U.S. trademark applications will
bring legal action to prevent us from registering and/or using the trademarks
eQuality and Bringing eQuality to eBusiness, and may also seek compensation for
damages resulting from our use of these trademarks. As a result, we cannot
assure that our efforts to use and register these trademarks will ultimately be
successful, or that this use will not result in liability for trademark
infringement, trademark dilution, and/or unfair competition.
Based on the limited information available to us regarding these prior
uses, U.S. trademark registrations, and U.S. trademark applications for the
trademark "(e)Quality" and its variations, we believe that our trademarks
eQuality and Bringing eQuality to eBusiness are available for use and U.S.
trademark registration in connection with the services stated in our
registration applications, or as the descriptions of those services may be
amended during the course of examination in the U.S. Patent and Trademark
Office.
Copyrights. We have seven pending copyright registrations covering the
most recent release of our eQuality software.
EMPLOYEES
As of December 31, 2000, we had 275 full-time employees. Of these
employees, 59 were engaged in research and development and software maintenance,
89 were engaged in sales and marketing, 73 were engaged in professional services
and 54 were engaged in executive, finance, administration and operations.
None of our employees are represented by a labor union or covered by a
collective bargaining agreement. We have not experienced any labor-related work
stoppages and consider our relations with our employees to be good.
ITEM 2. PROPERTIES
During the year ended December 31, 2000, we have moved our principal
administrative, sales, marketing, support, and research and development facility
from Alpharetta, Georgia to a new facility in Roswell, Georgia. This new
facility consists of approximately 96,400 square feet and is leased through
December 2007.
In addition, we lease a total of 16 sales offices in the United States, and
offices in Canada, the United Kingdom, the Netherlands, Sweden, Australia,
Mexico, and Japan for the direct sales force. We believe our facilities are
adequate for our current and expected near-term requirements.
ITEM 3. LEGAL PROCEEDINGS
We are not currently a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter ended December 31, 2000.
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PART II
ITEM 5. MARKET FOR OUR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
COMMON STOCK
Our common stock trades on the Nasdaq Stock Market under the symbol "WITS".
Public trading of common stock commenced on February 10, 2000. Prior to that,
there was no public market for the common stock. The following table sets forth,
for the periods indicated, the high and low sale price per share of the common
stock on the Nasdaq Stock Market in each of the last four quarters.
HIGH LOW
------ ------
Year Ended December 31, 2000:
Fourth quarter............................................ $19.94 $ 7.00
Third quarter............................................. $27.00 $12.06
Second quarter............................................ $31.00 $ 4.75
First quarter (from February 10, 2000).................... $44.94 $29.50
The closing sale price of our common stock as reported by the Nasdaq Stock
Market on March 16, 2001 was $6.19.
Dividend Policy. We have not paid any cash dividends on our common stock
to date. Our Board of Directors determines whether or not we will pay dividends.
The Board of Directors considers a number of factors in deciding whether or not
to pay dividends, including our earnings, our capital requirements and our
financial condition. Today the Board of Directors intends to retain all
earnings, if any, for use in our business operations, and accordingly, does not
expect to declare or pay any dividends in the foreseeable future.
Use of Proceeds. Our Registration Statement on Form S-1 (File No.
333-91383) became effective on February 9, 2000. On February 10, 2000, we
completed our initial public offering ("IPO") whereby we issued 3.8 million
shares of common stock at an offering price of $20.00 per share. Simultaneously,
our underwriters exercised their over-allotment option to issue an additional
570,000 shares, of which 219,269 shares were sold by us and the balance were
sold by existing stockholders. The managing underwriters were J.P. Morgan Chase
& Co. Net proceeds to us were $74.8 million, after deducting underwriting
discounts and commissions and selling stockholders' net proceeds of $5.6
million. Additional IPO related expenses totaled approximately $1.5 million,
leaving net proceeds of $73.2 million. Since the IPO, we have used the net
proceeds to repay all of our long-term debt totaling $2.8 million, to fund
operating deficits and working capital needs and for general corporate purposes.
Holders. As of March 16, 2001, we had approximately 410 holders of record
of our common stock. We believe that we have more than 3,900 beneficial owners.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with the Consolidated Financial Statements and Notes thereto and
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this report.
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Revenues:
License.................................................. $30,307 $16,706 $ 8,682 $ 3,775 $ 764
Services................................................. 13,601 6,221 2,444 1,138 425
Hardware................................................. -- 46 2,171 1,271 632
------- ------- ------- ------- -------
Total revenues.................................... 43,908 22,973 13,297 6,184 1,821
------- ------- ------- ------- -------
Cost of revenues:
License.................................................. 436 327 310 164 30
Services................................................. 7,681 3,921 2,526 1,204 622
Hardware................................................. -- 46 2,482 1,574 920
------- ------- ------- ------- -------
Total cost of revenues............................ 8,117 4,294 5,318 2,942 1,572
------- ------- ------- ------- -------
Gross profit...................................... 35,791 18,679 7,979 3,242 249
Operating expenses:
Sales and marketing...................................... 22,587 11,585 6,147 2,016 291
Research and development................................. 10,379 5,825 3,529 1,817 1,095
General and administrative............................... 8,770 4,403 2,141 1,684 1,058
Charge for termination of distribution agreement......... -- -- 900 -- --
Acquired in-process research and development............. -- 3,506 -- -- --
------- ------- ------- ------- -------
Operating loss.................................... (5,945) (6,640) (4,738) (2,275) (2,195)
Interest income (expense), net............................. 3,979 (364) (31) 62 4
------- ------- ------- ------- -------
Loss before provision for income taxes and
extraordinary loss.............................. (1,966) (7,004) (4,769) (2,213) (2,191)
Provision for income taxes................................. -- -- -- -- --
------- ------- ------- ------- -------
Loss before extraordinary loss.................... (1,966) (7,004) (4,769) (2,213) (2,191)
Extraordinary loss on the early extinguishment of debt..... (248) -- -- -- --
------- ------- ------- ------- -------
Net loss.......................................... (2,214) (7,004) (4,769) (2,213) (2,191)
Preferred stock dividends and accretion.................... (611) (1,815) (502) (84) --
------- ------- ------- ------- -------
Net loss applicable to common stockholders........ $(2,825) $(8,819) $(5,271) $(2,297) $(2,191)
======= ======= ======= ======= =======
Net loss per share -- basic and diluted:
Loss before extraordinary loss.................... $ (0.13) $ (1.37) $ (0.76) $ (0.32) $ (0.21)
Extraordinary loss................................ (0.01) -- -- -- --
------- ------- ------- ------- -------
Net loss.......................................... $ (0.14) $ (1.37) $ (0.76) $ (0.32) $ (0.21)
======= ======= ======= ======= =======
Shares used in computing net loss per share -- basic and
diluted.................................................. 19,997 6,424 6,964 7,238 10,307
======= ======= ======= ======= =======
Unaudited pro forma net loss per share -- basic and
diluted(1)............................................... $ (0.09) $ (0.44)
======= =======
Shares used in computing unaudited pro forma net loss per
share -- basic and diluted(1)............................ 21,232 15,755
======= =======
- ---------------
(1) Pro forma assumes conversion of convertible preferred stock into common
stock and the vesting of certain restricted shares as if such conversions
occurred on January 1, 1999.
DECEMBER 31,
-------------------------------------------------
2000 1999 1998 1997 1996
------- -------- -------- ------- -------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash and cash equivalents................................ $29,590 $ 2,630 $ 912 $ 2,092 $ 69
Working capital (deficit)................................ 58,512 (5,744) (3,156) (2,506) (2,399)
Total assets............................................. 86,466 10,843 5,026 3,966 1,108
Long-term debt, less current portion..................... -- 250 1,102 -- --
Total convertible preferred stock........................ -- 22,837 12,710 6,733 --
Total stockholders' equity (deficit)..................... 69,588 (25,656) (15,376) (8,241) (2,260)
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In addition to historical information, this annual report on Form 10-K
contains forward-looking statements that involve risks and uncertainties that
could cause actual results to differ materially from those we anticipate. These
forward-looking statements include, among other things: statements regarding the
market for technology generally, as well as technologies for customer
relationship management, call centers, and e-marketing; our ability to increase
our revenues, both through our foreign and domestic sales force and through
indirect sales channels, and through the introduction of new products created by
us or obtained through acquisitions; the impact of competition, seasonality, and
intellectual property protection; and our ability to attract and retain
qualified personnel. Factors that could cause actual results to differ
materially from those indicated by such forward-looking statements include, but
are not limited to, our ability to maintain profitability, fluctuations in
revenues and operating results, increased competition, fluctuations in our stock
price, and our ability to properly manage growth. These and additional factors
are set forth in the "Safe Harbor Compliance Statement for Forward-Looking
Statements" included as Exhibit 99.1 to this annual report on Form 10-K. Readers
are cautioned not to place undue reliance on the forward-looking statements,
including statements regarding our expectations, believes, intentions or
strategies regarding the future, which speak only as of the date of this report.
We undertake no obligation to update or revise forward-looking statements to
reflect changed assumptions, the occurrence of unanticipated events or changes
in future operating results.
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with the Consolidated
Financial Statements and Notes thereto included elsewhere in this report.
OVERVIEW
We are a leading provider of business-driven multimedia recording, analysis
and electronic learning software that enables companies to enhance their
customer interactions across multiple communications media. Our software is
designed to enable customer contact centers within a company to record and
evaluate complete customer interactions through one or more communications
media, such as telephone and Web chat; and then apply targeted electronic
learning for continuous performance improvement. We believe that the key
benefits of our products include increased revenues from improved customer
interactions, improved profitability from increased customer service
representative and supervisor productivity and reduced turnover and enhanced
customer retention through greater customer intimacy. Our software is designed
to integrate with a variety of third-party software, such as customer
relationship management and enterprise resource planning applications, and with
existing telephony and computer network hardware and software. The majority of
our customers are companies with one or more contact centers that handle voice
and data customer interactions for outbound sales and marketing operations,
inbound service/support lines, or both. We primarily utilize a direct sales
organization and a variety of strategic marketing alliances to reach our target
customer base.
SOURCES OF REVENUES AND REVENUE RECOGNITION POLICY
We derive our revenues from licensing software and providing related
services. Revenue is allocated to each element of the arrangement based on their
relative fair values, which is established by the price charged when the
respective element is sold separately. License revenues are recognized when
persuasive evidence of an agreement exists, delivery of the product has
occurred, the fee is fixed or determinable and collectibility is probable.
Software services include installation, training and maintenance. Revenues from
installation and training are recognized upon performance of the related
services. Installation and training services are offered and billed as separate
elements of contracts on a time-and-material basis. The functionality of the
software is not dependent on installation and training services. Maintenance is
offered as a separate element and includes the right to unspecified upgrades on
a when-and-if available basis. Maintenance revenues are deferred and recognized
ratably over the term of the related contract, usually one year. Specified
upgrades are not typically offered to customers. Historically, all customers
have purchased an initial maintenance contract for each newly licensed site.
During 2000 and 1999, 98% of our customers renewed their annual maintenance
contracts.
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During 2000 and 1999, approximately 94% and 95%, respectively, of revenues
were derived from sales within North America. Prior to 1999, substantially all
of our revenues were derived from sales within North America. We expect that a
greater proportion of future license and professional services revenues will be
derived from international markets and may be denominated in the currency of the
applicable market.
Our license agreements generally provide that customers pay a software
license fee for one or more software products for a specified number of users.
The amount of the license fee varies based on which software product is
licensed, the number of software products licensed and the number of users
licensed. Customers can subsequently pay additional license fees to allow
additional users to use previously licensed software products or to license
additional software products. Each software product contains common components,
allowing for easy integration of additional software products as they are
licensed from us. Customers that license software products usually receive the
software on compact disc.
Until the first quarter of 1999, we also generated revenues from the sale
of computer hardware. This hardware consisted of standard, readily available
computer servers that we purchased from third parties and resold. Because of the
relatively low volume of hardware sales compared to traditional computer
equipment providers, we were unable to compete on price with those providers and
frequently resorted to selling hardware at very low margins or below cost. The
losses that we incurred from selling hardware adversely affected our liquidity
and financial position. Because of this, we discontinued hardware sales in the
first quarter of 1999, which improved gross margins during 1999. Our customers
currently purchase their hardware from other suppliers.
COST OF REVENUES AND OPERATING EXPENSES
Cost of license revenues primarily consists of royalties due to third
parties and packaging costs. Cost of services revenues includes salaries and
related expenses for installation, training and maintenance personnel and
allocations of facilities, communications and depreciation expenses. Cost of
hardware revenues consisted of purchases of hardware. We discontinued sales of
hardware during the first quarter of 1999.
Operating expenses are classified into three general categories: sales and
marketing, research and development and general and administrative. We classify
all charges to these operating expense categories based on the nature of the
expenditures. We allocate the costs for overhead and facilities to each of the
functional areas that use the overhead and facilities services. These allocated
charges include rent for corporate offices, communication charges and
depreciation expenses for office furniture and equipment. We anticipate that
operating expenses will increase substantially as we increase sales and
marketing operations, develop new distribution channels, fund greater levels of
research and development, broaden professional services and support, improve
operational and financial systems and support our growth internationally.
Research and development costs are expensed as incurred. Costs incurred
subsequent to establishing technological feasibility are capitalized and
amortized over their estimated useful lives. To date, software development costs
incurred after technological feasibility has been established have not been
material.
We had 275 full-time employees at December 31, 2000, up from 178 and 111,
at December 31, 1999 and 1998, respectively. This rapid growth of our workforce
places a significant demand on management and operational resources. In order to
manage growth effectively, it is necessary for us to implement and improve
operational systems, procedures and controls on a timely basis. In addition, we
expect that future expansion will continue to challenge our ability to hire,
train, motivate and manage our employees. Competition is intense for highly
qualified technical, sales and marketing and management personnel. If total
revenue does not increase relative to operating expenses, and management systems
do not expand to meet increasing demands, and if we fail to attract, assimilate
and retain qualified personnel or our management otherwise fails to manage our
expansion effectively, there would be a material adverse effect on our business,
financial condition and operating results.
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RESULTS OF OPERATIONS
The table below shows operating data as a percentage of total revenues for
the periods indicated:
YEAR ENDED DECEMBER 31,
--------------------------
2000 1999 1998
----- ---------- -----
STATEMENT OF OPERATIONS DATA:
Revenues:
License................................................... 69.0% 72.7% 65.3%
Services.................................................. 31.0 27.1 18.4
Hardware.................................................. 0.0 0.2 16.3
----- ----- -----
Total revenues.................................... 100.0 100.0 100.0
Cost of revenues:
License................................................... 1.0 1.4 2.3
Services.................................................. 17.5 17.1 19.0
Hardware.................................................. 0.0 0.2 18.7
----- ----- -----
Total cost of revenues............................ 18.5 18.7 40.0
----- ----- -----
Gross profit...................................... 81.5 81.3 60.0
Operating expenses:
Sales and marketing....................................... 51.4 50.4 46.2
Research and development.................................. 23.6 25.4 26.5
General and administrative................................ 20.0 19.2 16.1
Charge for termination of distribution agreement.......... -- -- 6.8
Acquired in-process research and development.............. -- 15.2 --
----- ----- -----
Operating loss.................................... (13.5) (28.9) (35.6)
Interest income (expense), net.............................. 9.1 (1.6) (0.2)
----- ----- -----
Loss before provision for income taxes and
extraordinary loss.............................. (4.4) (30.5) (35.8)
Provision for income taxes.................................. -- -- --
----- ----- -----
Loss before extraordinary loss.................... (4.4)% (30.5)% (35.8)%
Extraordinary loss.......................................... (0.6) -- --
----- ----- -----
Net loss.......................................... (5.0)% (30.5)% (35.8)%
===== ===== =====
Revenues
Total revenues increased to $43.9 million in 2000 from $23.0 million in
1999 and from $13.3 million in 1998. The increases were attributable to
increases in our customer base, which grew to 593 sites at the end of 2000 from
325 at the end of 1999 and 168 at the end of 1998. Total revenues grew 91% from
1999 to 2000. Although we expect revenues to grow on an annual basis, we do not
expect to maintain this same rate of revenue growth year-over-year.
License revenues increased to $30.3 million in 2000 from $16.7 million in
1999 and from $8.7 million in 1998, representing 69.0%, 72.7% and 65.3% of total
revenues, respectively. The increases in license revenues were due to increases
in our customer base, the number of software applications we are offering, and
our average selling prices, resulting from a growing market awareness of our
products and, to a lesser extent, an expanded sales force. Further, during 2000,
1999 and 1998, 57%, 54% and 45%, respectively, of license revenues were
attributable to new customers compared to follow-on revenues from our existing
customer base.
Services revenues increased to $13.6 million in 2000 from $6.2 million in
1999 and from $2.4 million in 1998, representing 31.0%, 27.1% and 18.4% of total
revenues, respectively. Installation and training revenues grew primarily due to
the increase in software licenses to new customer sites. Maintenance revenues
increased due to new customer sites and renewals of annual maintenance contracts
from existing customer sites. Services revenues as a percentage of total
revenues increased due to the compounding effect of maintenance revenue from
both new customer sites and renewals of maintenance contracts from existing
customer sites.
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We discontinued the sale of hardware during the first quarter of 1999. As a
result, hardware revenues decreased to $46,000 in 1999 from $2.2 million in
1998.
Cost of Revenues
Total cost of revenues increased to $8.1 million in 2000 from $4.3 million
in 1999, representing 18.5% and 18.7% of total revenues, respectively. Total
cost of revenues as a percentage of total revenues decreased in 2000 from 1999
due to the discontinuance of hardware sales in the first quarter of 1999. Total
cost of revenues decreased in 1999 from $5.3 million in 1998, or 40.0% of total
revenues primarily due to the discontinuance of hardware sales. Over time we
expect that service revenues as a percentage of total revenues will grow due to
the compounding effect of maintenance revenue from existing customers as they
renew their annual contracts. We expect that as this happens, our gross margins
will decline slightly.
Cost of license revenues increased to $436,000 in 2000 from $327,000 in
1999 and from $310,000 in 1998, representing 1.0%, 1.4% and 2.3% of total
revenues, respectively. The increases in absolute dollars were due to increased
royalties for third-party software resulting from increased license revenues.
During 2000, we released new products and enhanced some of our existing
products, both of which contain additional third-party software components. As
we license more of these products in the future, and incur royalties for these
third-party products, we expect that the cost of license revenues as a
percentage of total revenues will increase, as will the absolute dollars.
Cost of services revenues increased to $7.7 million in 2000 from $3.9
million in 1999 and from $2.5 million in 1998; representing 17.5%, 17.1% and
19.0% of total revenues, respectively. The increases in absolute dollars were a
result of increases in the number of employees engaged in installation, training
and customer maintenance services. Cost of services revenues as a percentage of
services revenues was 56% in 2000, 63% in 1999 and 103% in 1998. The improvement
in the service margins in 2000 was due to fewer employees engaged in maintenance
services per customer. The improvement in 1999 in the services margin was
primarily due to improved project management for installation services and, to a
lesser extent, fewer employees engaged in maintenance services per customer. As
we license software to more new customers, we expect to continue to hire
additional service personnel and anticipate that cost of services revenues will
increase.
We discontinued the sale of hardware during the first quarter of 1999. As a
result, hardware cost of revenues decreased to $46,000 in 1999 from $2.5 million
in 1998.
Operating Expenses
Sales and Marketing. Sales and marketing expenses increased to $22.6
million in 2000 from $11.6 million in 1999 and from $6.1 million in 1998,
representing 51.4%, 50.4% and 46.2% of total revenues, respectively. Sales and
marketing expenses increased primarily due to an increase in sales personnel,
advertising and, to a lesser extent, an increase in marketing program expenses.
We expect that the absolute dollar amount of sales and marketing expenses will
continue to increase due to the planned growth of our sales force, including the
establishment of additional sales offices both domestically and internationally
in Europe, Asia Pacific and Latin America. We also expect additional increases
in advertising and marketing programs and other promotional activities.
Research and Development. Research and development expenses increased to
$10.4 million in 2000 from $5.8 million in 1999 and from $3.5 million in 1998,
representing 23.6% 25.4% and 26.5% of total revenues, respectively. Research and
development expenses increased primarily due to an increase in the number of
employees and consultants engaged in research and development activities. We
expect research and development expenses to increase in absolute dollars as we
continue to commit substantial resources to enhancing existing product
functionality and to developing new products. Furthermore, we may incur
additional research and development charges associated with purchased technology
(for further information see "Liquidity and Capital Resources").
General and Administrative. General and administrative expenses increased
to $8.8 million in 2000 from $4.4 million in 1999 and from $2.1 million in 1998,
representing 20.0%, 19.2% and 16.1% of total
19
20
revenues, respectively. General and administrative expenses increased primarily
due to an increase in the number of employees and related expenses in the
executive, finance and administrative functions to manage the growth of our
company. We expect general and administrative costs to increase in absolute
dollars as we continue to add infrastructure to support a larger organization
and continue to invest in our international expansion.
During the second quarter of 2000, we adopted a plan to relocate our
corporate headquarters to a larger facility within the Atlanta metropolitan
area. During July 2000, we executed a lease agreement for the new facility. We
estimated that costs associated with subletting our existing facilities, which
are under noncancellable leases expiring on September 30, 2002, would be
approximately $525,000. We recorded this obligation in the second quarter of
2000 and allocated such costs to each departmental functional area of the
organization. As of December 31, 2000, there had been no changes to the plan.
During the fourth quarter of 1999, we incurred a deferred stock
compensation charge of $1.0 million for the difference between the exercise
price and the deemed fair value of certain stock option grants. This charge is
being amortized over the vesting period of the underlying options, generally
four years. Deferred stock compensation was $271,000 and $13,000 in 2000 and
1999, respectively. For 2000 and 1999, $18,000 and $1,000 were included in cost
of services, $154,000 and $7,000 in sales and marketing, $50,000 and $4,000 in
research and development, and $49,000 and $1,000 in general and administrative,
respectively. In addition, we incurred other personnel costs of $665,000 during
1999, relating to severance payments for terminated executives as well as a
bonus and relocation costs in connection with recruiting a new executive. Such
costs were allocated so that $40,000 was included in research and development
and $625,000 in general and administrative.
During 1998, we incurred a $900,000 charge to terminate a distributor
agreement.
Acquired In-Process Research and Development. During 1999, we acquired
technology to store and retrieve substantially larger volumes of data than our
existing software was currently capable of storing and retrieving in exchange
for shares of our common stock valued at $3.5 million. The purchase price was
accounted for as acquired in-process research and development expense because,
at the date of the transaction, the in-process research and development acquired
by us related to the development of technology not possessed by us and the
results of this in-process research and development had not progressed to a
stage where they met technological feasibility as defined by SFAS No. 86,
Accounting for the Cost of Computer Software to Be Sold, Leased or Otherwise
Marketed.
Interest Income (Expense), Net
Interest income (expense), net increased to $4.0 million in 2000 from
($364,000) in 1999 due to the investment of the proceeds from our initial public
offering ("IPO"). Interest income (expense), net increased in 1999 from
($31,000) in 1998 due to an increase in borrowings under the then existing
credit facilities.
Provision for Income Taxes
No provision for federal, state or foreign income taxes has been recorded
as we incurred net operating losses or utilized new operating loss carryforwards
for all periods presented. We have recorded a full valuation allowance against
the deferred tax asset generated as a result of these net operating loss
carryforwards, as the future realization of the tax benefit is not currently
considered more likely than not.
20
21
QUARTERLY RESULTS OF OPERATIONS
The following tables present unaudited quarterly statements of operations
data for each of the last eight quarters in the period ended December 31, 2000,
as well as the percentage of total revenues represented by each item. The
information has been derived from our unaudited consolidated financial
statements, which have been prepared on substantially the same basis as the
audited consolidated financial statements contained in this report. The
unaudited consolidated financial statements contain all adjustments, consisting
only of normal recurring adjustments that we consider to be necessary to present
fairly this information when read in conjunction with the consolidated financial
statements and notes thereto appearing elsewhere in this report. The results of
operations for any quarter are not necessarily indicative of the results to be
expected for any future period.
THREE MONTHS ENDED
-----------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MARCH 31, DEC. 31, SEPT. 30, JUNE 30, MARCH 31,
2000 2000 2000 2000 1999 1999 1999 1999
-------- --------- -------- --------- -------- --------- -------- ---------
Revenues:
License.......................... $10,057 $ 8,056 $ 6,976 $ 5,218 $5,695 $ 4,436 $3,484 $ 3,091
Services......................... 4,078 3,810 3,281 2,432 2,142 1,694 1,294 1,091
Hardware......................... -- -- -- -- -- -- -- 46
------- ------- ------- ------- ------ ------- ------ -------
Total revenues............ 14,135 11,866 10,257 7,650 7,837 6,130 4,778 4,228
Cost of revenues:
License.......................... 110 141 124 61 69 73 83 102
Services......................... 2,275 2,069 1,923 1,414 1,325 1,048 818 730
Hardware......................... -- -- -- -- -- -- -- 46
------- ------- ------- ------- ------ ------- ------ -------
Total cost of revenues.... 2,385 2,210 2,047 1,475 1,394 1,121 901 878
------- ------- ------- ------- ------ ------- ------ -------
Gross profit....................... 11,750 9,656 8,210 6,175 6,443 5,009 3,877 3,350
Operating expenses:
Sales and marketing.............. 6,816 5,817 5,726 4,228 4,176 2,768 2,502 2,139
Research and development......... 3,031 2,689 2,415 2,244 1,645 1,682 1,334 1,164
General and administrative....... 2,596 2,310 2,199 1,665 1,222 1,318 768 1,095
Acquired in-process research and
development.................... -- -- -- -- -- 3,506 -- --
------- ------- ------- ------- ------ ------- ------ -------
Operating loss..................... (693) (1,160) (2,130) (1,962) (600) (4,265) (727) (1,048)
Interest income (expense), net..... 1,159 1,180 1,151 489 (44) (229) (72) (19)
------- ------- ------- ------- ------ ------- ------ -------
Income (loss) before provision for
income taxes and extraordinary
loss............................. 466 20 (979) (1,473) (644) (4,494) (799) (1,067)
Provision for income taxes......... -- -- -- -- -- -- -- --
------- ------- ------- ------- ------ ------- ------ -------
Income (loss) before extraordinary
loss............................. 466 20 (979) (1,473) (644) (4,494) (799) (1,067)
Extraordinary loss................. -- -- -- (248) -- -- -- --
------- ------- ------- ------- ------ ------- ------ -------
Net income (loss).................. $ 466 $ 20 $ (979) $(1,721) $ (644) $(4,494) $ (799) $(1,067)
======= ======= ======= ======= ====== ======= ====== =======
21
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THREE MONTHS ENDED
-----------------------------------------------------------------------------------------
DEC. 31, SEPT. 30, JUNE 30, MARCH 31, DEC. 31, SEPT. 30, JUNE 30, MARCH 31,
2000 2000 2000 2000 1999 1999 1999 1999
-------- --------- -------- --------- -------- --------- -------- ---------
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
License............................. 71.1% 67.9% 68.0% 68.2% 72.7% 72.4% 72.9% 73.1%
Services............................ 28.9 32.1 32.0 31.8 27.3 27.6 27.1 25.8
Hardware............................ -- -- -- -- -- -- -- 1.1
----- ----- ----- ----- ----- ----- ----- -----
Total revenues............... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- ----- ----- ----- -----
Cost of revenues:
License............................. 0.8 1.2 1.2 0.7 0.9 1.2 1.7 2.4
Services............................ 16.1 17.4 18.8 18.6 16.9 17.1 17.2 17.3
Hardware............................ -- -- -- -- -- -- -- 1.1
----- ----- ----- ----- ----- ----- ----- -----
Total cost of revenues....... 16.9 18.6 20.0 19.3 17.8 18.3 18.9 20.8
----- ----- ----- ----- ----- ----- ----- -----
Gross profit.......................... 83.1 81.4 80.0 80.7 82.2 81.7 81.1 79.2
Operating expenses:
Sales and marketing................. 48.2 49.0 55.8 55.2 53.3 45.2 52.3 50.6
Research and development............ 21.4 22.7 23.5 29.3 21.0 27.4 27.9 27.5
General and administrative.......... 18.4 19.5 21.4 21.8 15.6 21.5 16.1 25.9
Acquired in-process research and
development....................... -- -- -- -- -- 57.2 -- --
----- ----- ----- ----- ----- ----- ----- -----
Operating loss........................ (4.9) (9.8) (20.7) (25.6) (7.7) (69.6) (15.2) (24.8)
Interest income (expense), net........ 8.2 10.0 11.2 6.3 (0.5) (3.7) (1.5) (0.4)
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) before provision for
income taxes and extraordinary
loss................................ 3.3 0.2 (9.5) (19.3) (8.2) (73.3) (16.7) (25.2)
Provision for income taxes............ -- -- -- -- -- -- -- --
----- ----- ----- ----- ----- ----- ----- -----
Income (loss) before extraordinary
loss................................ 3.3 0.2 (9.5) (19.3) (8.2) (73.3) (16.7) (25.2)
Extraordinary loss.................... -- -- -- (3.2) -- -- -- --
----- ----- ----- ----- ----- ----- ----- -----
Net income (loss)............ 3.3% 0.2% (9.5)% (22.5)% (8.2)% (73.3)% (16.7)% (25.2)%
===== ===== ===== ===== ===== ===== ===== =====
During 2000, license revenues as a percentage of total revenues generally
decreased from quarter to quarter in comparison to 1999. This resulted primarily
from increased services revenues. License and services revenues as percentages
of total revenues held constant throughout 1999. We expect the relative amount
of license revenues as compared to services revenues to be consistent with 2000.
We discontinued the sale of hardware during the first quarter of 1999.
Our quarterly revenues increased throughout 2000 and 1999 primarily as a
result of a growing market awareness of our products and, to a lesser extent, an
expanded sales force. Cost of revenues as a percentage of total revenues were
lower in the fourth quarter of 2000 due to the increase in license revenues.
Operating expenses increased each quarter primarily as a result of the increase
in the number of employees engaged in all areas of our business.
We believe that our quarterly operating results may experience seasonal
fluctuations in the future. For instance, quarterly results may fluctuate based
on client calendar-year budgeting cycles, slow summer purchasing patterns and
compensation policies that tend to compensate sales personnel, typically in the
latter half of the year, for achieving annual quotas.
As a result of the foregoing and other factors, we believe that
quarter-to-quarter comparisons of results are not necessarily meaningful, and
such comparisons should not be relied upon as indications of future performance.
LIQUIDITY AND CAPITAL RESOURCES
On February 10, 2000, we completed our IPO whereby we issued 3.8 million
shares at an offering price of $20.00 per share. Simultaneously, our
underwriters exercised their over-allotment option to issue an additional
21
23
570,000 shares, 219,269 shares of which were sold by us. Net proceeds to us were
$74.8 million, after deducting underwriting discounts and commissions and
selling stockholders' net proceeds. Since the IPO, we have repaid all of our
long-term debt totaling of $2.8 million, including $67,000 in prepayment
penalties. We recorded an extraordinary loss on the early extinguishment of debt
of $248,000 during 2000 due to the write-off of unamortized debt discount and
deferred financing fees and the payment of the prepayment penalty. The remaining
net proceeds were invested in high-grade marketable securities.
The principal use of cash to date has been to fund our losses from
operations and to purchase furniture and equipment. Cash used for operating
activities was $4.7 million, $384,000 and $3.1 million in 2000, 1999 and 1998,
respectively. The increases in cash used in operating activities were due
primarily to changes in operating losses and working capital.
Investing activities consisted of capital expenditures totaling $7.2
million, $2.2 million and $1.3 million in 2000, 1999 and 1998, respectively,
used to acquire furniture and equipment and other assets. We expect to have
total capital expenditures of approximately $7.0 million in 2001. We anticipate
that our capital expenditures will increase over the next several years as we
expand our facilities and acquire equipment to support expansion of our sales
and marketing and research and development activities. As a result of our IPO
proceeds, investing activities during 2000 included gross purchases of
short-term investments totaling $99.6 million and sales and maturities of $66.2
million. We intend to use these investments primarily to fund our sales and
marketing and research and development expenses, operating deficits and other
working capital needs and for general corporate purposes, including the
development of our product lines potentially through acquisitions of products,
technologies and businesses.
Net cash provided by financing activities was $72.3 million, $4.3 million
and $3.3 million in 2000, 1999 and 1998, respectively. The increase in 2000 was
due primarily to the receipt of proceeds from our IPO. The increase in 1999 was
mainly due to the receipt of proceeds from the sale of Series C convertible
preferred stock.
As of December 31, 2000, we had $68.0 million in cash and cash equivalents,
short-term investments and restricted investments, and $58.5 million in working
capital. In connection with our new corporate headquarters lease and furniture
rental, we executed three letters of credit in the aggregate amount of $4.9 as
security. In addition, we currently have $5.4 million of short-term investments
pledged as collateral for the letters of credit. The letters of credit and
related restricted investments have decreasing schedules and expire in 2002 and
2007.
During 2000, we entered into an option agreement to purchase technology for
research and development activities. If the option, which expires on March 31,
2001, is exercised, we will pay $2.0 million to purchase the technology. As of
December 31, 2000, the option's carrying value was $650,000 and classified as an
other asset. If we choose to exercise the option, we may be required to record a
$2.8 million charge in the period exercised depending upon technological
feasibility and alternative future uses at the time of exercise.
We believe that our existing cash and cash equivalents and short-term
investments, offset by any cash used in operating activities, will be sufficient
to meet our anticipated cash needs for working capital and capital expenditures
for the next 12 months. If cash generated from operations is insufficient to
satisfy our liquidity requirements, we may seek to sell additional equity or
debt securities or establish new financing arrangements. The sale of additional
equity or convertible debt securities could result in additional dilution to our
stockholders. We cannot assure that any financing arrangements will be available
in sufficient amounts or on acceptable terms.
At December 31, 2000, our accounts receivable days sales outstanding was 54
days. We expect our days sales outstanding to increase as we receive a greater
proportion of our revenues from international operations, where payment is
typically slower than in the United States.
22
24
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. In June
1999, the FASB issued SFAS No. 137, Accounting for Derivative Instruments and
Hedging Activities -- Deferral of the Effective Date of SFAS No. 133, which
defers the effective date of SFAS No. 133 until fiscal years beginning after
June 15, 2000. In June 2000, the FASB issued SFAS No. 138, Accounting for
Certain Derivative Instruments and Certain Hedging Activities, which amended the
accounting and reporting standards of SFAS No. 133 for certain derivative
instruments and certain hedging activities. The adoption of SFAS No. 133 will
not have a material impact on the Company's results of operations or its
financial position.
In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation ("Interpretation No. 44"),
with an effective date of July 1, 2000. Interpretation No. 44 clarifies guidance
for certain issues that arose in the application of APB Opinion No. 25. The
adoption of Interpretation No. 44 did not have an impact on the Company's
results of operations or financial position.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Our interest income is sensitive to changes in the general level of U.S.
interest rates, particularly since the majority of our investments are in
short-term instruments. Due to the nature of our short-term instruments, we have
concluded that we do not have material market risk exposure.
The majority of our operations are based in the United States and,
accordingly, the majority of our transactions are denominated in U.S. dollars.
However, we do have foreign-based operations where transactions are denominated
in foreign currencies and are subject to market risk with respect to
fluctuations in the relative value of currencies. Currently, we have operations
in Canada, the United Kingdom, the Netherlands, Sweden, Australia, Mexico and
Japan and conduct transactions in the local currency of each location. To date,
the impact of fluctuations in the relative value of other currencies has not
been material.
We have not conducted transactions, established commitments or entered into
relationships requiring disclosures beyond those provided elsewhere in this Form
10-K.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements, together with related notes and the
report of KPMG LLP, our independent auditors, are set forth on the pages
indicated in Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
23
25
PART III
Certain information required by Part III is omitted from this Report in
that the Company will file a definitive proxy statement within 120 days after
the end of this fiscal year pursuant to Regulation 14A (the "Proxy Statement")
for its 2001 Annual Meeting of Stockholders proposed to be held on May 21, 2001,
and the information included therein is incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The information required by this Item is incorporated by reference from the
Proxy Statement under the headings "Election of Directors" and "Executive
Compensation."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference from the
Proxy Statement under the heading "Executive Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference from the
Proxy Statement under the heading "Security Ownership of Certain Beneficial
Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference from the
Proxy Statement under the heading "Executive Compensation."
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
a) The following documents are filed as part of this report:
PAGE
----
1. Financial Statements
Independent Auditors' Report............................. F-2
Consolidated Balance Sheets.............................. F-3
Consolidated Statements of Operations.................... F-4
Consolidated Statements of Stockholders' Equity
(Deficit).............................................. F-5
Consolidated Statements of Cash Flows.................... F-6
Notes to Consolidated Financial Statements............... F-7
2. Financial Statement Schedule
Schedule II -- Valuation and Qualifying Accounts......... F-20
b) Reports on Form 8-K:
No reports on Form 8-K were filed by the Registrant during the fiscal
quarter ended December 31, 2000.
c) Exhibits
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
3.1(1) -- Amended and Restated Articles of Incorporation of the
Registrant.
3.2(1) -- Amended and Restated Bylaws of the Registrant.
4.1(1) -- See Exhibits 3.1 and 3.3 for provisions of the Amended and
Restated Articles of Incorporation and Amended and Restated
Bylaws of the Registrant defining rights of the holders of
Common Stock of the Registrant.
4.2(1) -- Specimen Stock Certificate.
24
26
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.1(1) -- Office Lease Agreements between Regency Park West
Associates, L.P. and Witness Systems, Inc., dated April 15,
1997.
10.2(2) -- Lease Agreement between Registrant and Colonial Center at
Mansell Overlook/Colonial Business Center dated July 28,
2000
10.3(1) -- Amended and Restated Stock Incentive Plan of the Registrant.
10.4* -- Form of Stock Option Grant Certificate.
10.5(1) -- Form of Amendment to Stock Option Grant Certificate between
Registrant and certain of the officers of the Registrant.
10.6(3) -- Employee Stock Purchase Plan of the Registrant.
10.7(1) -- Employment Agreement entered into between David B. Gould and
the Registrant, effective February 2, 1999.
10.8(1) -- Promissory Note, dated March 31, 1999, between the
Registrant and David Gould.
10.9(1) -- Restricted Stock Award Agreement, dated March 31, 1999,
between the Registrant and David Gould.
10.10(1) -- Form of Promissory Note and Subscription Agreement, dated
August 2, 1999, between the Registrant and certain of the
officers of the Registrant.
10.11(1) -- Promissory Note and Subscription Agreement, dated August 2,
1999, between the Registrant and John Abraham.
10.12(1) -- Form of Stock Repurchase Agreement between the Registrant
and certain shareholders of the Registrant.
10.13(1) -- Warrant to Purchase Stock, dated June 29, 1999 between
Greyrock Capital and the Registrant.
10.14(1) -- Asset Purchase Agreement among Registrant, Advanced
Integrators, Inc. and Formation, Inc. dated September 30,
1999.
10.15(1) -- Amended and Restated Registration Rights Agreement, dated as
of August 2, 1999, as amended, among the Registrant and
certain shareholders of the Registrant.
10.16(1) -- Subsidiary License and Distribution Agreement.
10.17(1) -- Form of Indemnification Agreement between Registrant and
each of its executive officers and directors.
10.18(1) -- Amendment No 1 to Employment Agreement entered into between
David B. Gould and the Registrant, dated as of August 2,
1999.
21.1* -- List of subsidiaries
23.1* -- Independent Auditors' Report on Financial Statement Schedule
of KPMG LLP.
23.2* -- Independent Auditors' Consent of KPMG LLP.
99.1* -- Safe Harbor Compliance Statement for Forward-Looking
Statements.
- ---------------
* Filed herewith
(1) Incorporated by reference to exhibits previously filed with the Company's
Registration Statement on Form S-1 (File No. 333-91383)
(2) Incorporated by reference to exhibits previously filed with the Company's
Quarterly Report on Form 10-Q for the period ended June 30, 2000
(3) Incorporated by reference to exhibits previously filed with the Company's
Annual Report on Form 10-K for the period ended December 31, 1999
26
27
WITNESS SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets as of December 31, 2000 and
1999...................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999, and 1998......................... F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended December 31, 2000, 1999, and 1998..... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999, and 1998......................... F-6
Notes to Consolidated Financial Statements.................. F-7
F-1
28
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Witness Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Witness
Systems, Inc. and subsidiaries (the "Company") as of December 31, 2000 and 1999,
and the related consolidated statements of operations, stockholders' equity
(deficit) and cash flows for each of the years in the three-year period ended
December 31, 2000. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Witness
Systems, Inc. and subsidiaries at December 31, 2000 and 1999, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States of America.
/s/ KPMG LLP
Atlanta, Georgia
January 24, 2001
F-2
29
WITNESS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-------------------
2000 1999
-------- --------
(IN THOUSANDS,
EXCEPT SHARE DATA)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 29,590 $ 2,630
Short-term investments.................................... 34,747 --
Accounts receivable, net of allowance for doubtful
accounts of $775 in 2000 and $438 in 1999............... 8,278 4,015
Prepaid and other current assets.......................... 2,775 1,023
-------- --------
Total current assets................................ 75,390 7,668
Restricted investments...................................... 3,660 --
Property and equipment, net................................. 4,907 1,947
Intangible and other assets, net............................ 2,509 1,228
-------- --------
$ 86,466 $ 10,843
======== ========
LIABILITIES, CONVERTIBLE PREFERRED
STOCK, AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term debt......................... $ -- $ 2,409
Accounts payable.......................................... 2,770 1,632
Accrued expenses.......................................... 8,592 5,642
Deferred revenue.......................................... 5,516 3,729
-------- --------
Total current liabilities........................... 16,878 13,412
Long-term debt, net of current portion...................... -- 250
-------- --------
Total liabilities................................... 16,878 13,662
-------- --------
Convertible preferred stock, $.01 par value; redeemable;
authorized 948,632 shares and 6,731,954 shares at December
31, 2000 and 1999, respectively; stated at redemption
value, net of unaccreted discount:
Series A, 4,000,000 shares designated, 3,184,000 shares
issued and outstanding; estimated redemption amount of
$114,624 at December 31, 1999........................... -- 8,915
Series B, 1,231,954 shares designated, 1,181,954 shares
issued and outstanding; estimated redemption amount of
$5,496 at December 31, 1999............................. -- 5,481
Series C, 1,500,000 shares designated, 1,325,028 shares
issued and outstanding;estimated redemption amount of
$47,401 at December 31, 1999............................ -- 8,441
-------- --------
Total convertible preferred stock................... -- 22,837
-------- --------
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock, $0.01 par value; 10,000,000 shares
authorized, no shares issued or outstanding............. -- --
Common stock, $.01 par value; 50,000,000 shares
authorized, 21,907,593 and 10,316,696 shares issued at
December 31, 2000 and 1999, respectively; 21,907,593 and
6,876,912 shares outstanding at December 31, 2000 and
1999, respectively;..................................... 219 103
Additional paid-in capital................................ 94,565 4,347
Accumulated deficit....................................... (22,805) (20,591)
Notes receivable for stock................................ (2,413) (2,594)
Treasury stock, 3,439,784 shares at December 31, 1999, at
cost.................................................... -- (6,921)
Accumulated other comprehensive income.................... 22 --
-------- --------
Total stockholders' equity (deficit)................ 69,588 (25,656)
-------- --------
$ 86,466 $ 10,843
======== ========
See accompanying notes to consolidated financial statements.
F-3
30
WITNESS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
DECEMBER 31,
--------------------------------------
2000 1999 1998
---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenues:
License................................................... $30,307 $16,706 $ 8,682
Services.................................................. 13,601 6,221 2,444
Hardware.................................................. -- 46 2,171
------- ------- -------
Total revenues.................................... 43,908 22,973 13,297
------- ------- -------
Cost of revenues:
License................................................... 436 327 310
Services.................................................. 7,681 3,921 2,526
Hardware.................................................. -- 46 2,482
------- ------- -------
Total cost of revenues............................ 8,117 4,294 5,318
------- ------- -------
Gross profit...................................... 35,791 18,679 7,979
Operating expenses:
Sales and marketing....................................... 22,587 11,585 6,147
Research and development.................................. 10,379 5,825 3,529
General and administrative................................ 8,770 4,403 2,141
Charge for termination of distribution agreement.......... -- -- 900
Acquired in-process research and development.............. -- 3,506 --
------- ------- -------
Operating loss.................................... (5,945) (6,640) (4,738)
Interest income (expense), net.............................. 3,979 (364) (31)
------- ------- -------
Loss before provision for income taxes and
extraordinary loss.............................. (1,966) (7,004) (4,769)
Provision for income taxes.................................. -- -- --
------- ------- -------
Loss before extraordinary loss.................... (1,966) (7,004) (4,769)
Extraordinary loss on early extinguishment of debt.......... (248) -- --
------- ------- -------
Net loss.......................................... (2,214) (7,004) (4,769)
Preferred stock dividends and accretion..................... (611) (1,815) (502)
------- ------- -------
Net loss applicable to common stockholders........ $(2,825) $(8,819) $(5,271)
======= ======= =======
Net loss per share (see Note 1(n) for pro forma net loss per
share):
Basic and diluted
Loss before extraordinary loss......................... $ (0.13) $ (1.37) $ (0.76)
Extraordinary loss..................................... (0.01) -- --
------- ------- -------
Net loss.......................................... $ (0.14) $ (1.37) $ (0.76)
======= ======= =======
Basic and diluted weighted-average common shares
outstanding.......................................... 19,997 6,424 6,964
======= ======= =======
See accompanying notes to consolidated financial statements.
F-4
31
WITNESS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
COMMON STOCK
------------------ TREASURY STOCK
NUMBER OF ADDITIONAL NOTES ---------------------
SHARES PAID-IN ACCUMULATED RECEIVABLE NUMBER OF AMOUNT
ISSUED AMOUNT CAPITAL DEFICIT FOR STOCK SHARES (AT COST)
--------- ------ ---------- ----------- ---------- --------- ---------
(IN THOUSANDS)
Balance at December 31,
1997........................ 8,078 $ 81 $ 604 $ (8,818) $ (108) -- $ --
Common stock granted for
services.................. 40 -- 25 -- -- -- --
Purchase of treasury
stock..................... -- -- -- -- -- 1,260 (1,900)
Accretion on Series A and
Series B convertible
preferred stock........... -- -- (434) -- -- -- --
Dividends accrued on Series
A convertible preferred
stock..................... -- -- (68) -- -- -- --
Exercise of stock options... 88 1 10 -- -- -- --
Comprehensive loss:
Net loss.................. -- -- -- (4,769) -- -- --
Total comprehensive
loss....................
------ ---- ------- -------- ------- ------ -------
Balance at December 31,
1998........................ 8,206 82 137 (13,587) (108) 1,260 (1,900)
Accretion on Series A,
Series B, and Series C
convertible preferred
stock..................... -- -- (1,747) -- -- -- --
Dividends accrued on Series
A convertible preferred
stock..................... -- -- (68) -- -- -- --
Exercise of stock options... 390 4 430 -- (333) -- --
Fair value of common stock
warrants issued........... -- -- 275 -- -- -- --
Purchase of treasury
stock..................... -- -- -- -- -- 1,800 (5,350)
Issuance of common stock for
notes..................... 880 9 1,847 -- (2,261) (270) 405
Fair value of shares issued
for acquired in-process
research and
development............... 841 8 3,473 -- -- -- --
Forgiveness of note
receivable for stock...... -- -- -- -- 108 650 (76)
Comprehensive loss:
Net loss.................. -- -- -- (7,004) -- -- --
Total comprehensive
loss....................
------ ---- ------- -------- ------- ------ -------
Balance at December 31,
1999........................ 10,317 103 4,347 (20,591) (2,594) 3,440 (6,921)
Accretion on Series A,
Series B, and Series C
convertible preferred
stock..................... -- -- (604) -- -- -- --
Dividends accrued on Series
A convertible preferred
stock..................... -- -- (7) -- -- -- --
Conversion of preferred
stock upon initial public
offering.................. 10,410 104 23,344 -- -- -- --
Common stock issued upon
initial public offering,
net....................... 4,019 40 73,197 -- -- -- --
Exercise of stock options &
warrants.................. 563 6 665 -- -- -- --
Shares issued under employee
stock purchase plan....... 39 -- 510 -- -- -- --
Retirement of treasury
stock..................... (3,440) (34) (6,887) -- -- (3,440) 6,921
Repayment of notes
receivable for stock...... -- -- -- -- 181 -- --
Comprehensive loss:
Foreign currency
translation
adjustments............. -- -- -- -- -- -- --
Unrealized gain of
investments, net........ -- -- -- -- -- -- --
Net loss.................. -- -- -- (2,214) -- -- --
Total comprehensive
loss....................
------ ---- ------- -------- ------- ------ -------
Balance at December 31,
2000........................ 21,908 $219 $94,565 $(22,805) $(2,413) -- $ --
====== ==== ======= ======== ======= ====== =======
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME TOTAL
------------- -------
(IN THOUSANDS)
Balance at December 31,
1997........................ $ -- $(8,241)
Common stock granted for
services.................. -- 25
Purchase of treasury
stock..................... -- (1,900)
Accretion on Series A and
Series B convertible
preferred stock........... -- (434)
Dividends accrued on Series
A convertible preferred
stock..................... -- (68)
Exercise of stock options... -- 11
Comprehensive loss:
Net loss.................. -- (4,769)
-------
Total comprehensive
loss.................... (4,769)
---- -------
Balance at December 31,
1998........................ -- (15,376)
Accretion on Series A,
Series B, and Series C
convertible preferred
stock..................... -- (1,747)
Dividends accrued on Series
A convertible preferred
stock..................... -- (68)
Exercise of stock options... -- 101
Fair value of common stock
warrants issued........... -- 275
Purchase of treasury
stock..................... -- (5,350)
Issuance of common stock for
notes..................... -- --
Fair value of shares issued
for acquired in-process
research and
development............... -- 3,481
Forgiveness of note
receivable for stock...... -- 32
Comprehensive loss:
Net loss.................. -- (7,004)
-------
Total comprehensive
loss.................... (7,004)
---- -------
Balance at December 31,
1999........................ -- (25,656)
Accretion on Series A,
Series B, and Series C
convertible preferred
stock..................... -- (604)
Dividends accrued on Series
A convertible preferred
stock..................... -- (7)
Conversion of preferred
stock upon initial public
offering.................. -- 23,448
Common stock issued upon
initial public offering,
net....................... -- 73,237
Exercise of stock options &
warrants.................. -- 671
Shares issued under employee
stock purchase plan....... -- 510
Retirement of treasury
stock..................... -- --
Repayment of notes
receivable for stock...... -- 181
Comprehensive loss:
Foreign currency
translation
adjustments............. (75) (75)
Unrealized gain of
investments, net........ 97 97
Net loss.................. -- (2,214)
-------
Total comprehensive
loss.................... (2,192)
---- -------
Balance at December 31,
2000........................ $ 22 $69,588
==== =======
See accompanying notes to consolidated financial statements.
F-5
32
WITNESS SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
DECEMBER 31,
----------------------------
2000 1999 1998
-------- ------- -------
(IN THOUSANDS)
Cash flows used in operating activities:
Net loss before extraordinary loss........................ $ (1,966) $(7,004) $(4,769)
Adjustments to reconcile net loss before extraordinary
loss to net cash used in operating activities:
Depreciation and amortization.......................... 1,895 1,248 743
Provision for doubtful accounts........................ 544 226 200
Stock issued for in-process research and development... -- 3,481 --
Other noncash expenses................................. 271 174 225
Changes in operating assets and liabilities:
Accounts receivable.................................. (4,820) (1,777) (2,588)
Prepaid expenses and other assets.................... (5,038) (1,136) (58)
Inventory............................................ -- -- 587
Accounts payable..................................... 1,100 935 236
Accrued expenses..................................... 1,547 3,203 1,307
Deferred revenue..................................... 1,791 266 972
-------- ------- -------
Net cash flows used in operating activities....... (4,676) (384) (3,145)
-------- ------- -------
Cash flows used in investing activities:
Capital expenditures...................................... (5,530) (1,660) (1,324)
Purchases of short-term investments....................... (99,637) -- --
Proceeds from sales and maturities of short-term
investments............................................ 66,208 -- --
Purchases of other assets................................. (1,664) (500) --
-------- ------- -------
Net cash flows used in investing activities....... (40,623) (2,160) (1,324)
-------- ------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock, net............... 73,801 -- --
Proceeds from long-term debt.............................. -- 3,000 1,000
Repayments on long-term debt.............................. (2,862) (1,801) (297)
Purchase of treasury shares............................... -- (5,350) (1,900)
Proceeds from exercise of stock options................... 671 101 11
Proceeds from employee stock purchase plan................ 510 -- --
Repayments of notes receivable from stockholders.......... 181 -- --
Proceeds from sale of Series C convertible preferred
stock, net............................................. -- 8,312 --
Proceeds from sale of Series B convertible preferred
stock, net............................................. -- -- 5,475
Net repayments of working capital line of credit.......... -- -- (1,000)
Other..................................................... (42) -- --
-------- ------- -------
Net cash flows provided by financing activities... 72,259 4,262 3,289
-------- ------- -------
Net change in cash and cash equivalents........... 26,960 1,718 (1,180)
Cash and cash equivalents at beginning of period............ 2,630 912 2,092
-------- ------- -------
Cash and cash equivalents at end of period.................. $ 29,590 $ 2,630 $ 912
======== ======= =======
Supplemental cash flow information:
Cash paid for interest.................................... $ 68 $ 298 $ 87
======== ======= =======
See accompanying notes to consolidated financial statements.
F-6
33
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Description of Business
Witness Systems, Inc. and subsidiaries (the "Company") provides
business-driven multimedia recording, analysis and electronic learning software
that enables companies to optimize their customer relationships across multiple
communications media and to improve their customer relationship management. The
Company is headquartered in Roswell, Georgia with other offices in the United
States, Canada, Mexico, United Kingdom, the Netherlands, Sweden, Japan and
Australia.
The Company was originally incorporated in 1988 in Georgia and was
reincorporated in Delaware on March 13, 1997.
(b) Initial public offering
On February 9, 2000, the Securities and Exchange Commission declared the
Company's initial public offering ("IPO") of its common stock effective, and
public trading of the registered shares commenced February 10, 2000. The initial
public offering consisted of 3,800,000 newly issued shares followed by the
underwriters' exercise of their over-allotment option for 570,000 shares
(219,269 of which were newly issued and 350,731 which were sold by certain
stockholders). The Company received $74.8 million in proceeds, net of
underwriting discounts and commissions, less offering costs of $1.5 million.
(c) Principles of Consolidation and Reclassifications
The consolidated financial statements include the financial statements of
the Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
Certain amounts in the accompanying 1999 and 1998 financial statements have
been reclassified to conform to the presentation adopted in the 2000 financial
statements.
(d) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures 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.
(e) Revenue Recognition and Deferred Revenue
The Company recognizes revenue in accordance with Statement of Position
("SOP") 97-2, Software Revenue Recognition, and SOP 98-9, Software Revenue
Recognition with Respect to Certain Transactions. Revenue is derived from
licensing software and providing related services and is allocated to each
element of the arrangement based on their relative fair values, which is
established by the price charged when the respective element is sold separately.
Revenue from license fees is recognized when persuasive evidence of an
agreement exists, delivery of the product has occurred, the fee is fixed or
determinable and collectibility is probable.
Software services include installation, training and maintenance. Revenues
from installation and training are recognized upon performance of the related
services. Installation and training services are offered and billed as separate
elements of contracts. The functionality of the software is not dependent on
installation and training services.
Maintenance is offered as a separate element and includes the right to
unspecified upgrades on a when-and-if available basis. Maintenance revenue is
deferred and recognized ratably over the term of the related contract, usually
one year. Specified upgrades are not typically offered to customers.
F-7
34
Accounts receivable include amounts due from customers for which revenue
has been recognized. Deferred revenue consists of amounts collected from
customers for license and software services that have not met the criteria for
revenue recognition.
(f) Cash and Cash Equivalents and Short-Term Investments
The Company considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents. The Company's
investments are classified as available for sale and are carried at fair market
value. Unrealized holding gains and losses on such investments are reported as a
part of accumulated other comprehensive income. Realized gains and losses from
sales are based on the specific identification method.
(g) Prepaid and Other Current Assets
Prepaid and other current assets consist principally of prepayments of
certain operating expenses, unbilled services revenue, prepaid software
royalties and investment interest receivable.
(h) Property and Equipment
Property and equipment are stated at cost, less accumulated depreciation
and amortization. Property and equipment are depreciated on a straight-line
basis over the estimated useful lives of the assets, typically 18 months to five
years. Leasehold improvements are amortized using the straight-line method over
the shorter of the estimated life of the asset or the remaining term of the
lease. Property and equipment are comprised of the following:
DECEMBER 31,
---------------
2000 1999
------ ------
(IN THOUSANDS)
Property and equipment
Computer equipment........................................ $4,316 $2,580
Software.................................................. 1,950 950
Other equipment........................................... 1,246 --
Furniture and fixtures.................................... 987 638
Leasehold improvements.................................... 1,262 70
------ ------
9,761 4,238
Less accumulated depreciation............................. 4,854 2,291
------ ------
$4,907 $1,947
====== ======
During the later half of 2000, the Company accelerated the depreciation of
its furniture and fixtures and leasehold improvements at its former headquarters
facility in order to coincide with its relocation in December 2000.
(i) Intangible and Other Assets
Other assets include principally prepaid software royalties and deposits.
Intangible assets consist of purchased technology and are being amortized using
the straight-line method generally over three years. During 2000, the Company
amortized to research and development expense $538,000 of purchased technology.
There was no amortization prior to 2000.
(j) Impairment of Long-Lived Assets
Long-lived and intangible assets are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of the assets to the future net cash
flows expected to be generated by the assets. If such assets are considered to
be impaired, the impairment to be
F-8
35
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets.
(k) Research and Development and Software Development Costs
Research and development costs are expensed as incurred. SFAS No. 86,
Accounting for the Cost of Computer Software to Be Sold, Leased or Otherwise
Marketed requires capitalization of certain software development costs
subsequent to the establishment of technological feasibility. Costs incurred
subsequent to establishing technological feasibility, in the form of a working
model, are capitalized and amortized over their estimated useful lives. To date,
software development costs incurred after technological feasibility has been
established have not been material.
(l) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
(m) Stock Compensation
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations, in accounting for its
fixed plan stock options. As such, compensation expense is recorded on the date
of grant only if the current estimated fair value of the underlying stock
exceeds the exercise price. The Company has also provided pro forma disclosures
as if the fair value-based method of accounting prescribed by Statement of
Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock Based
Compensation, had been used to account for its fixed plan stock options (Note
4(c)).
(n) Computation of Historical and Unaudited Pro Forma Net Loss Per Share
The Company has presented historical net loss per share pursuant to SFAS
No. 128, Earnings Per Share, and the Securities and Exchange Commission Staff
Accounting Bulletin ("SAB") No. 98. Pursuant to SFAS No. 128, unvested stock is
excluded from basic earnings per share and included in diluted earnings per
share if dilutive. Pursuant to SAB No. 98, common stock and convertible
preferred stock issued for nominal consideration, prior to the effective date of
an initial public offering, are required to be included in the calculation of
basic and diluted net loss per share, as if they were outstanding for all
periods presented. The Company has not had any such issuances or grants for
nominal consideration.
The unaudited pro forma net loss per share for the years ended December 31,
2000 and 1999 is calculated using the historical weighted-average common shares
outstanding and reflecting: (1) the subsequent conversions of Series A, Series B
and Series C convertible preferred stock, including conversions of accrued
dividends on the Series A convertible preferred stock, into shares of the
Company's common stock, as if such conversions had occurred on January 1, 1998,
or at the date of issuance, if later; and (2) the vesting of certain restricted
common shares held by an officer of the Company which became fully vested upon
the Company's initial public offering in February 2000, as if such vesting
became effective on the date such shares were issued. The numerator of the
calculation excludes preferred stock dividends and accretion of $611,000 and
$1.8 million for the years ended December 31, 2000 and 1999, respectively.
F-9
36
Following is a reconciliation of the numerator and denominator used in the
calculation of historical and pro forma basic and diluted net loss per share (in
thousands, except per share data):
YEAR ENDED DECEMBER 31,
---------------------------
2000 1999 1998
------- ------- -------
Historical:
Net loss before extraordinary loss...................... $(1,966) $(7,004) $(4,769)
Preferred stock dividends and accretion................. (611) (1,815) (502)
------- ------- -------
Net loss applicable to common Stockholders...... $(2,577) $(8,819) $(5,271)
======= ======= =======
Basic and diluted common shares outstanding............. 19,997 6,424 6,964
======= ======= =======
Basic and diluted net loss per share before
Extraordinary loss................................... $ (0.13) $ (1.37) $ (0.76)
======= ======= =======
YEAR ENDED DECEMBER 31,
------------------------
2000 1999
--------- ---------
Net loss before extraordinary loss.......................... $(1,966) $(7,004)
Unaudited pro forma:
Historical basic and diluted common shares outstanding.... 19,997 6,424
Adjustment at December 31, 2000 and 1999 to reflect the
initial public offering:
Conversion of Series A preferred stock................. 664 5,776
Conversion of Series B preferred stock................. 240 2,128
Conversion of Series C preferred stock................. 269 993
Vesting of restricted common shares.................... 62 434
------- -------
Pro forma basic and diluted common shares
outstanding..................................... 21,232 15,755
======= =======
Unaudited pro forma basic and diluted net loss per share
before extraordinary loss.............................. $ (0.09) $ (0.44)
======= =======
The Company has excluded all convertible preferred stock, warrants for
common and preferred shares, nonvested restricted common shares, and outstanding
stock options from the calculation of historical diluted net loss per common
share because all such securities are anti-dilutive for the periods presented.
The total number of shares excluded from the calculations of diluted net loss
per share were 2,178,846, 14,014,876 and 10,304,502 for the years ended December
31, 2000, 1999 and 1998, respectively (see Notes 3 and 4 for further
information).
(o) Segment Reporting
Effective January 1, 1998, the Company adopted SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information. The Company operates
and manages its business in one segment, that being a software and services
provider to the customer interaction recording and analysis market.
The Company's revenues derived from sources outside of the United States,
primarily in the United Kingdom, Canada and Australia, for the years ended
December 31, 2000 and 1999 were $3.9 million and $1.5 million, respectively.
Prior to 1998, the Company's revenues were earned primarily from customers in
the United States. In addition, all significant long-lived assets are located in
the United States.
(p) Fair Value of Financial Instruments
At December 31, 2000 and 1999, the Company's financial instruments included
cash and cash equivalents, accounts receivables, accounts payable and
borrowings. The fair values of such instruments approximated the carrying values
due to their short-term nature.
F-10
37
(q) Foreign Currency
For certain of the Company's foreign subsidiaries, the functional currency
has been determined to be the local currency, and therefore, assets and
liabilities are translated at year-end exchange rates, and income statement
items are translated at average exchange rates prevailing during the year. Such
translation adjustments are recorded in aggregate as a component of
stockholders' equity (deficit) and other comprehensive income. Gains and losses
from foreign currency denominated transactions are included in other income
(expense) and are not material.
(r) Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, Accounting for Derivative Instruments and Hedging Activities. In June
1999, the FASB issued SFAS No. 137, Accounting for Derivative Instruments and
Hedging Activities -- Deferral of the Effective Date of SFAS No. 133, which
defers the effective date of SFAS No. 133 until fiscal years beginning after
June 15, 2000. In June 2000, the FASB issued SFAS No. 138, Accounting for
Certain Derivative Instruments and Certain Hedging Activities, which amended the
accounting and reporting standards of SFAS No. 133 for certain derivative
instruments and certain hedging activities. The adoption of SFAS No. 133 will
not have a material impact on the Company's results of operations or its
financial position.
In March 2000, the FASB issued Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation ("Interpretation No. 44"),
with an effective date of July 1, 2000. Interpretation No. 44 clarifies guidance
for certain issues that arose in the application of APB Opinion No. 25. The
adoption of Interpretation No. 44 did not have an impact on the Company's
results of operations or financial position.
(2) INVESTMENTS
The amortized cost and fair market value of investments available for sale
as of December 31, 2000, were as follows:
UNREALIZED
-------------------------------
COST GAIN LOSS MARKET
------- ---- ---- -------
(IN THOUSANDS)
Cash and cash equivalents:
Cash................................................. $ 4,502 $-- $ -- $ 4,502
Money market fund.................................... 8,699 -- -- 8,699
Commercial paper..................................... 14,389 -- -- 14,389
Auction rate preferred securities.................... 2,000 -- -- 2,000
------- --- ---- -------
Total cash and cash equivalents.............. $29,590 $-- $ -- $29,590
======= === ==== =======
Short-term investments:
Commercial paper..................................... $14,427 $-- $ -- $14,427
Corporate debt securities............................ 17,883 92 -- 17,975
U.S. Government Agency securities.................... 6,000 5 -- 6,005
------- --- ---- -------
Total short-term investments................. 38,310 97 -- 38,407
Less: Restricted investments......................... (3,660) -- -- (3,660)
------- --- ---- -------
$34,650 $97 $ -- $34,747
======= === ==== =======
At December 31, 2000, the estimated fair market value of investments with
maturity dates ranging from 91 days to one year totaled $32.4 million and
investments with maturity dates ranging from one to two years totaled $6.0
million.
Restricted investments represent the collateral pledged to secure a $3.3
million letter of credit issued in connection with the lease of the Company's
headquarters (Note 10). The letter of credit and restricted investments
contractually decrease over time to zero by May 31, 2007.
F-11
38
(3) REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
(a) Summary of Redeemable Convertible Preferred Stock
During 1997, the Company issued 3,184,000 shares of Series A convertible
preferred stock ("Series A") for $2.145 per share. The holders of Series A
shares were entitled to participation rights and cumulative preferred dividends
(payable at redemption or upon the Company's initial public offering) at $.02145
per share per annum to be paid in Series A shares or cash. From inception date
through the IPO, the Company recorded accretion and dividends due each year to
the Series A stockholders. During 1998, the Company issued 1,181,954 shares of
Series B convertible preferred stock ("Series B") for $4.65 per share, resulting
in net proceeds of $5.5 million. During 1999, the Company issued 1,325,028
shares of Series C convertible preferred stock ("Series C") for $6.30 per share,
resulting in net proceeds of $8.3 million.
From each inception date through the IPO, the Company recorded accretion
equal to the net proceeds received and the redemption amount, as defined through
the contractual redemption date.
In February 2000, upon the closing of the Company's IPO, the holders of the
convertible preferred stock were entitled to convert each share of the Company's
convertible preferred stock converted into 1.8 shares of the Company's common
stock resulting in the issuance of 10,409,978 shares of common stock, of which
166,211 shares represented the conversion of the Series A preferred stock
dividends.
(b) Stock Repurchases
During 1998, the Company entered into a Stock Repurchase Agreement with a
stockholder of the Company, under which the Company repurchased 1,260,000 shares
of the Company's common stock for $1.9 million. These shares were included in
treasury stock as of December 31, 1999 and 1998.
In February 1999, the Company repurchased 648,979 shares of the Company's
common stock in connection with the cancellation of a related note receivable
(Note 3(c)).
In August 1999, the Company entered into Stock Repurchase Agreements with
three directors of the Company, under which the Company repurchased 1,800,000
shares of the Company's common stock for $5.4 million. Such consideration was
paid concurrent with the sale of the Series C convertible preferred stock (Note
3(a)). These shares were included in treasury stock as of December 31, 1999.
In June 2000, all of the treasury stock was retired.
(c) Notes Receivable from Stock Sales
In February 1999, an officer of the Company resigned and the amount of a
note receivable related to vested shares plus all accrued interest was forgiven.
The remainder of the note was canceled in connection with the Company's stock
repurchase of unvested shares (Note 3(b)).
In March 1999, the Company issued 879,763 shares of restricted common stock
to an officer of the Company in exchange for a note receivable of $1.5 million.
In August 1999, an officer of the Company was granted and exercised options to
acquire 112,230 shares of the Company's common stock in exchange for a note
receivable of $334,000. Under the terms of such arrangements, the underlying
restricted stock was fully vested and the maturity dates of the notes are
February 2002 as a result of the Company's IPO.
In August 1999, the Company issued 269,195 shares of common stock (from
treasury shares) to certain officers and directors of the Company in exchange
for individual notes receivable aggregating $800,000. Under the terms of such
arrangements, the maturity dates of the notes are February 2002 as a result of
the Company's IPO.
(d) Warrants
During 1998, the Company granted, in connection with certain of its
long-term debt arrangements, a warrant to purchase 20,000 shares of the
Company's Series B for $4.65 per share that was converted to 36,000
F-12
39
shares of common stock upon the Company's IPO. The fair value of the warrant was
nominal in December 1998. The warrant was exercised in full in October 2000.
During 1999, the Company granted, in connection with certain of its
long-term debt arrangements, a warrant to purchase 117,000 shares of common
stock for $2.58 per share. The warrant vested immediately, expires June 24, 2004
and remained outstanding and exercisable as of December 31, 2000. The fair value
of the warrant, estimated at $198,000 in April 1999, was recorded as a debt
discount and was amortized over the term of the debt. The remaining balance was
written off in connection with the early extinguishment of the related debt
(Note 7).
In September 2000, the Company granted a performance-based warrant to
purchase 10,000 shares of common stock for $19.25 per share. As of December 31,
2000, the performance criteria had not been met and accordingly no compensation
had been recorded. If and when the performance criteria has been met, the
Company will record a charge based on the fair market value at that date.
(e) Stock Split
On December 27, 1999, the Company effected a 1.8-for-1 stock split which
became effective immediately. All common share and per share information has
been adjusted to reflect the stock split as if it had occurred at the inception
of the Company.
(4) EMPLOYEE BENEFIT PLANS
(a) Stock Incentive Plan
Under the 1997 Stock Incentive Plan (the "Stock Plan") the Company's Board
of Directors may grant up to 4,717,440 shares of common stock in the form of
stock options, restricted stock awards, or stock appreciation rights to
employees and key persons affiliated with the Company, as defined in the Stock
Plan document. The Stock Plan remains in effect until the earlier of the tenth
anniversary of its effective date or the date on which all reserved shares have
been issued or are no longer available for use under the Stock Plan. In November
1999, the Company amended the Stock Plan to authorize an additional 1,557,360
shares subject to grant, and adopted a provision to increase, without further
approval required, the number of shares authorized each year beginning on
January 1, 2001 by a number equal to the lesser of 5% of the total number of
shares of common stock then outstanding or 1,800,000 shares. Through December
31, 2000, the Company had issued 1,199,409 shares of restricted common stock. As
of December 31, 2000, 210,855 shares remain available for grant under the Stock
Plan. In July 2000, the Company amended the Stock Plan to provide for
accelerated option vesting terms if the Company undergoes a change in control,
as defined, and there is a significant reduction in each individual's respective
responsibilities as a result of the change in control. To the extent that these
events occur, the Company would have a charge based on the fair market value of
the options at that time.
Options granted under the Stock Plan and approved by the Board of Directors
may be incentive stock options ("ISO"), which qualify for certain tax benefits,
or nonqualified stock options. Only employees are eligible to receive ISOs,
which must be granted at a price not less than the estimated fair value of the
stock on the grant date, or not less than 110% of the estimated fair value if
granted to a participant who is a greater than 10% stockholder of the Company.
Nonqualified stock options may be granted to employees and key persons at a
price that may be greater than, equal to, or less than the estimated fair value
of the stock on the grant date. Option vesting terms are established by the
Board of Directors at the time of grant, and typically range from three to four
years. The expiration date of options granted under the Stock Plan is determined
at the time of grant and may not exceed ten years from the date of the grant for
a non-10% owner of the Company, or five years from the date of the grant in the
case of an ISO granted to a participant who is a greater than 10% owner of the
Company.
During 1999, the Company incurred a deferred stock compensation charge in
the amount of $1.0 million representing the difference between the exercise
price of certain stock option grants for 278,658 shares of common stock with a
weighted-average exercise price of $6.99 per share and the deemed pre-IPO fair
value of
F-13
40
the Company's common stock at the time of such grants which was $11.70 per
share. The compensation is being amortized over the vesting periods, which is
generally four years. For the years ended December 31, 2000 and 1999, the
Company incurred $271,000 and $13,000, respectively, in related charges that
have been classified into their respective department functional areas.
The following summarizes stock option activity:
WEIGHTED-
AVERAGE
NUMBER EXERCISE
OF SHARES PRICE
--------- ---------
Balance at December 31, 1997................................ 868,927 $ 0.12
Granted................................................... 919,854 1.18
Exercised................................................. (89,111) 0.12
Cancelled................................................. (149,476) 0.14
--------- ------
Balance at December 31, 1998................................ 1,550,194 $ 0.74
Granted................................................... 2,039,628 3.26
Exercised................................................. (389,571) 1.11
Cancelled................................................. (318,193) 1.10
--------- ------
Balance at December 31, 1999................................ 2,882,058 $ 2.44
Granted................................................... 1,811,871 11.22
Exercised................................................. (534,724) 1.25
Cancelled................................................. (360,722) 5.76
--------- ------
Balance at December 31, 2000................................ 3,798,483 $ 6.43
========= ======
The following table summarizes information about stock options outstanding
at December 31, 2000:
EXERCISABLE
WEIGHTED- WEIGHTED- --------------------------
AVERAGE AVERAGE WEIGHTED-
RANGE OF NUMBER REMAINING EXERCISE NUMBER AVERAGE
EXERCISE PRICES OUTSTANDING LIFE PRICE OF SHARES EXERCISE PRICE
- --------------- ----------- ---------- --------- --------- --------------
$0.12 - $ 1.42 584,420 7.22 years $ 0.71 281,857 $0.68
$1.43 - $ 4.14 1,073,680 8.28 years 2.12 503,907 1.95
$4.15 - $ 7.50 1,307,195 9.59 years 7.03 67,467 6.25
$7.51 - $38.25 833,188 9.44 years 15.08 57,481 9.77
The weighted-average remaining contractual life of options outstanding at
December 31, 2000 was 8.82 years.
(b) Employee Stock Purchase Plan
The Company's employee stock purchase plan (the "ESPP") became effective
upon the Company's IPO and there are 990,000 shares of common stock reserved.
Under the ESPP, the Company's employees may purchase shares of common stock at a
price per share that is 85% of the lesser of the fair market value as of the
beginning or end of the semi-annual option period. The ESPP includes a provision
to increase, without further approval required, the number of shares authorized
each year beginning on January 1, 2001 by a number equal to the lesser of 2% of
the total number of shares of common stock then outstanding or 900,000 shares.
As of December 31, 2000, 39,167 shares of common stock were issued under the
ESPP.
F-14
41
(c) Accounting for Stock-Based Compensation
The Company applies the provisions of APB Opinion No. 25 in accounting for
its Stock Plan and ESPP and, accordingly, no compensation cost has been
recognized in the accompanying financial statements. Had the Company determined
compensation cost based on the fair value at the grant date for its stock
options and purchase rights under SFAS No. 123, the Company's net loss would
have been increased to the pro forma amounts indicated below (in thousands,
except per share data):
YEAR ENDED DECEMBER 31,
---------------------------
2000 1999 1998
------- ------- -------
Historical net loss....................................... $(2,214) $(7,004) $(4,769)
Pro forma net loss........................................ (7,117) (7,623) (4,830)
Pro forma basic and diluted net loss per share............ (0.36) (1.47) (0.77)
The weighted-average fair value of stock options granted during 2000, 1999,
and 1998 was $10.27, $1.65 and $0.42 per share, respectively, on the date of
grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions: 2000 -- assumed volatility of 120%, expected
dividend yield of 0%, risk-free interest rate of 5.8%, and an expected life of
7.5 years; 1999 -- assumed volatility of 0%, expected dividend yield of 0%,
risk-free interest rate of 6%, and an expected life of 7.28 years,
1998 -- assumed volatility of 0%, expected dividend yield of 0%, risk-free
interest rate of 6%, and an expected life of 7.51 years.
The weighted-average fair value of the employee's purchase rights under the
ESPP granted during 2000 was $10.53 per share, using the Black-Scholes
option-pricing model with the following weighted-average assumptions: for each
of the two six-month periods in 2000 -- assumed volatility of 120%, expected
dividend yield of 0%, and risk-free interest rate of 5.8%.
(d) Retirement Plan
The Company maintains a tax-qualified defined contribution plan under
Section 401(k) of the Internal Revenue Code (the "401(k) Plan"). Employees are
eligible to participate the first of the month following their date of hire. The
401(k) Plan allows participants to contribute by salary reduction up to 20% of
eligible compensation, subject to Internal Revenue Service limitations. The
401(k) Plan also provides for discretionary employer matching contributions. The
Company contributed $204,000 in 2000. No Company contributions were made prior
to 2000.
(5) ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
During 1999, the Company obtained certain in-process research and
development efforts ("IPR&D") for 841,120 shares of the Company's common stock
valued at $4.14 per share. As a result, the Company recorded a charge of $3.5
million in the accompanying consolidated statement of operations. The IPR&D
related to the development of technology to store and retrieve substantially
larger volumes of data than the Company's software was currently capable of
storing and retrieving. At the date of the transaction, the results of the IPR&D
had not progressed to a stage where they met technological feasibility as
defined by SFAS No. 86. During 2000, the development efforts were being
completed according to the Company's initial plans.
F-15
42
(6) OTHER BALANCE SHEET INFORMATION
Accrued expenses consisted of the following:
DECEMBER 31,
----------------
2000 1999
------ ------
(IN THOUSANDS)
Accrued expenses
Accrued wages, salaries, and employee benefits......... $2,974 $2,128
Sales taxes payable.................................... 1,151 1,558
Accrued property and equipment payable................. 1,236 --
Other.................................................. 3,231 1,956
------ ------
$8,592 $5,642
====== ======
(7) LONG-TERM DEBT
Long-term debt consisted of the following:
DECEMBER 31,
----------------
2000 1999
------ ------
(IN THOUSANDS)
Term loan of $2.0 million -- interest payable in monthly
installments at prime plus 2% (10.5% at December 31,
1999), principal payable at earlier of December 31, 2000
or upon an IPO of the Company's equity securities, net of
unamortized discount of $132,500 at December 31, 1999... $ -- $1,909
Equipment loan of $1.0 million -- payable in monthly
principal installments of $41,667, plus interest at prime
plus 2% (10.5% at December 31, 1999) through maturity,
June 30, 2001................................. -- 750
Revolving loan -- the lesser of $4.0 million or 80% eligible
accounts receivable -- interest at prime plus 2% due
monthly through maturity, December 31, 2000... -- --
------ ------
Total long-term debt.............................. -- 2,659
Less current portion........................................ -- 2,409
------ ------
Long-term debt, excluding current portion......... $ -- $ 250
====== ======
In February 2000, the Company used a portion of the proceeds from its IPO
to repay all of its existing borrowings under its financing arrangements. As a
result, the Company incurred an extraordinary loss on the early extinguishment
of debt of $248,000.
(8) OTHER COSTS
During 1999, the Company incurred $315,000 of severance costs for
terminated executives and $350,000 for a bonus and relocation costs in
connection with recruiting a new executive. Such costs were charged to each
department's functional area of the organization accordingly. During 1998, the
Company terminated an agreement with a distributor. The Company agreed to pay
$900,000 in order to terminate the arrangement, all of which was paid by
December 31, 1998.
F-16
43
(9) INCOME TAXES
During 2000, 1999 and 1998, no income taxes were recorded because the
Company reported operating losses with no recognizable benefit. Income tax
expense (benefit) differed from the amounts computed by applying the statutory
U.S. federal income tax rate of 34% to loss before income taxes as a result of
the following (in thousands):
YEAR ENDED
DECEMBER 31,
-------------------------
2000 1999 1998
----- ------- -------
Computed "expected" tax provision (benefit)................. $(753) $(2,381) $(1,621)
Increase (decrease) in income taxes resulting from:
State income taxes, net of federal income taxes........... (54) (269) (191)
Nondeductible meals & entertainment....................... 113 85 29
Other nondeductible items................................. (33) 19 6
Income tax effect attributable to foreign operations at
different rates........................................ 272 -- --
Generation of research and experimentation credit
carryforward........................................... (100) -- (150)
Other, net................................................ 2 (228) (85)
Increase in valuation allowance........................... 553 2,774 2,012
----- ------- -------
$ -- $ -- $ --
===== ======= =======
The income tax effects of temporary differences that give rise to
significant portions of the Company's deferred income tax assets and liabilities
are presented below (in thousands):
DECEMBER 31,
-----------------
2000 1999
------- -------
Deferred income tax assets:
Allowance for bad debts................................... $ 309 $ 175
Accruals not deducted for tax............................. 462 565
Property and equipment, principally due to differences in
Depreciation........................................... 1,886 1,488
Net operating loss and research and experimentation credit
Carryforwards.......................................... 3,478 3,235
------- -------
Total gross deferred income tax assets............ 6,135 5,463
Less valuation allowance.................................. (5,941) (5,388)
------- -------
Net deferred income tax assets.................... 194 75
Deferred income tax liabilities:
Changes in tax accounting method to accrual basis........... -- (75)
Deferred stock compensation................................. (194) --
------- -------
$ -- $ --
======= =======
The net change in the valuation allowance for deferred income tax assets
for 2000, 1999 and 1998 was an increase of $0.5 million, $2.8 million, and $2.0
million, respectively. In assessing the realizability of deferred tax assets,
management considers whether it is more likely than not that some portion or all
of the deferred income tax assets will not be realized. The ultimate realization
of deferred income tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred income tax
liabilities, projected future taxable income, and tax planning strategies in
making this assessment.
At December 31, 2000, the Company has net operating loss and research and
experimentation credit carryforwards for U.S. federal income tax purposes of
approximately $4.6 million and $0.3 million, respectively, which expire in
varying amounts beginning in the year 2014. The Company also has incurred
foreign losses in the amount of approximately $4.0 million, which are available
to offset future taxable income in foreign jurisdictions.
F-17
44
The $4.6 million of the U.S. federal net operating loss carryforwards that
the Company may use to offset taxable income in future years is limited as a
result of an ownership change, as defined under Internal Revenue Code Section
382, which occurred during 2000. Based on the calculated value of the Company
immediately preceding this ownership change, it is anticipated that all of the
U.S. federal net operating losses generated through December 31, 2000 will be
available for carryforward and use against future taxable income in the year
ended December 31, 2001, assuming no further ownership changes.
Losses before income taxes from foreign operations were $3.3 million, $0.7
million and $0 in 2000, 1999 and 1998, respectively. Income (losses) before
income taxes from U.S. operations were $1.0 million, ($6.3) million and ($4.8)
million in 2000, 1999 and 1998, respectively.
(10) COMMITMENTS AND CONTINGENCIES
(a) Leases
The Company adopted a plan to relocate its corporate headquarters to a
larger facility within the Atlanta metropolitan area. The plan called for the
Company to sublet its existing office facilities, which were under
noncancellable leases expiring on June 30, 2002. The plan also identified all
significant actions to be taken. The Company took actions to complete the plan
in a specified amount of time and believes that changes to the plan are not
likely.
The Company estimated that costs associated the noncancellable leases net
of any sublease income would be approximately $525,000. The Company recorded
this obligation during the second quarter of 2000 and allocated such costs to
each departmental functional area of the organization. There have been no
changes to the plan and a balance of $447,000 remained at December 31, 2000
(Note 12).
During July 2000, the Company executed a new lease agreement for its
corporate headquarters with an 86-month term and future minimum lease payments
of $93,000 in 2000, $2.0 million in 2001, $2.2 million in 2002, $2.2 million in
2003, $2.3 million in 2004, $2.3 million in 2005 and $4.6 million thereafter. In
connection with this lease, the Company executed an irrevocable standby letter
of credit in the amount of $3.3 million to secure the lease with a decreasing
schedule that expires on May 31, 2007 (Note 2).
The Company leases its office facilities and office equipment under various
noncancelable operating lease agreements that expire at various times through
2007. Future minimum payments under these leases, are as follows:
DECEMBER 31,
--------------
(IN THOUSANDS)
2001........................................................ $ 3,355
2002........................................................ 2,913
2003........................................................ 2,581
2004........................................................ 2,568
2005........................................................ 2,611
Thereafter.................................................. 4,871
-------
$18,899
=======
The future minimum payments exclude sublease income on noncancelable leases
of $949,000 due in the future. Rent expense for the years ended December 31,
2000, 1999 and 1998 was $2.1 million, $0.7 million, and $0.5 million,
respectively.
(b) Option to Purchase Technology
During 2000, the Company entered into an option agreement to purchase
technology for research and development activities. If the option, which expires
on March 31, 2001, is exercised, the Company will pay $2.0 million to purchase
the technology. As of December 31, 2000, the option's carrying value was
$650,000 and classified as an other asset. If the Company chooses to exercise
the option, the Company may be required
F-18
45
to record a $2.8 million charge in the period exercised depending upon
technological feasibility and alternative future uses at the time of the
exercise.
(11) BUSINESS AND CREDIT CONCENTRATIONS
No customer accounted for more than 10% of the Company's revenue in 2000
and 1999. Two customers accounted for a total of 27% of the Company's revenue in
1998. Total accounts receivable outstanding from these major customers were
approximately $0.1 million at December 31, 1998.
The Company estimates an allowance for doubtful accounts and sales returns
and allowances based on the creditworthiness of its customers, general economic
conditions, and other factors. Consequently, an adverse change in those factors
could affect the Company's estimate of its bad debts.
(12) SUBSEQUENT EVENTS (UNAUDITED)
During the first quarter of 2001, the Company executed two subleases for
its former office facility (Note 10).
In January 2001, the Company executed a second irrevocable standby letter
of credit in the amount of $1.2 million to secure the new office lease with a
decreasing schedule that expires on November 30, 2007. In addition, the Company
executed a $450,000 irrevocable standby letter of credit to secure a furniture
lease that expires on January 4, 2002. The Company's restricted investments
balance increased by $1.5 million as a result of the additional letters of
credit.
F-19
46
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGES TO COSTS CHARGED TO BALANCE AT
BEGINNING OF YEAR AND EXPENSES REVENUES DEDUCTIONS END OF YEAR
----------------- ---------------- ---------- ---------- -----------
Allowance for Doubtful Accounts:
Year ended December 31, 2000.... $438 $544 $ -- $(207) $775
Year ended December 31, 1999.... $300 $226 $ -- $ (88) $438
Year ended December 31, 1998.... $100 $200 $ -- $ -- $300
Sales Concessions:
Year ended December 31, 2000.... $225 $ -- $170 $(166) $229
Year ended December 31, 1999.... $225 $ -- $ 47 $ (47) $225
Year ended December 31, 1998.... $ -- $ -- $225 $ -- $225
Hardware Warranty Reserve:
Year ended December 31, 2000.... $163 $ -- $ -- $ (73) $ 90
Year ended December 31, 1999.... $217 $ -- $ -- $ (54) $163
Year ended December 31, 1998.... $ -- $217 $ -- $ -- $217
F-20
47
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
WITNESS SYSTEMS, INC.
By: /s/ DAVID B. GOULD
------------------------------------
David B. Gould
Chairman of the Board, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities and on
the date indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ DAVID B. GOULD Chairman of the Board, March 28, 2001
- ----------------------------------------------------- President and Chief Executive
David B. Gould Officer
/s/ JON W. EZRINE Chief Financial Officer and March 28, 2001
- ----------------------------------------------------- Assistant Secretary
Jon W. Ezrine
/s/ THOMAS J. CROTTY Director March 28, 2001
- -----------------------------------------------------
Thomas J. Crotty
/s/ JOHN ABRAHAM Director March 28, 2001
- -----------------------------------------------------
John Abraham
/s/ JOEL G. KATZ Director March 28, 2001
- -----------------------------------------------------
Joel G. Katz
/s/ PETER SINISGALLI Director March 28, 2001
- -----------------------------------------------------
Peter Sinisgalli