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[LOGO] MicroMuse_OFC
2001 Annual Report
Micromuse Inc.
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (FEE REQUIRED)
For the Fiscal Year Ended September 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from __________ to ___________.
Commission File No. 000-23783
MICROMUSE INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3288385
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
139 Townsend Street
San Francisco, California 94107
(415) 538-9090
(Address of Principal Executive Office, including ZIP code and telephone number)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
(Title of class)
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 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. [X]
The aggregate market value of the Registrant's common stock, $.01 par value,
held by non-affiliates of the Registrant on November 30, 2001 was approximately
$1.2 billion. As of November 30, 2001, there were 73,760,749 shares of
Registrant's common stock, $.01 par value, outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive proxy statement (the "Proxy Statement") to
be mailed to stockholders in connection with its 2001 annual meeting of
stockholders scheduled to be held in San Francisco, California on Thursday,
January 31, 2002, are incorporated by reference into Part III of this report.
Except as expressly incorporated by reference, the Registrant's Proxy Statement
shall not be deemed to be part of this report.
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MICROMUSE INC.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business............................................................................. 3
Item 2. Properties........................................................................... 10
Item 3. Legal Proceedings.................................................................... 10
Item 4. Submission of Matters to a Vote of Security Holders.................................. 10
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters............ 11
Item 6. Selected Financial Data.............................................................. 12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
Item 7a. Quantitative and Qualitative Disclosures About Market Risk........................... 30
Item 8. Financial Statements and Supplementary Data.......................................... 31
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures 48
PART III
Item 10. Directors and Executive Officers of the Registrant................................... 48
Item 11. Executive Compensation............................................................... 49
Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 49
Item 13. Certain Relationships and Related Transactions....................................... 49
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K...................... 49
Signatures 50
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PART I
This document contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from the
results discussed in such forward-looking statements. Factors that might cause
such differences include, but are not limited to, fluctuations in customer
demand, the Company's ability to manage its growth, risks associated with
competition and risks identified in the Company's Securities and Exchange
Commission filings, including, but not limited to, those discussed elsewhere in
this Form 10-K under the heading "Risk Factors" located at the end of Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, of this Form 10-K.
Item 1. Business
Micromuse develops, markets and supports a family of scalable, highly
configurable, rapidly deployable software solutions that enable service and
business assurance -- the effective monitoring of the status of multiple
devices and elements underlying an Information Technology (IT) service delivery
infrastructure, to help provide the continuous availability of IT-based
services and businesses. The Micromuse Netcool(R) product suite collects,
normalizes and consolidates high volumes of event information from
heterogeneous network management environments into an active database that
de-duplicates and correlates the resulting data in real-time. It then rapidly
distributes graphical views of the information to operators and administrators
responsible for monitoring service levels. Netcool's unique architecture allows
for the rapid, programmerless association of devices and specific attributes of
those devices to the business services they impact. This readily enables
network operations teams to create and modify their service views during
systems operations to monitor particular business services, rapidly identify
which users are affected by which network faults, pinpoint sources of network
problems, automate operator responses, facilitate problem resolution and report
on the results.
We market and distribute to customers through our own sales force, OEMs,
value-added resellers and systems integrators. We have distribution agreements
with Cisco Systems, Ericsson Data Services, Nortel, Siemens, Unisphere and Sun
Microsystems. As of September 30, 2001, we had licensed our software to nearly
1,300 customers operating in and serving a variety of industries. Micromuse
customers include AT&T, BT, Cable & Wireless, Cellular One, Charles Schwab,
Deutsche Telekom, Digex, EarthLink, GE Appliances, ITC^DeltaCom, J.P. Morgan
Chase, One2One and Verizon.
Micromuse operates as a single operating segment, and further geographic and
segment information is included in Note 7 "Geographic and Segment Information"
of the Notes to Consolidated Financial Statements included in this Form 10-K.
Micromuse was founded in 1989 in London, England, and in 1997 reorganized as a
Delaware corporation and re-located its headquarters to San Francisco,
California.
Products and Technology
Micromuse provides a suite of software products that provide realtime fault
management, which enables service and business assurance. Our Netcool solutions
include the flagship Netcool/OMNIbus(TM) application, which collects,
consolidates, de-duplicates and correlates information from more than 300
network management platforms and devices and presents realtime
user-configurable views of faults, network, service and business status. The
application allows network operations personnel to react to problems in the
network infrastructure before they cause outages in service availability and/or
to identify outages and their probable causes. These capabilities enable
network managers to improve the reliability and functionality of their
networks, thereby enhancing operating efficiencies, productivity and
profitability of network operators and users. The components of Netcool/OMNIbus
are described in the section entitled "Netcool/OMNIbus Components."
Micromuse also provides enhanced applications that work in conjunction with
the Netcool/OMNIbus application. These include the Netcool/Service Monitors(TM)
suite, the Netcool/Reporter(TM) application, the Netcool/Impact(TM)
application, the Netcool/Visionary(TM) application, and Netcool/Precision(TM)
application.
The Netcool/Service Monitors suite not only manages network and system
devices, but also looks at service and application availability from the
customer's perspective. It monitors the following
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applications and services over fixed line and wireless infrastructures:
eCommerce applications, eMail services, Wireless services, Service
infrastructure, and bandwidth/usage.
The Netcool/Reporter(TM) application takes Netcool/OMNIbus data and
provides historical reports on events occurring within a network
infrastructure.
The Netcool/Impact application facilitates policy-based management and
helps determine how Netcool/OMNIbus-collected faults will impact the
availability of services.
The Netcool/Visionary application facilitates network problem diagnosis.
The Netcool/Precision application, which includes the patented Network
Slice(TM) technology, provides network inventory, network discovery and
network topology functions.
In addition, the Netcool suite includes a targeted series of software
"applications." These proactively collect network and service status
information from the following environments:
. Voice switches and services - Netcool/Telco Service Managers(TM) suite
. Mainframe management systems - Netcool/Data Center Monitors(TM) suite
. Security management - Netcool/Firewall(TM) application
Netcool/OMNIbus Components
Netcool/OMNIbus is based on an open, client/server architecture. It consists
of four primary components: the Netcool ObjectServer(TM), which is at the heart
of the architecture; Netcool Probes & Monitors(TM); Netcool Desktops(TM); and
Netcool Gateways(TM).
Netcool Probes & Monitors collect fault information from network element
management systems, network devices, computing systems, applications or legacy
systems. Netcool Probes & Monitors then normalize and consolidate this data
into the Netcool ObjectServer, a high-speed, memory-resident database,
optimized for realtime fault monitoring and building views of network status
and service availability. By manipulating the data in the Netcool ObjectServer,
Netcool Desktop users can design customized views of event data to monitor
segments of the network or services that span the entire network. Netcool
Gateways permit data to be shared between multiple ObjectServers for load
balancing or fail-over facilities, exported to common relational database
management systems (Oracle, Sybase, etc.) for historical service level views,
or integrated with other applications such as helpdesk applications (Remedy,
Clarify, etc.).
Netcool ObjectServer(TM)
The Netcool ObjectServer is a realtime, object-oriented, memory-resident,
active database that stores and manages the collected network faults and
service status data. The Netcool ObjectServer consolidates, associates and
de-duplicates normalized data from the Netcool Probes & Monitors, converting
events, such as faults and alarms, into event objects that can be easily
manipulated to create associations and filters. The active components of the
Netcool ObjectServer include its de-duplication capability and its ability to
correlate event objects with other event objects, make decisions on
information, automate operator responses and facilitate problem resolution. The
Netcool ObjectServer, which has been designed and optimized for handling large
volumes of events messages, can process hundreds of alarms per second and can
collect data from multiple Netcool Probes concurrently. The Netcool
ObjectServer architecture also permits multiple authenticated users to view all
the events throughout the enterprise. In addition, since one network fault can
impact several locations in a distributed environment and can therefore trigger
multiple events, the Netcool ObjectServer is designed to automatically
de-duplicate repeated events so that network operators can easily identify the
root cause. The Netcool ObjectServer architecture provides us with a
competitive advantage in both the speed with which it collects network events
and the ability to associate event information with the services it manages.
Netcool Probes & Monitors(TM)
Netcool Probes are passive supersets of software code that collect network
event data (including messaged network data such as faults, alerts, and traps)
from elements on the network or from domain-based network
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management systems. These Probes can collect information presented from either
management platforms or devices (i.e. HP OpenView, Aprisma Management
Technologies SPECTRUM, Cisco StrataView Plus, and Newbridge 46020) and standard
protocols such as screen-oriented ASCII character streams, application log
files (i.e. Syslog) TL1, SNMP, and most other methods of management information
provision. They recognize Management Information Base information from switches
and routers from leading vendors, including Nortel, Lucent, Cisco, and 3Com.
Netcool Probes use rules and lookup tables to categorize and add information to
events. As a result, network data collected by the Netcool Probes is normalized
into a common alert format and then passed to the Netcool ObjectServer. As
described in the previous section, Netcool Monitors provide more active,
intelligent service and status monitoring.
Netcool Desktops
The Netcool Desktop is an integrated suite of software tools designed for
use by operators and administrators to create filters, customize views of
network event data, monitor several services simultaneously, and automatically
resolve service problems. Network operators can quickly build filters by
responding to simple onscreen queries about user preferences. Operators can
also associate events with services through the use of simple "drag-and-drop"
technology that automatically creates the Boolean logic and software query
language required to retrieve the data from the Netcool ObjectServer. In this
way, non-programmers can manipulate the data in the Netcool ObjectServer to
custom-design views of event data. In addition, each operator can use Netcool
Desktops to resolve element problems directly or automate responses to common
network problems when critical thresholds are reached.
Operators can use Netcool Desktops to monitor services through Netcool
EventLists(TM), Netcool EventList dashboards summary or Netcool maps. The
Netcool EventList presents a configurable spreadsheet-like view of the
de-duplicated faults and acts as the primary interface through which operators
access problem resolution tools. The Netcool EventList dashboard summary
depicts a concise view of the EventLists for several services while the Netcool
map provides a graphical view of the network or services that depend upon it.
Administrators can use Desktops to configure the Netcool ObjectServer and the
operator's Netcool Desktop environment. Netcool Desktops run on multiple
platforms, including Web Browsers, UNIX/ Motif, and Microsoft Windows NT.
Netcool Gateways
Netcool Gateways are interfaces to third-party applications that allow
sharing of Netcool event data. For example, Netcool ObjectServer data can be
exported through Netcool Gateways to databases such as Oracle or Sybase for
historical analysis and reporting or to trouble-ticketing packages such as
Remedy's trouble-ticketing application. In addition, multiple Netcool
ObjectServers can share data using a Netcool Gateway to offer customers
load-balancing and fail-over facilities.
Sales and Marketing
We market our software and services primarily through our direct sales
organization with American offices in Atlanta, Chicago, Dallas, Minneapolis,
New York, San Francisco, and McLean, Virginia; and international offices in
Australia, Austria, Brazil, China, France, Germany, Italy, Japan, Mexico, the
Netherlands, Poland, Singapore, South Korea, Spain, Taiwan, the United Arab
Emirates, and the United Kingdom, among other places. Additionally, we have a
growing channel consisting of OEMs, value-added resellers and systems
integrators.
Typically, the sales process will include an initial sales presentation, a
product demonstration, at times a proof of concept evaluation, a closing
meeting and a purchase process. The sales process typically takes one to three
months, although we have experienced longer and less predictable cycles.
Companies often purchase Netcool products to manage their internal data network
initially and upon its demonstrated effectiveness subsequently make additional
and larger purchases. A majority of our sales are from repeat customers who
generally purchase additional software as their networks expand, or as
additional sites within a customer learn of the services provided by, and the
benefits of, Netcool.
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We have a number of marketing programs designed to inform potential
customers about the capabilities and benefits of our products. Our marketing
efforts include investing in our technical leadership, participation in
industry trade shows, technical conferences and technology seminars,
preparation of competitive analyses, analyzing returns on investment in our
software, sales training, publication of technical and educational articles in
industry journals and advertising.
Although we increased the size of our sales organization during the year
ended September 30, 2001, we experienced difficulty in recruiting a sufficient
number of highly qualified and effective sales people during that period. If we
are to achieve significant revenue growth in the future, we must successfully
train our existing sales force and recruit additional premier sales personnel
and increase their productivity. Competition for such individuals is intense,
and there can be no assurance that we will be able to either retain and
adequately train our current sales force or attract qualified sales personnel
in the future. If we are unable to hire such people and make them productive on
a timely basis, our business, operating results or financial condition would be
adversely affected. See "Risk Factors -- We need to continue to expand and
improve the productivity of our sales force and our technical services and
customer support organization."
To achieve significant growth in revenues in the future we must continue to
expand and improve the performance of our network of distribution partners. Our
network of distribution partners currently includes VARs, systems integrators
and OEM partners, including Cisco, Ericsson Data Services, Nortel, Siemens,
Unisphere and Sun Microsystems. These partners license our products at a
discount to list price for re-licensing and may provide training, support and
technical and customer services to the end users of the our products. At times,
members of our technical services organization will assist a channel partner
with training and technical support. We offer a comprehensive
channel-partnering program consisting of training, certification, technical
support, priority communications regarding upcoming activities and products,
and joint sales and marketing activities. There can be no assurance that we
will be able to continue to attract and retain VARs, systems integrators and
OEMs or that such organizations will be able to market and sell our products
effectively. In addition, there can be no assurance that our existing or future
channel partners will continue to represent our products. See "Risk Factors --
We need to continue to expand our distribution channels and retain our existing
third-party distributors."
In part, because we first sold our software in the United Kingdom and were
previously domiciled in London, sales of our software outside of the United
States (i.e., "international sales") have historically comprised a significant
portion of our total revenue. International sales accounted for 39%, 36% and
29% of total revenues in fiscal 2001, 2000 and 1999, respectively. We believe
that a majority of these international sales were made to customers in the
United Kingdom, France and Germany. While we believe there are significant
opportunities in Europe, we expect international revenues from Europe as a
percentage of total revenues to decline in future periods as we more fully
exploit opportunities in the United States and in the Pacific Rim. See "Risk
Factors -- Our international sales and operations expose us to currency
fluctuation risks and other inherent risks."
Technical Services
Our technical services organization provides customers with a broad range of
support services including pre-sales demonstrations, evaluations,
implementations, consulting services, training and ongoing technical support.
In addition, the technical services organization serves a variety of internal
functions, including drafting support and training documentation, product
management, product testing, research and development related to specific
customer industries.
Our recent growth and the expansion of the customer base of Netcool have
increased the demands on our technical services organization. Competition for
qualified technical personnel is intense. There can be no assurance that the
current resources in our technical services organization will be sufficient to
manage any future growth in our business. The failure to expand our technical
services organization at least commensurate with the expansion in the installed
base of Netcool products would have a material adverse effect on our business,
operating results and financial condition. See "Risk Factors--We need to
continue to expand and improve the
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productivity of our sales force and our technical services and customer support
organization" and "We depend on our key personnel, and the loss of any of our
key personnel could harm our business."
Customer Support
The customer support organization is responsible for providing ongoing
technical support for our customers after implementation of the product and for
training the next generation of our software engineers and technical services
personnel. Based on feedback by customers, we believe that the quality and
responsiveness of our customer support organization provides it with a
significant competitive advantage.
For an annual maintenance fee, a customer will receive toll-free telephone
and email support, as well as certain new releases of our products. We offer
two support packages to our customers: 8 hours a day, 5 days a week support or
24 hours a day, 7 days a week support. While support personnel generally answer
the technical support calls and resolve most problems over the phone, we will
deploy one of our technical support personnel in the event that an on-site
visit is necessary. As our installed base of Netcool customers has grown,
revenue from maintenance fees has grown. Due to more recent general economic
and specific customer factors and the reliability of our products, some
customers have chosen to reduce or forego their maintenance coverage. We are
implementing initiatives to counter these trends but there can be no assurance
that maintenance revenue will continue at its current level or will continue
its historic growth. The failure to grow maintenance revenue would have a
material adverse impact on our business results and financial condition.
Research and Development
We believe that our future success depends in large part on our ability to
continue to enhance existing products and develop new products that maintain
technological and operational competitiveness and leadership and deliver a
rapid ROI to our customers. We have historically developed and expect to
continue to develop our products in conjunction with our existing and potential
customers. Extensive product development input is obtained through customers,
through our monitoring of end-user needs and changes in the marketplace and
through partnerships with leading research institutes such as Cambridge
University Centre for Communication Systems Research.
Our research and development organization is composed of two related
engineering groups. The core technology group is responsible for the
enhancement of Netcool/OMNIbus, including our real-time technologies and the
exploration of new directions and applications of our core ObjectServer, Probe,
Gateway and Desktop technologies. The application development group is
responsible for designing and developing off-the-shelf products that leverage
the technologies developed by the core technology group. While both groups work
closely with customers, the application development group depends on customer
contact and partnerships for the rapid development of new Fault and Service
Level Management products. Both research and development groups work closely
with our technical services organization and our marketing organization to
incorporate customer feedback and market requirements into their product
development agendas.
We have made and intend to continue to make substantial investments in
research and development. Our total expenses for research and development,
exclusive of purchased research and development costs, for fiscal 2001, 2000
and 1999 were $33.8 million, $19.1 million and $9.5 million, respectively.
Since we anticipate that we will continue to commit substantial resources to
research and development in the future, product development expenses are
expected to increase in absolute dollars in future periods. To date, our
development efforts have not resulted in any capitalized software development
costs.
The market for our products is characterized by rapidly changing
technologies, evolving industry standards, changing regulatory environments,
frequent new product introductions and rapid changes in customer requirements.
The introduction or announcement of products by the Company or our competitors
embodying new technologies and the emergence of new industry standards and
practices can render existing products obsolete
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and unmarketable. As a result, the life cycles of our products are difficult to
estimate. Our future success will depend on our ability to enhance our existing
products and to develop and introduce, on a timely and cost- effective basis,
new products and product features that keep pace with technological
developments and emerging industry standards and that address the increasingly
sophisticated needs of our customers. There can be no assurance that we will be
successful in developing and marketing new products or product features that
respond to technological change or evolving industry standards, that we will
not experience difficulties that could delay or prevent the successful
development, introduction and marketing of these new products and features, or
that our new products or product features will adequately meet the requirements
of the marketplace and achieve market acceptance. In addition, to the extent
that any product upgrade or enhancement requires extensive installation and
configuration, current customers may postpone or forgo the purchase of new
versions of our products. If we are unable, for technological or other reasons,
to develop and introduce enhancements of existing products or new products in a
timely manner, our business, operating results and financial condition will be
materially adversely affected. See "Risk Factors--Rapid technological change,
including evolving industry standards and regulations and new product
introductions by our competitors, could render our products obsolete" and "Our
products operate on third-party software platforms, and we could lose market
share if our products do not operate on the hardware and software operating
platforms employed by our customers." In addition, software products as complex
as ours may contain defects or failures when introduced or when new versions or
enhancements are released. For example, the initial commercial release of
Netcool/Reporter had features and performance characteristics that had limited
market appeal. See "Risk Factors -- If we ship products that contain defects,
the market acceptance or our products and our reputation will be harmed, and
our customers could seek to recover their damages from us."
Competition
As noted above, our products are designed for use in the evolving business
and service assurance and enterprise network management markets. Competition in
these markets is intense and is characterized by rapidly changing technologies,
new and evolving industry standards, frequent new product introductions and
rapid changes in customer requirements. Our current and prospective competitors
offer a variety of solutions to address the SLM (Service Level Management) and
enterprise network management markets and generally fall within the following
five categories: (i) customer's internal design and development organizations
that produce SLM and network management applications for their particular
needs, in some cases using multiple instances of products from hardware and
software vendors such as Sun Microsystems, Inc. ("Sun") and Hewlett-Packard
Company ("HP"); (ii) vendors of network and systems management frameworks
including Computer Associates International, Inc. ("CA") and International
Business Machines Corporation ("IBM"); (iii) vendors of network and systems
management applications including HP, BMC Software, Inc, Sun and IBM; (iv)
providers of specific market applications; and (v) systems integrators serving
the telecommunications industry which primarily provide programming services to
develop customer specific applications including TCSI Corporation, Telcordia
and Agilent. In the future, as we enter new markets, we expect that such
markets will have additional, market-specific competitors. In addition, because
there are relatively low barriers to entry in the software market, we have
become aware of new and potential entrants in portions of our market space and
we expect additional competition from these and other established and emerging
companies. Increased competition may result in price reductions and may result
in reduced gross margins and loss of market share, any of which could
materially adversely affect our business, operating results or financial
condition.
Some of our existing and potential customers and distributors continuously
evaluate whether to design and develop their own network operations support and
management applications or purchase them from outside vendors. Sometimes these
customers internally design and develop their own software solutions for their
particular needs and therefore may be reluctant to purchase products offered by
independent vendors such as ours. As a result, we must continuously educate
existing and prospective customers as to the advantages of our products versus
internally developed network operations support and management applications.
Many of our current and potential competitors have longer operating
histories and have significantly greater financial, technical, sales, marketing
and other resources, as well as greater name recognition and a larger
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customer base, than we do. As a result, they may be able to devote greater
resources to the development, promotion, sale and support of their products or
to respond more quickly to new or emerging technologies and changes in customer
requirements than we can. Existing competitors could also increase their market
share by bundling products having management functionality offered by our
products with their current applications. Moreover, our current and potential
competitors may increase their share of the Fault and Service Level Management
market by strategic alliances and/or the acquisition of competing companies. In
addition, network operating system vendors could introduce new or upgrade and
extend existing operating systems or environments that include management
functionality offered by our products, which could render our products obsolete
and unmarketable. There can be no assurance that we will be able to compete
successfully against current or future competitors or that competitive
pressures faced by us will not materially adversely affect our business,
operating results or financial condition.
Intellectual Property and Other Proprietary Rights
Our success and ability to compete is significantly dependent upon our
proprietary software technology. We rely on a combination of trade secret,
copyright, patent and trademark laws, nondisclosure and other contractual
agreements and technical measures to protect our proprietary rights. Despite
our efforts to protect our proprietary rights, unauthorized parties may attempt
to copy aspects of our products or to obtain and use information that we regard
as proprietary. There can be no assurance that the steps taken by us to protect
our proprietary technology will prevent misappropriation of such technology,
and such protections may not preclude competitors from developing products with
functionality or features similar to our products. In addition, effective
copyright and trade secret protection may be unavailable or limited in certain
foreign countries. While we believe that our products and trademarks do not
infringe upon the proprietary rights of third parties, there can be no
assurance that we will not receive future communications from third parties
asserting that our products infringe, or may infringe, the proprietary rights
of third parties. We expect that software product developers will be
increasingly subject to infringement claims as the number of products and
competitors in our industry segment grows and the functionality of products in
different industry segments overlaps. Any such claims, with or without merit
could be time-consuming, result in costly litigation and diversion of technical
and management personnel, cause product shipment delays or require us to
develop non-infringing technology or enter into royalty or licensing
agreements. Such royalty or licensing agreements, if required, may not be
available on terms acceptable to us or at all. In the event of a successful
claim of product infringement against us and our failure or inability to
develop non-infringing technology or license the infringed or similar
technology, our business, operating results or financial condition could be
materially adversely affected.
We rely on certain software that we license from third parties, including
software that is integrated with internally developed software and used in our
products to perform key functions. There can be no assurance that these
third-party software licenses will continue to be available to us on
commercially reasonable terms or at all. Although we believe alternative
software is available from other third-party suppliers, the loss of or
inability to maintain any of these software licenses or the inability of the
third parties to enhance in a timely and cost-effective manner their products
in response to changing customer needs, industry standards or technological
developments could result in delays or reductions in our product shipments
until equivalent software could be developed internally or identified, licensed
and integrated, which would have a material adverse effect on our business,
operating results and financial condition. See "Risk Factors -- Our efforts to
protect our intellectual property may not be adequate, or a third-party could
claim that we are infringing its proprietary rights" and "We rely on software
that we have licensed from third-party developers to perform key functions in
our products."
Employees
As of September 30, 2001, we had 742 employees. None of our employees are
represented by a collective bargaining agreement, nor have we experienced work
stoppages. We believe that our relations with our employees are good.
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We believe that our future success will depend in large part on our ability
to attract and retain highly skilled managerial, sales, technical services,
customer support and product development personnel. We have at times
experienced and continue to experience difficulty in recruiting and retaining
qualified personnel. Competition for qualified personnel in the software
industry is intense, and there can be no assurance that we will be successful
in attracting and retaining such personnel. Failure to attract and retain key
personnel could materially adversely affect our business, operating results or
financial condition. See "Risk Factors -- Failure to manage our growth may
adversely affect our business; Failure to improve our infrastructure may
adversely affect our business; We need to continue to expand and improve the
productivity of our sales force and our technical services and customer support
organization; and We depend on our key personnel, and the loss of any of our
key personnel could harm our business."
Item 2. Properties
Our headquarters are located in approximately 21,935 square feet of office
space in San Francisco, under a lease that expires in January 2008. Our
principal product development operations as well as our European headquarters
are located in approximately 30,077 square feet of office space in London
pursuant to a lease that expires in April 2009. We also maintain offices in
Atlanta; Chicago; Dallas; New York; McLean, Virginia; Beijing; Dubai;
Eindhoven; Frankfurt; Hong Kong; Madrid; Mexico; Milan; Paris; Sao Paulo;
Seoul; Singapore; Sydney; Taipei; Tokyo; Vienna and Warsaw. We believe that our
current facilities are adequate for our needs through the next twelve months,
and that, should it be needed, suitable additional space will be available to
accommodate expansion of our operations on commercially reasonable terms,
although there can be no assurance in this regard.
Item 3. Legal Proceedings
The Company is routinely involved in legal and administrative proceedings in
the ordinary course of its business. Management does not regard any of those
proceedings to be material.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders during the
fourth quarter of the fiscal year ended September 30, 2001.
10
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
Price Range of Common Stock
Our common stock is traded publicly on the Nasdaq National Market under the
symbol "MUSE." The following table sets forth for the quarterly periods
indicated the high and low closing prices of the common stock for the last two
fiscal years:
Fiscal 2001 Fiscal 2000
---------------- ----------------
High Low High Low
-------- ------- -------- -------
September 30 $ 26.500 $ 5.680 $105.000 $56.313
June 30..... 51.110 23.660 82.750 31.000
March 31.... 86.750 28.600 103.000 36.422
December 31. 106.219 38.375 45.625 15.688
The share prices above are adjusted for the two-for-one stock split
effective February 2000, and the two-for-one stock split effective December
2000.
On November 30, 2001, the closing price of the common stock on the Nasdaq
National Market was $15.875 per share. As of November 30, 2001, there were
approximately 117 holders of record of the common stock.
Dividend Policy
We did not declare or pay any cash dividends on our capital stock during
fiscal 2001, 2000 and 1999 and do not expect to do so in the foreseeable
future. We anticipate that all future earnings, if any, generated from
operations will be retained by us to develop and expand our business. Any
future determination with respect to the payment of dividends will be at the
discretion of the Board of Directors and will depend upon, among other things,
our operating results, financial condition and capital requirements, the terms
of then-existing indebtedness, general business conditions and such other
factors as the Board of Directors deems relevant.
11
Item 6. Selected Financial Data
Consolidated Statements of Operations Data:
(In thousands, except per share amounts)
Year ended September 30,
--------------------------------------------
2001 2000 1999 1998 1997
-------- -------- ------- ------- -------
Revenues:
License.............................................. $148,214 $ 90,763 $43,692 $22,432 $ 6,968
Maintenance and services............................. 64,294 32,770 14,378 5,829 2,324
-------- -------- ------- ------- -------
Total revenues................................... 212,508 123,533 58,070 28,261 9,292
Cost of revenues:
License.............................................. 8,225 4,998 2,379 1,320 523
Maintenance and services............................. 25,101 15,554 7,465 3,491 1,042
-------- -------- ------- ------- -------
Total cost of revenues........................... 33,326 20,552 9,844 4,811 1,565
-------- -------- ------- ------- -------
Gross profit.................................. 179,182 102,981 48,226 23,450 7,727
-------- -------- ------- ------- -------
Operating expenses:.....................................
Sales and marketing.................................. 91,797 54,039 27,420 15,710 8,970
Research and development............................. 33,768 19,117 9,453 5,535 2,042
General and administrative........................... 18,455 11,104 5,998 4,521 4,244
Purchased in-process research and development........ -- 11,406 -- -- --
Amortization of goodwill and purchased intangible
assets............................................. 11,068 5,737 -- -- --
Executive recruiting costs........................... -- -- 720 -- --
-------- -------- ------- ------- -------
Total operating expenses......................... 155,088 101,403 43,591 25,766 15,256
-------- -------- ------- ------- -------
Income (loss) from operations................. 24,094 1,578 4,635 (2,316) (7,529)
-------- -------- ------- ------- -------
Other income (expense):
Interest income...................................... 7,112 4,762 3,480 1,840 64
Interest expense..................................... -- -- (341) (312) (1,268)
Other................................................ 74 401 952 100 (200)
-------- -------- ------- ------- -------
Income (loss) before income taxes................ 31,280 6,741 8,726 (688) (8,933)
Income taxes............................................ 10,011 8,835 840 150 --
-------- -------- ------- ------- -------
Income (loss) from continuing operations............. 21,269 (2,094) 7,886 (838) (8,933)
Discontinued operations:
Income (loss) from discontinued operations........... -- -- -- -- (104)
Gain on disposition.................................. -- -- -- -- 1,161
-------- -------- ------- ------- -------
Net income (loss)................................ 21,269 (2,094) 7,886 (838) (7,876)
Accretion on redeemable convertible preferred stock..... -- -- -- (1,334) (755)
-------- -------- ------- ------- -------
Net income (loss) applicable to holders of common
stock.............................................. $ 21,269 $ (2,094) $ 7,886 $(2,172) $(8,631)
======== ======== ======= ======= =======
Per share data:
Basic net income (loss) from continuing operations
applicable to holders of common stock.............. $ 0.29 $ (0.03) $ 0.12 $ (0.05) $ (0.38)
Diluted net income (loss) from continuing operations
applicable to holders of common stock.............. $ 0.27 $ (0.03) $ 0.11 $ (0.05) $ (0.38)
Basic net income (loss) applicable to holders of
common stock....................................... $ 0.29 $ (0.03) $ 0.12 $ (0.05) $ (0.34)
Diluted net income (loss) applicable to holders of
common stock....................................... $ 0.27 $ (0.03) $ 0.11 $ (0.05) $ (0.34)
Weighted average shares used in computing:
Basic net income (loss) per share applicable to
holders of common stock............................ 72,500 68,586 63,636 47,176 25,492
Diluted net income (loss) per share applicable to
holders of common stock............................ 78,758 68,586 70,016 47,176 25,492
12
Consolidated Balance Sheet Data:
(In thousands)
As of September 30,
-----------------------------------------
2001 2000 1999 1998 1997
-------- -------- ------- ------- -------
Cash and cash equivalents............. $138,581 $ 83,679 $35,058 $22,798 $13,741
Working capital....................... 127,956 96,847 62,991 58,193 13,181
Total assets.......................... 273,638 197,011 90,605 80,644 22,740
Redeemable convertible preferred stock -- -- -- -- 22,865
Total stockholders' equity (deficit).. 200,181 152,523 70,006 67,718 (7,234)
Quarterly Financial Data:
(In thousands, except per share amounts)
4th 3rd 2nd 1st
Quarter Quarter Quarter Quarter
Fiscal 2001: ------- ------- ------- -------
Revenues............................ $40,031 $63,335 $59,322 $49,820
Gross profit........................ 33,251 53,477 49,930 42,524
Income (loss) from operations....... (192) 9,647 8,648 5,991
Net income.......................... 976 7,863 6,961 5,469
Diluted net income per share........ $ 0.01 $ 0.10 $ 0.09 $ 0.07
4th 3rd 2nd 1st
Quarter Quarter Quarter Quarter
Fiscal 2000: ------- ------- ------- -------
Revenues............................ $41,131 $32,932 $27,139 $22,331
Gross profit........................ 34,590 27,337 22,565 18,489
Income (loss) from operations....... 3,908 3,185 2,420 (7,935)
Net income (loss)................... 2,527 2,442 1,529 (8,592)
Diluted net income (loss) per share. $ 0.03 $ 0.03 $ 0.02 $ (0.13)
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with
"Selected Financial Data" and our Consolidated Financial Statements and Notes
thereto included elsewhere in this Form 10-K. This document contains
forward-looking statements that involve risks and uncertainties. Our actual
results may differ materially from the results discussed in such
forward-looking statements. Factors that might cause such differences include,
but are not limited to, fluctuations in customer demand, our ability to manage
our growth, risks associated with competition and risks identified in our most
recent Securities and Exchange Commission filings, including, but not limited
to, those discussed in this Form 10-K under the heading "Risk Factors."
Overview
Micromuse Inc. develops, markets and supports a family of scalable, highly
configurable, rapidly deployable software solutions that enable fault
management and service assurance. The Company was founded in 1989 in London,
England, and initially operated a systems integration business, reselling
computer hardware and software products and providing consulting services,
principally for managing networks. Leveraging our expertise in network
management, we developed our Netcool/OMNIbus software, which we began shipping
in January 1995. In March 1997, the Company was reorganized in Delaware and
relocated its headquarters from London to San Francisco. In connection with the
reorganization, we raised $4.9 million through the sale of equity securities
and arranged a $3.0 million credit facility. In September 1997, we raised an
additional $15.9 million through the sale of equity securities and sold our
systems integration business for approximately $0.4 million, net of fees. In
order to further the growth of the Netcool business, we completed an initial
public offering ("IPO") of common stock on February 12, 1998, raising
approximately $34.2 million, net of fees and expenses. With the
13
proceeds from the financings and the sale of the systems integration business,
we expanded operations and substantially increased development, sales and
administrative headcount for the Netcool business. On July 28, 1998, we
completed a follow-on offering of common stock, raising approximately $22.9
million, net of fees and expenses. To accommodate recent growth, to compete
effectively and manage future growth, if any, we will be required to continue
to implement and improve operational, financial and management information
systems, procedures and controls on a timely basis and to expand, train,
motivate and manage our workforce.
All of our revenues have been derived from licenses for our Netcool family
of products and related maintenance, training and consulting services. We
currently expect that Netcool-related revenues will continue to account for all
or substantially all of our revenues for the foreseeable future. As a result,
our future operating results are dependent upon continued market acceptance of
our Netcool products and enhancements thereto.
As of September 30, 2001, we had licensed our Netcool products to nearly
1,300 customers worldwide. We license our software through our direct sales
force, OEMs and value-added resellers. License revenues from OEMs and resellers
combined, which are recognized upon the shipment to the OEMs and value-added
resellers, accounted for approximately 42%, 34% and 34% of our total license
revenues for fiscal 2001, 2000 and 1999, respectively. Our ability to achieve
significant additional revenue growth in the future will depend substantially
on our success in recruiting and training sufficient sales and technical
services personnel, maintaining our current distribution relationships and
establishing additional relationships with OEMs, resellers and systems
integrators.
As a result of our multinational operations and sales, our operating results
are subject to significant fluctuations based upon changes in the exchange
rates of certain currencies, particularly the British pound, in relation to the
U.S. dollar. For example, while our United States headquarters is located in
San Francisco, California, our principal product development operations are
located in London, England. As a result, a substantial portion of our costs and
expenses are denominated in currencies other than the U.S. dollar. For the
fiscal years ended September 30, 2001, 2000 and 1999, license, maintenance and
service revenues outside of the United States accounted for 39%, 36% and 29% of
our total revenues, respectively. See Note 7 "Geographic and Segment
Information" of Notes to Consolidated Financial Statements. Although we will
continue to monitor our exposure to currency fluctuations, there can be no
assurance that exchange rate fluctuations will not have a material adverse
effect on our business and operating results.
14
Results of Operations
The following table sets forth certain items in our consolidated statements
of operations as a percentage of total revenues, except as indicated:
Year ended September 30,
----------------------
2001 2000 1999
As a Percentage of Total Revenues: ----- ----- -----
Revenues:
License.................................................. 69.7% 73.5% 75.2%
Maintenance and services................................. 30.3% 26.5% 24.8%
----- ----- -----
Total revenues....................................... 100.0% 100.0% 100.0%
Cost of revenues:
License.................................................. 3.9% 4.0% 4.1%
Maintenance and services................................. 11.8% 12.6% 12.9%
----- ----- -----
Total cost of revenues............................... 15.7% 16.6% 17.0%
----- ----- -----
Gross profit...................................... 84.3% 83.4% 83.0%
----- ----- -----
Operating expenses:
Sales and marketing...................................... 43.2% 43.7% 47.2%
Research and development................................. 15.9% 15.5% 16.3%
General and administrative............................... 8.7% 9.0% 10.3%
Purchased in-process research and development............ -- 9.2% --
Amortization of goodwill and purchased intangible assets. 5.2% 4.7% --
Executive recruiting costs............................... -- -- 1.2%
----- ----- -----
Total operating expenses............................. 73.0% 82.1% 75.0%
----- ----- -----
Income from operations............................ 11.3% 1.3% 8.0%
----- ----- -----
Other income (expense):
Interest income.......................................... 3.3% 3.9% 6.0%
Interest expense......................................... -- -- (0.6)%
Other.................................................... 0.1% 0.3% 1.6%
----- ----- -----
Income before income taxes........................... 14.7% 5.5% 15.0%
Income taxes................................................ 4.7% 7.2% 1.4%
----- ----- -----
Net income (loss).................................... 10.0% (1.7)% 13.6%
===== ===== =====
As a Percentage of Related Revenues:
Cost of license revenues.................................... 5.5% 5.5% 5.4%
Cost of maintenance and services revenues................... 39.0% 47.5% 51.9%
Revenues
Our total revenues are derived from license revenues for our Netcool family
of products, as well as associated maintenance, consulting and training
services revenues. License revenues are recognized upon the acceptance of a
purchase order and shipment of the software provided that the fee is fixed and
determinable, no significant obligation remains and collection of the resulting
receivable is probable. Allowances for credit losses and for estimated future
returns are provided for upon shipment. Credit losses and returns to date have
not been material. Maintenance revenues from ongoing customer support and
product upgrades are deferred and recognized ratably over the term of the
maintenance agreement, typically 12 months. Payments for maintenance fees (on
initial order or on renewal) are generally made in advance and are
nonrefundable. Revenues for consulting and training services are recognized as
the services are performed. See Note 1 of Notes to Consolidated Financial
Statements.
15
Our total revenues increased to $212.5 million in fiscal 2001 from $123.5
million in fiscal 2000 and $58.1 million in fiscal 1999. License revenues
increased to $148.2 million in fiscal 2001 from $90.8 million in fiscal 2000
and $43.7 million in fiscal 1999, primarily as a result of an increase in the
number of product licenses sold and in average transaction size, reflecting the
increased acceptance of Netcool/OMNIbus, the expansion of our sales
organization and the growing sales of Netcool/Internet Service Monitors,
Netcool/Impact, Netcool/Reporter, Netcool/Precision and Netcool/Visionary.
Maintenance and services revenues increased to $64.3 million in fiscal 2001
from $32.8 million in fiscal 2000 and $14.4 million in fiscal 1999, as a result
of providing maintenance and services to a larger installed base in each
successive year. The percentage of our total revenues attributable to software
was 70%, 74% and 75% in fiscal 2001, 2000 and 1999, respectively. Maintenance
and services revenues accounted for 30%, 26% and 25% in fiscal 2001, 2000 and
1999, respectively.
However, total revenue for the fourth quarter of fiscal 2001 decreased as
compared to the prior quarters in the fiscal year. Revenues for the fourth
quarter were $40.0 million as compared to $63.3 million, $59.3 million and
$49.9 in the third, second and first fiscal quarter respectively. The decrease
was mainly due to the current economic slowdown that is limiting the overall
capital spending of our existing and potential customers. Additionally, results
for the fourth quarter were negatively impacted by the terrorist attacks in New
York and Washington on September 11, 2001. We expect that results for the first
quarter of fiscal 2002 will remain relatively consistent with the fourth
quarter of fiscal 2001.
Revenues from U.S. operations were 61%, 64% and 71% of total revenues in
fiscal 2001, 2000 and 1999, respectively. International revenues include all
revenues other than those from the United States. See Note 7 of Notes to
Consolidated Financial Statements.
To date, our revenues have resulted primarily from sales to the
telecommunications industry, including ISPs. License revenues from
telecommunications industry customers and ISPs combined accounted for 79%, 82%
and 79% of our total license revenues in fiscal 2001, 2000 and 1999,
respectively. Also, one third-party distributor, Cisco Systems, Inc, accounted
for approximately 15% of revenues for the year ended September 30, 2001.
However, no one end-user customer accounted for more than 10% of total revenue
for the year ended September 30, 2001. No one third party distributor or
end-user customer accounted for more than 10% of total revenue in fiscal 2000
and 1999.
Cost of Revenues
Cost of license revenues consists primarily of technology license fees paid
to third-party software vendors and the costs of software media, packaging and
production. Cost of license revenues as a percentage of license revenues has
remained relatively consistent from year to year at 5.5% in both fiscal 2001
and 2000 and 5.4% in fiscal 1999.
Cost of maintenance and service revenues consists primarily of
personnel-related costs incurred in providing maintenance, consulting and
training to customers. Cost of maintenance and service revenues decreased as a
percentage of maintenance and service revenues to 39% in fiscal 2001 from 48%
in fiscal 2000 and 52% in fiscal 1999, principally due to economies of scale.
These decreases were partially offset by increased personnel, facilities and
travel costs associated with growth in the customer support and technical
services organization. We expect that maintenance and services costs will
continue to increase in dollar amounts in future periods as we continue to hire
additional customer support and technical services personnel and expand our
maintenance, consulting and training activities.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of salaries, commissions and
bonuses earned by personnel engaged in sales, technical presales and marketing
activities, as well as the costs of trade shows, public relations, marketing
materials and other marketing activities. Sales and marketing expenses
increased to $91.8 million in
16
fiscal 2001 from $54.0 million in fiscal 2000 and $27.4 million in fiscal 1999.
The increases in both fiscal 2001 and fiscal 2000 reflected the hiring of
additional personnel in connection with the building of our sales force. Sales
and marketing expenses represented 43%, 44% and 47% of total revenues in fiscal
2001, 2000 and 1999, respectively. These percentage reductions were primarily
due to the increased scale of operations. We expect that sales and marketing
expenses will continue to increase in absolute dollar amounts in future periods
in accordance with our planned growth.
Research and Development Expenses
Research and development expenses, exclusive of purchased research and
development costs, consist primarily of salaries and other personnel-related
expenses and costs of computer systems and software development tools. Research
and development expenses increased to $33.8 million in fiscal 2001 from $19.1
million in fiscal 2000 and $9.5 million in fiscal 1999. The increase in
research and development expenses in each year was primarily attributable to
increased personnel, additional facilities and an increase in the computer
systems and software development tools required by the additional personnel. In
addition to increasing our research and development facility in London, we
expanded our research and development presence in New York. Research and
development expenses represented 16% of total revenues in fiscal 2001, 2000 and
1999. We expect that our research and development costs will increase in
absolute dollar amounts as we continue to enhance and extend our core
technologies and product lines. To date, all research and development costs
have been expensed as incurred. See Note 1 of Notes to Consolidated Financial
Statements.
General and Administrative Expenses
General and administrative expenses consist primarily of personnel costs for
administration, finance, information systems and human resources, as well as
professional fees and bad debt expense. General and administrative expenses
increased to $18.5 million in fiscal 2001 from $11.1 million in fiscal 2000 and
from $6.0 million in fiscal 1999. These changes each year were primarily due to
increased staffing, facilities costs and associated expenses necessary to
manage and support our increased scale of operations. General and
administrative expenses as a percentage of total revenues were 9%, 9% and 10%
in fiscal 2001, 2000 and 1999, respectively. These percentage reductions were
primarily due to the increased scale of operations. We expect that our general
and administrative expenses will increase in absolute dollar amounts as we
expand our administrative staff, add infrastructure and incur additional costs
related to the growth of our business.
Amortization of Goodwill and Purchased Intangible Assets
On December 28, 1999, the Company acquired all of the outstanding common and
preferred stock of Calvin Alexander Networking, Inc. ("CAN"), a privately-held
developer of network auto-discovery technology. Under the terms of the
acquisition agreement, the Company issued approximately 1.8 million shares of
its common stock, then valued at approximately $43.0 million, and we recorded
goodwill and other intangible assets ofapproximately $31.7 million in fiscal
2000, which is being amortized on a straight-line basis over a period of three
to five years. We also recorded an immediate expense of $11.1 million relating
to in-process research and development in fiscal 2000.
On July 18, 2000, the Company acquired all of the outstanding common and
preferred stock of NetOps Corporation ("NetOps"), a privately-held developer of
diagnostic technology. Under the terms of the acquisition agreement, the
Company issued cash and approximately 286,000 shares of its common stock, then
valued in aggregate at approximately $21.4 million, and we recorded goodwill
and other intangible assets of approximately $21.2 million in fiscal 2000,
which is being amortized on a straight-line basis over a period of three to
five years. We also recorded an immediate expense of $0.3 million relating to
in-process research and development in fiscal 2000.
Research and development costs to bring the products from the acquired
companies to technological feasibility did not have a material impact on the
company's results of operations or condition.
17
Amortization of goodwill and intangible assets relating to our acquisitions
of CAN and NetOps aggregated $11.1 and $5.7 million for the year ended
September 30, 2001 and 2000, respectively. The increase is due to a full year's
amortization in fiscal 2001 as compared to partial year amortization in fiscal
2000 as the acquisitions occurred during the fiscal year 2000.
We expect amortization of approximately $10.7 million in the fiscal year
ending September 30, 2002 relating to the amortization of goodwill and other
intangible assets.
On October 1, 2002, we will adopt the Statement of Financial Accounting
Standard Board ("SFAS") No. 142, Goodwill and Other Intangible Assets. SFAS No.
142 changes the accounting for goodwill from an amortization method to an
impairment-only approach. Upon adoption of SFAS No. 142, amortization of
goodwill recorded for business combinations consummated prior to July 1, 2001
will cease, and goodwill will be tested annually and whenever events or
circumstances occur indicating that goodwill might be impaired. As of October
1, 2002, approximately $16.4 million of goodwill will no longer be amortized
but will be tested annually for impairment. Before the issuance of SFAS 142,
the Company expected to amortize on a straight-line basis, approximately $6.8
million, $6.8 million and $2.8 million of goodwill in fiscal years 2003, 2004
and 2005.
Executive Recruiting Costs
The executive recruiting costs in fiscal 1999 include a $0.5 million charge
related to the fair value of the warrant issued to the executive search firm to
purchase 106,668 shares of our common stock at a price of $7.41 per share and
approximately $0.2 million related to cash fees paid to the executive search
firm and certain relocation costs.
Other Income (Expense)
Other income in fiscal 2001, 2000 and 1999 includes the interest earned from
the proceeds raised from the public offerings and cash generated from
operations, and foreign exchange gains and losses. Fiscal 1999 also included
insurance proceeds related to the death of the former Chairman and Chief
Executive Officer.
Income Taxes
For the year ended September 30, 2001, our effective tax rate was 32%. The
effective rate differs from the combined federal and state statutory rates
primarily due to acquisition related charges that were non-deductible for tax
purposes and the tax impact of foreign operations. Our future effective tax
rate could be affected by any future acquisition related charges that were
non-deductible for tax purposes, if earnings are materially different than
anticipated in countries where we have lower effective tax rates or by
unfavorable changes in tax laws and regulations.
Liquidity and Capital Resources
As of September 30, 2001, we had $138.6 million in cash and cash equivalents
and $37.0 million in marketable securities, up from $83.7 million in cash and
cash equivalents and $31.6 million in marketable securities as of September 30,
2000. The net increase in cash and cash equivalents in fiscal 2001 was due
primarily to net income adjusted for non-cash expenses, the increase in accrued
expenses and deferred revenue, the increase in accounts payable, the maturity
of investments and the proceeds from the issuance of common stock. These
sources of cash and cash equivalents were partially offset by capital
expenditures, the increase in billed receivables and prepaid expenses and other
current assets, the purchase of investments and the repurchase of treasury
stock in September 2001. The increase in accrued expense, deferred revenue, and
accounts receivable reflects the growth in the business.
18
As of September 30, 2000, we had $83.7 million in cash and cash equivalents
and $31.6 million in marketable securities, up from $35.1 million in cash and
cash equivalents and $34.7 million in marketable securities as of September 30,
1999. The net increase in cash and cash equivalents in fiscal 2000 was due
primarily to the proceeds from the issuance of common stock, the increase in
accrued expenses, deferred revenue, the net maturity of investments and the net
loss adjusted for non-cash items. These sources of cash and cash equivalents
were partially offset by capital expenditures, the increase in billed
receivables and prepaid expenses and other current assets, the acquisition of
CAN and NetOps, and the decrease in accounts payable and income taxes payable.
The increase in accrued expense, deferred revenue, and accounts receivable
reflects the growth in the business.
As of September 30, 2001, the Company's principal commitments consisted of
obligations under operating leases. See Note 8 "Commitments" of Notes to
Consolidated Financial Statements.
We believe that our current cash balances and the cash flows generated by
operations, if any, will be sufficient to meet our anticipated cash needs for
working capital and capital expenditures for the next 12 months. Thereafter, if
cash generated from operations is insufficient to satisfy our liquidity
requirements, we may seek to sell additional equity or convertible debt
securities or obtain credit facilities. The decision to sell additional equity
or debt securities could be made at any time and would likely result in
additional dilution to our stockholders. A portion of our cash may be used to
acquire or invest in complementary businesses or products or to obtain the
right to use complementary technologies. From time to time, in the ordinary
course of business, we evaluate potential acquisitions of such businesses,
products or technologies.
RISK FACTORS
The following factors, in addition to the other information contained in
this Form 10-K, should be considered carefully in evaluating the Company and
our prospects. This Form 10-K (including without limitation the following Risk
Factors) contains forward-looking statements (within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934) regarding the Company and our business, financial condition, results of
operations and prospects. Words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates" and similar expressions or variations
of such words are intended to identify forward-looking statements, but are not
the exclusive means of identifying forward-looking statements in this Form
10-K. Additionally, statements concerning future matters such as the
development of new products, enhancements or technologies, possible changes in
legislation and other statements regarding matters that are not historical are
forward-looking statements.
Although forward-looking statements in this Form 10-K reflect the good faith
judgment of our management, such statements can only be based on facts and
factors we currently know about. Consequently, forward-looking statements are
inherently subject to risks and uncertainties, and actual results and outcomes
may differ materially from the results and outcomes discussed in the
forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include, but are not limited to, those
discussed below elsewhere in this Form 10-K. Readers are urged not to place
undue reliance on these forward-looking statements, which speak only as of the
date of the this Form 10-K. We undertake no obligation to revise or update any
forward-looking statements in order to reflect any event or circumstance that
may arise after the date of the Form 10-K.
Our operating results may vary as a result of the current economic slowdown
We face uncertainty in the degree to which the current economic slowdown
will negatively affect growth and capital spending by our existing and
potential customers. We have recently experienced increased instances of
customers delaying or deferring licenses of our software and maintenance
agreement, and longer lead times needed to close our customer sales. If the
economic conditions in the United States and globally do not improve, or if we
experience a worsening in the global economic slowdown, we may continue to
experience material adverse impacts on our business, operating results, and
financial condition. We may not be able to accurately anticipate the magnitude
of these impacts on future quarterly results.
19
The recent terrorist attacks are unprecedented events that have created many
economic and political uncertainties, some of which may harm our business and
prospects and our ability in general to conduct business in the ordinary
course.
Terrorist attacks in New York and Washington, D.C. in September 2001 have
disrupted commerce throughout the world. The continued threat of terrorism and
the resulting military, economic and political response and heightened security
measures may cause significant disruption to commerce throughout the world. To
the extent that this disruption results in a general decrease in our customers'
spending, our business and results of operations could be materially and
adversely affected. Following the attack, one of our New York offices was
closed for a number of weeks causing some delays in our product development
effort and business travel was seriously disrupted. We also may experience
delays in receiving payments from customers that have been affected by the
attacks, which, in turn, would harm our cash flow. We are unable to predict
whether the threat of terrorism or the responses thereto will result in any
long-term commercial disruptions or if such activities or responses will have a
long-term adverse effect on our business, results of operations or financial
condition. These and other developments arising out of the attacks may make the
occurrence of one or more of the factors discussed under "Risk Factors" more
likely to occur.
Because we have a limited operating history in a dynamic market, it is
difficult to predict our future operating results.
Because we have a relatively limited operating history in a rapidly evolving
and dynamic market, it is difficult to predict our future operating results. We
first shipped our Netcool/OMNIbus product in January of 1995 and therefore have
a limited operating history of developing and providing service level
management software. Our limited operating history and rapidly changing product
development, installation, maintenance and market dynamics make the prediction
of future results of operations difficult. Our prospects must be considered in
light of the risks, costs and difficulties frequently encountered by emerging
companies, particularly companies in the competitive software industry. We
intend to increase our operating expenses to hire experienced senior managers,
develop new distribution channels, increase our sales and marketing efforts,
implement and improve operational, financial and management information
systems, broaden technical services and customer support capabilities, fund
higher levels of research and development and expand administrative resources
in anticipation of future growth. Our operating results will be harmed if these
increased expenditures do not result in increased revenues and profitability.
Our operating results may vary from quarter to quarter, causing our stock
price to fluctuate.
Our quarterly revenues and operating results in geographic segments that we
track fluctuate and are difficult to predict. It is possible that in some
quarter or quarters our operating results will be below the expectations of
public market analysts or investors. In such event, or in the event adverse
conditions prevail, or are perceived to prevail, with respect to our business
or financial markets generally, the market price of our common stock may
decline significantly.
We realize a significant portion of our license revenues in the last month
of a quarter, frequently in the last weeks or even days of a quarter. As a
result, license revenues in any quarter are difficult to forecast because it is
substantially dependent on orders booked and shipped in that quarter. Moreover,
our sales cycle, from initial evaluation to delivery of software, varies
substantially from customer to customer. Further, we base our expense levels in
part on forecasts of future orders and sales, which are extremely difficult to
predict. A substantial portion of our operating expenses is related to
personnel, facilities, and sales and marketing programs. The level of spending
for such expenses cannot be adjusted quickly and is, therefore, relatively
fixed in the short term. Accordingly, our operating results will be harmed if
revenues fall below our expectations in a particular quarter. In addition, the
number and timing of large individual sales has been difficult for us to
predict, and large individual sales have, in some cases, occurred in quarters
subsequent to those we anticipated, or have not occurred at all. The loss or
deferral of one or more significant sales in a quarter could harm our operating
results.
20
Because of these fluctuations we believe that quarter-to-quarter comparisons
of our operating results are not necessarily meaningful or indicative of our
future performance. A number of other factors are likely to cause these
variations, including:
. changes in the demand for our software products and services and the level
of product and price competition that we encounter;
. the timing of new hires and our ability to attract, retain and motivate
qualified personnel, including changes in our sales incentives;
. the mix of products and services sold, including the mix of sales to new
and existing customers and through third-party distributors and our direct
sales force;
. changes in the mix of, and lack of demand from, distribution channels
through which our products are sold;
. the length of our sales cycles and the success of our new customer
generation activities;
. spending patterns and budgetary resources of our customers on network
management software solutions;
. product life-cycles and the timing of introductions or enhancements of
products, or delays in the introductions or enhancements of our products
and those of our competitors;
. market acceptance of new products;
. changes in the renewal rate of maintenance agreements;
. expansion of international operations, including gains and losses on the
conversion to United States dollars of accounts receivable and accounts
payable arising from international operations and the mix of international
and domestic revenue;
. the extent of market consolidation; and
. software defects and other product quality problems.
Failure to manage our growth may adversely affect our business.
We have grown rapidly, adding customers, personnel and expanding the scope
and geographic area of our operations. Our growth has resulted in new and
increased responsibilities for our management personnel and has placed and will
continue to place a significant strain upon our management and our operating
and financial systems and resources. We have grown from 514 employees on
September 30, 2000 to 742 employees on September 30, 2001. In the fourth
quarter of fiscal 2001, the number of employees declined due to planned
reductions and attrition. Given the uncertainties discussed in this Risk
Factors section, together with factors that might affect our ability to quickly
expand or contract our work force around the world, it is difficult to predict
future requirements for the number and type of employees in the fields and
geographies in which we operate. Failure to align employee skills and
populations with revenue and market requirements would have a material adverse
impact on our business and its operating results.
Failure to improve our infrastructure may adversely affect our business.
We need to continue to implement and improve a variety of operational,
financial and management information systems, procedures and controls. In
particular, we need to improve our accounting and financial reporting systems,
which currently require substantial management effort, and to successfully
manage an increasing number of relationships with customers, suppliers and
employees. These demands require the addition of new management personnel, and
we are currently in the process of recruiting individuals to fill important
management positions. Further, we need to continue to develop a global
financial and accounting system. Our business will be harmed if we are unable
to recruit and retain these key personnel, if our current and future executive
officers do not operate effectively, both independently and as a group, or if
we fail to implement improved operational, financial and management systems.
21
We need to continue to expand and improve the productivity of our sales force
and our technical services and customer support organization.
Our success has always depended in large part on our ability to attract and
retain highly skilled sales and technical personnel. In spite of the economic
slowdown, competition for these personnel is intense. Sales personnel are in
high demand and are difficult to attract and retain and require nine months, or
longer, to become fully productive. Further, because of the recent expansion of
the installed base of our products, the demands on our technical services and
customer support resources have grown rapidly. The loss of services of any of
our key personnel, the inability to retain and attract qualified personnel in
the future, or delays in hiring required personnel, particularly sales and
technical personnel, could make it difficult to meet key objectives, such as
timely product introductions.
We need to continue to expand our distribution channels and retain our
existing third-party distributors.
We need to continue to develop relationships with leading network equipment
and telecommunications providers and to expand our third-party channels of
distribution through OEMs, resellers and systems integrators. We are currently
investing, and plan to continue to invest, significant resources to develop
these relationships and channels of distribution, which could reduce our
ability to generate profits. Third-party distributors accounted for
approximately 42%, 34% and 34% of our total revenues in fiscal 2001, 2000 and
1999, respectively. Our business will be harmed if we are not able to attract
additional distributors that market our products effectively. Further, many of
our agreements with third-party distributors are nonexclusive, and many of the
companies with which we have agreements also have similar agreements with our
competitors or potential competitors. Our third-party distributors have
significantly greater sales and marketing resources than we do, and their sales
and marketing efforts may conflict with our direct sales efforts. In addition,
although sales through third-party distributors result in reduced sales and
marketing expense with respect to such sales, we sell our products to
third-party distributors at reduced prices, resulting in lower gross margins on
such third-party sales. We believe that our success in penetrating markets for
our fault and service level management applications depends substantially on
our ability to maintain our current distribution relationships, in particular,
those with Cisco Systems, Ericsson, Unisphere (Siemens), Sun Microsystems and
others. Our business will be harmed if network equipment and telecommunications
providers and distributors discontinue their relationships with us, compete
directly with us or form additional competing arrangements with our competitors.
We are dependent on the market for software designed for use with advanced
communications services, and the size of this market is unproven.
The market for our products is in an early stage of development and is very
dynamic. Although the rapid expansion and increasing complexity of computer
networks in recent years and the resulting emergence of service level
agreements has increased the demand for fault and service level management
software products, the awareness of and the need for such products is a recent
development. Because the market for these products is only beginning to
develop, it is difficult to assess the size of this market, the appropriate
features and prices for products to address this market, the optimal
distribution strategy and the competitive environment that will develop.
We are substantially dependent upon telecommunications carriers and other
service providers continuing to purchase our products.
Telecommunications carriers, including Internet service providers, that
deliver advanced communications services to their customers have accounted for
approximately 79%, 82% and 79% of our total revenues in fiscal 2001, 2000 and
1999, respectively. In addition, these providers are the central focus of our
sales strategy. If these customers cease to deploy advanced communications
services for any reason, the market for our products will be harmed. Also,
delays in the introduction of advanced services, such as network management
outsourcing, or the failure of such services to gain widespread market
acceptance or the decision of telecommunications carriers and other service
providers not to use our products in the deployment of these services would
harm our business.
22
Consolidations in, or a slowdown in the growth of, the telecommunications
industry could harm our business.
We have derived a substantial amount of our revenues from sales of products
and related services to the telecommunications industry. The telecommunications
industry has experienced significant growth and consolidation in the past few
years, although recent trends indicate that this growth and capital spending by
this industry has decreased and may continue to decrease in the future as a
result of a general decline in economic growth in local and international
markets. Our business is highly dependent on the growth of the
telecommunications industry and on continued capital spending by our customers
in that industry. In the event of a continued of further significant slowdown
in the growth or capital spending of the telecommunications industry, our
business would be adversely affected. Furthermore, as a result of industry
consolidation, there may be fewer potential customers requiring our software in
the future. Larger, consolidated telecommunications companies may also use
their purchasing power to create pressure on the prices and the margins we
could realize. We cannot be certain that consolidations in, or a slowdown in
the growth of, the telecommunication industry will not harm our business.
Our business depends on the continued growth of the Internet.
A significant portion of our revenues comes from telecommunications
carriers, Internet service providers and other customers that rely upon or are
driven by the Internet. As a result, our future results of operations
substantially depend on the continued acceptance and use of the Internet as a
medium for commerce and communication. Rapid growth in the use of and interest
in the Internet and online services is a recent phenomenon. Our business could
be harmed if this rapid growth does not continue or if the rate of
technological innovation, deployment or use of the Internet slows or declines.
Recent data and reports indicate that both the growth of significant portions
of the Internet and technological innovations have slowed. If these trends
continue, they will likely have an adverse impact on our business.
Furthermore, the growth and development of the market for Internet-based
services may prompt the introduction of new laws and regulations. Laws, which
impose additional burdens on those companies that conduct business online,
could decrease the expansion of the use of the Internet. A decline in the
growth of the Internet could decrease demand for our products and services and
increase our cost of doing business, or otherwise harm our business.
We face intense competition, including from larger competitors with greater
resources than our own, which could result in our losing market share or
experiencing a decline in gross margins.
We face intense competition in our markets. As we enter new markets, we
encounter additional, market-specific competitors. In addition, because the
software market has relatively low barriers to entry, we are aware of new and
potential entrants in portions of our market space. Increased competition is
likely to result in price reductions and may result in reduced gross margins
and loss of market share.
Further, many of our competitors have longer operating histories and have
significantly greater financial, technical, sales, marketing and other
resources, as well as greater name recognition and a larger customer base, than
we do. As a result, they may be able to devote greater resources to the
development, promotion, sale and support of their products or to respond more
quickly to new or emerging technologies and changes in customer requirements
than we can. Existing competitors could also increase their market share by
bundling products having functionality offered by our products with their
current applications. Moreover, our current and potential competitors may
increase their share of the fault and service level management market by
strategic alliances and/or the acquisition of competing companies. In addition,
network operating system vendors could introduce new or upgrade and extend
existing operating systems or environments that include functionality offered
by our products, which could render our products obsolete and unmarketable.
23
Our current and prospective competitors offer a variety of solutions to
address the fault and service level and enterprise network management markets
and generally fall within the following five categories:
. customer's internal design and development organizations that produce
service level management and network management applications for their
particular needs, in some cases using multiple instances of products from
hardware and software vendors such as Compaq, Hewlett-Packard Company and
Cabletron Systems, Inc.;
. vendors of network and systems management frameworks including Computer
Associates International, Inc. and International Business Machines
Corporation;
. vendors of network and systems management applications including
Hewlett-Packard Company, BMC Software, Inc, and International Business
Machines Corporation;
. providers of specific market applications; and
. systems integrators serving the telecommunications industry which
primarily provide programming services to develop customer specific
applications including TCSI Corporation and Agilent Technologies, Inc.
with its acquisition of Objective Systems Integrators, Inc.
Many of our existing and potential customers and distributors continuously
evaluate whether to design and develop their own network operations support and
management applications or purchase them from outside vendors. Sometimes these
customers internally design and develop their own software solutions for their
particular needs and therefore may be reluctant to purchase products offered by
independent vendors such as ours. As a result, we must continuously educate
existing and prospective customers as to the advantages of our products versus
internally developed network operations support and management applications.
If we ship products that contain defects, the market acceptance of our
products and our reputation will be harmed, and our customers could seek to
recover their damages from us.
Complex software products frequently contain errors or defects, especially
when first introduced or when new versions or enhancements are released.
Despite our extensive product testing, we have in the past released versions of
Netcool/OMNIbus with defects and have discovered software errors in certain of
our products after their introduction. For example, version 3.0 of
Netcool/OMNIbus, released in 1996, had a number of material defects. Version
1.0 of Netcool/Reporter, released in 1998, had features and performance
characteristics that limited market acceptance. A significant portion of our
technical personnel resources were required to address these defects. Because
of these defects, we could continue to experience delays in or failure of
market acceptance of products, or damage to our reputation or relationships
with our customers. Any defects and errors in new versions or enhancements of
our products after commencement of commercial shipments would harm our business.
In addition, because our products are used to monitor and address network
problems and avoid failures of the network to support critical business
functions, any design defects, software errors, misuse of our products,
incorrect data from network elements or other potential problems within or out
of our control that may arise from the use of our products could result in
financial or other damages to our customers. Our customers could seek to have
us pay for these losses. Although we maintain product liability insurance, it
may not be adequate. Further, although our license agreements with our
customers typically contain provisions designed to limit our exposure to
potential claims as well as any liabilities arising from such claims, such
provisions may not effectively protect us against such claims and the liability
and costs associated therewith.
The sales cycle for our software products is long, and the delay or failure
to complete one or more large license transactions in a quarter could cause
our operating results to fall below our expectations.
The sales cycle is highly customer specific and can vary from a few weeks to
many months. The software requirements of customers is highly dependent on many
factors, including but not limited to their projections of business growth,
capital budgets and anticipated cost savings from implementation of our
software. Our delay or failure to complete one or more large license
transactions in a quarter could harm our operating results. Our
24
software is generally used for division-wide or enterprise-wide,
business-critical purposes and involves significant capital commitments by
customers. Potential customers generally commit significant resources to an
evaluation of available enterprise software and requires us to expend
substantial time, effort and money educating them about the value of our
solutions. Licensing of our software products often requires an extensive sales
effort throughout a customer's organization because decisions to license such
software generally involve the evaluation of the software by a significant
number of customer personnel in various functional and geographic areas, each
often having specific and conflicting requirements. A variety of factors,
including actions by competitors and other factors over which we have little or
no control, may cause potential customers to favor a particular supplier or to
delay or forego a purchase.
We depend on our key personnel, and the loss of any of our key personnel
could harm our business.
Our success is substantially dependent upon a limited number of key
management, sales, product development, technical services and customer support
personnel. The loss of the services of one or more of such key employees could
harm our business. We do not generally have employment contracts with key
personnel. In addition, we are dependent upon our continuing ability to
attract, train and retain additional highly qualified management, sales,
product development, technical services and customer support personnel. We have
at times experienced and continue to experience difficulty in recruiting
qualified personnel. Also, the volatility or lack of positive performance in
our stock price may also adversely affect our ability to attract and retain key
employees, who often expect to realize value from stock options. Because we
face intense competition in our recruiting activities, we may be unable to
attract and/or retain qualified personnel.
We have acquired other businesses and we may make additional acquisitions in
the future, which will complicate our management tasks and could result in
substantial expenditures.
We have acquired other businesses and we may make additional acquisitions in
the future, which will complicate our management tasks and could result in
substantial expenditures. For example, on December 28, 1999 we completed the
acquisition of Calvin Alexander Networking, Inc., a developer of network
auto-discovery software. On July 18, 2000, the Company completed the
acquisition of NetOps Corporation, a developer of network diagnostic software.
Because of these acquisitions, we are integrating distinct products, customers
and corporate cultures into our own. These past and potential future
acquisitions create numerous risks for us, including:
. failure to successfully assimilate acquired operations and products;
. diversion of our management's attention from other matters;
. loss of key employees of acquired companies;
. substantial transaction costs;
. substantial liabilities or exposures in the acquired entity that were not
known or accurately evaluated or forecast by us; and
. substantial additional costs charged to operations as a result of the
failure to consummate a potential acquisition.
Further, some of the products we acquire would require significant
additional development before they can be marketed and may not generate revenue
at levels we anticipate. Moreover, our future acquisitions, if any, may result
in issuances of our equity securities which dilute our stockholders, the
incurrence of debt, large one-time write-offs and creation of goodwill or other
intangible assets that could result in amortization expense. It is possible
that our efforts to consummate or integrate acquisitions will not be
successful, which would harm our business.
25
We have relied and expect to continue to rely on a limited number of products
for a significant portion of our revenues.
All of our revenues have been derived from licenses for our Netcool family
of products and related maintenance, training and consulting services. We
currently expect that Netcool/OMNIbus-related revenues will continue to account
for a substantial percentage of our revenues beyond fiscal 2001 and for the
foreseeable future thereafter. Although we have Netcool/OMNIbus for Voice
Networks, Netcool/Precision, Netcool/Visionary and other products, our future
operating results, particularly in the near term, are significantly dependent
upon the continued market acceptance of Netcool/OMNIbus, improvements to
Netcool/OMNIbus and new and enhanced Netcool/OMNIbus applications. Our business
will be harmed if Netcool/OMNIbus does not continue to achieve market
acceptance or if we fail to develop and market improvements to Netcool/OMNIbus
or new or enhanced products. The life cycles of Netcool/OMNIbus, including the
Netcool/OMNIbus applications, are difficult to estimate due in large part to
the recent emergence of many of our markets, the effect of future product
enhancements and competition. A decline in the demand for Netcool/OMNIbus as a
result of competition, technological change or other factors would harm our
business.
We have relied and expect to continue to rely on a limited number of
customers for a significant portion of our revenues.
We derive a significant portion of our revenues in any particular period
from a limited number of customers. See "Concentration of Credit Risk" in Note
1 of the Notes to Consolidated Financial Statements. We expect to derive a
significant portion of our revenues from a limited number of customers in the
future. If a significant customer, or group of customers, cancels or delays
orders for our products, or does not continue to purchase our products at or
above historical levels, our business will be harmed. For example, pre-existing
customers may be part of, or become part of, large organizations that
standardize using a competitive product. The terms of our agreements with our
customers typically contain a one-time license fee and a prepayment of one year
of maintenance fees. The maintenance agreement is renewable annually at the
option of the customer and there are no minimum payment obligations or
obligations to license additional software. Therefore, we generally do not have
long-term customer contracts upon which we can rely for future revenues.
Our international sales and operations expose us to currency fluctuation
risks and other inherent risks.
We license our products in foreign countries. In addition, we maintain a
significant portion of our operations, including the bulk of our software
development operations, in the United Kingdom. Fluctuations in the value of
these currencies relative to the United States dollar have adversely impacted
our results in the past and may do so in the future. See Note 7 "Geographic and
Segment Information" in Notes to Consolidated Financial Statements for
information concerning revenues outside the United States. We expect that
international license, maintenance and consulting revenues will continue to
account for a significant portion of our total revenues in the future. We pay
the expenses of our international operations in local currencies and do not
currently engage in hedging transactions with respect to such obligations.
Our international operations and revenues involve a number of other inherent
risks, including:
. longer receivables collection periods and greater difficulty in accounts
receivable collection;
. difficulty in staffing and generally higher costs associated with managing
foreign operations;
. an even lengthier sales cycle than with domestic customers;
. the impact of possible recessionary environments in economies outside the
United States;
. sales in Europe and certain other parts of the world generally are
adversely affected in the quarter ending September 30, as many customers
reduce their business activities during the summer months. If our
international sales become a greater component of total revenue, these
seasonal factors may have a more pronounced effect on our operating
results;
26
. changes in regulatory requirements, including a slowdown in the rate of
privatization of telecommunications service providers, reduced protection
for intellectual property rights in some countries and tariffs and other
trade barriers;
. changes in or failure to be aware of or to account for payroll, stock
option, employee stock purchase and business related taxation;
. political, economic or terrorism induced instability;
. lack of acceptance of non-localized products;
. legal and cultural differences in the conduct of business; and
. immigration regulations that limit our ability to deploy our employees.
We intend to enter into additional international markets and to continue to
expand our operations outside of the United States by expanding our direct
sales force and pursuing additional strategic relationships. Such expansion
will require significant management attention and expenditure of significant
financial resources and could adversely affect our ability to generate profits.
If we are unable to establish additional foreign operations in a timely manner,
our growth in international sales will be limited, and our business could be
harmed.
Rapid technological change, including evolving industry standards and
regulations and new product introductions by our competitors, could render
our products obsolete.
Rapid technological change, including evolving industry standards and
regulations and new product introductions by our competitors, could render our
products obsolete. As a result, the life cycles of our products are difficult
to estimate and we must constantly develop, market and sell new and enhanced
products. If we fail to do so, our business will be harmed. For example, the
widespread adoption of new architecture standards for managing
telecommunications networks (for example TMN architecture) would force us to
adapt our products to such standard, which we may be unable to do on a timely
basis or at all. In addition, to the extent that any product upgrade or
enhancement requires extensive installation and configuration, current
customers may postpone or forgo the purchase of new versions of our products.
Further, the introduction or announcement of new product offerings by us or one
or more of our competitors may cause our customers to defer licensing of our
existing products.
Our products operate on third-party software platforms, and we could lose
market share if our products do not operate on the hardware and software
operating platforms employed by our customers.
Our products operate on third-party software platforms and we could lose
market share if our products do not operate on the hardware and software
operating platforms employed by our customers. Our products are designed to
operate on a variety of hardware and software platforms employed by our
customers in their networks. We must continually modify and enhance our
products to keep pace with changes in hardware and software platforms and
database technology. As a result, uncertainties related to the timing and
nature of new product announcements, introductions or modifications by systems
vendors, particularly Sun Microsystems, Inc., International Business Machines
Corporation, Hewlett-Packard Company, Cabletron Systems, Inc. and Cisco
Systems, Inc. and by vendors of relational database software, particularly
Oracle Corporation and Sybase, Inc., could harm our business. For example, we
are modifying certain of our products to operate with the Linux operating
system.
Our efforts to protect our intellectual property may not be adequate, or a
third-party could claim that we are infringing its proprietary rights.
We cannot guarantee that the steps we have taken to protect our proprietary
rights will be adequate to deter misappropriation of our intellectual property.
In addition, we may not be able to detect unauthorized use of our intellectual
property and take appropriate steps to enforce our rights. If third parties
infringe or misappropriate our trade secrets, copyrights, patents, trademarks
or other proprietary information or intellectual property, our
27
business could be harmed. In addition, protection of intellectual property in
many foreign countries is weaker and less reliable than in the United States,
so as our international operations expand, the risk that we will fail to
adequately protect our intellectual property increases. Further, while we
believe that our products and trademarks do not infringe upon the proprietary
rights of third parties, other parties may assert that our products infringe,
or may infringe, their proprietary rights or we have not fulfilled the terms of
agreements with them. Any such claims, with or without merit could be
time-consuming, result in costly litigation and diversion of technical and
management personnel, cause product shipment delays or require us to develop
non-infringing technology or enter into royalty, licensing or other agreements.
Such royalty or licensing agreements, if required, may not be available on
terms acceptable to us or at all. We expect that software product developers
will be increasingly subject to infringement claims as the number of products
and competitors in our industry segment grows and the functionality of products
in different industry segments overlaps.
We rely on software that we have licensed from third-party developers to
perform key functions in our products.
We rely on software that we license from third parties, including software
that is integrated with internally developed software and used in our products
to perform key functions. We could lose the right to use this software or it
could be made available to us only on commercially unreasonable terms. Although
we believe that alternative software is available from other third-party
suppliers or internal developments, the loss of or inability to maintain any of
these software licenses or the inability of the third parties to enhance in a
timely and cost-effective manner their products in response to changing
customer needs, industry standards or technological developments could result
in delays or reductions in product shipments by us until equivalent software
could be developed internally or identified, licensed and integrated, which
would harm our business.
Our stock price is volatile.
The market price of our common stock has been and is likely to continue to
be highly volatile. The market price may vary in response to many factors, some
of which are outside our control, including:
. actual or anticipated fluctuations in our operating results;
. announcements of technological innovations, new products or new contracts
by us or our competitors;
. developments with respect to intellectual property rights;
. adoption of new accounting standards affecting the software industry; and
. general market conditions and other factors.
In addition, the stock market has from time to time experienced significant
price and volume fluctuations that have particularly affected the market price
for the common stock of technology companies. These types of broad market
fluctuations may adversely affect the market price of our common stock. In the
past, following periods of volatility in the market price of a company's
securities, securities class action litigation has often been initiated against
such company. Such litigation could result in substantial costs and a diversion
of our management's attention and resources that could harm our business.
General economic and market conditions may impair our business.
Segments of the software industry have experienced significant economic
downturns characterized by decreased product demand, price erosion, work
slowdowns and layoffs. Our operations may in the future experience substantial
fluctuations as a consequence of general economic conditions affecting the
timing of orders from major customers and other factors affecting capital
spending. Although we have a diverse client base, we target certain market
segments. Therefore, any economic downturns in general or in the targeted
segments in particular would harm our business.
28
Our goodwill and other intangible assets may become impaired.
Due to rapidly changing market conditions, our goodwill and other intangible
assets may become impaired such that their carrying amounts may not be
recoverable, and we may be required to record an impairment charge impacting
our financial position. As of September 30, 2001, we had approximately $36.1
million of goodwill and other intangible assets, which were primarily related
to the acquisitions of CAN in December 1999 and NetOps in July 2000. The
Company regularly performs reviews to determine if the carrying value of assets
is impaired. The purpose for the review is to identify any facts or
circumstances, either internal or external, which indicate that the carrying
value of the asset cannot be recovered. No such impairment has been indicated
to date. However, if for example the demand for the products and services
underlying this goodwill decreases as a result of the general economic slowdown
or other causes and, as a result, the estimated future undiscounted net cash
flows from the acquired businesses are insufficient to recover the carrying
value of the assets over their estimated lives, we will record an impairment of
our goodwill and recognize asset impairment charges in the quarter in which
that impairment is determined. Asset impairment charges of this nature could be
large and could have a material adverse effect on our financial condition and
reported results of operations.
Future sales of our common stock may affect the market price of our common
stock.
As of September 30, 2001, we had approximately 73.5 million shares of common
stock outstanding, excluding approximately 10.9 million shares subject to
options outstanding as of such date under our stock option plans that are
exercisable at prices ranging from approximately $0.58 to $106.22 per share. We
cannot predict the effect, if any, that future sales of common stock or the
availability of shares of common stock for future sale, will have on the market
price of common stock prevailing from time to time. Sales of substantial
amounts of common stock (including shares issued upon the exercise of stock
options), or the perception such sales could occur, may materially and
adversely affect prevailing market prices for common stock. In addition, tax
charges resulting from the exercise of stock options could adversely affect the
reported results of operations.
We have various mechanisms in place to discourage takeover attempts.
Certain provisions of our certificate of incorporation and bylaws and
certain provisions of Delaware law could delay or make difficult a change in
control of Micromuse that a stockholder may consider favorable. The provisions
include:
. "blank check": preferred stock that could be used by our board of
directors to increase the number of outstanding shares and thwart a
takeover attempt; and
. a classified board of directors with staggered, two-year, terms, which may
lengthen the time required to gain control of the board of directors
In addition, Section 203 of the General Corporation Law of the State of
Delaware, which is applicable to us, and our stock incentive plans, may
discourage, delay or prevent a change of control of Micromuse.
Year 2000 issues could impair our business.
We have designed and tested our products to be Year 2000 compliant. We
continue to believe that our products performed well during the roll-over from
1999 to 2000 and February 29, 2000. However, any undetected or unreported
errors or defects associated with Year 2000 date functions could result in
material costs to us. In addition, certain components of our products process
timestamp information from third-party applications or local operating systems.
If such third-party applications or local operating systems are not Year 2000
compliant, our products that process such timestamp information may not be Year
2000 compliant.
In our standard license agreements, we provide certain warranties to
licensees that our software routines and programs are Year 2000 compliant. If
any of our licensees experience Year 2000 problems, such licensees could assert
claims for damages against us. Any such claims or litigation could result in
substantial costs and diversion of our resources even if ultimately decided in
our favor. Based on work done to date and our best estimates, we have not
incurred material costs and do not expect to incur future material costs in
addressing the Year 2000 issue in our systems and products.
29
Euro conversion may adversely affect our business.
On January 1, 1999, various European countries established fixed conversion
rates between their existing currencies and a new single currency known as the
Euro to be introduced through a transition period ending in 2002. Issues we are
reviewing as a result of the Euro include updating information technology
systems, assessing currency risk, reviewing licensing agreements and contracts
for currency issues, and processing tax and accounting records. Although we do
not currently expect the Euro to have a material adverse effect on our
financial conditions or results of operations, we cannot assure that issues
relating to the Euro will not harm our business.
Power blackouts and rising energy costs in California could disrupt our
business and increase our expenses.
Our principal executive offices are located in San Francisco, California.
Our principal product development operations are located in London, and we have
other offices in more than 10 cities outside California. In fiscal 2001,
California experienced rolling blackouts of electricity and rising energy costs
throughout the state. We have not experienced any material power disruptions or
material energy expense increases to date. However, a continuation or worsening
of these adverse energy circumstances may disrupt our ability to market our
products or provide services to customers or otherwise adversely affect our
business.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Foreign Currency Hedging Instruments
We transact business in various foreign currencies. Accordingly, we are
subject to exposure from adverse movements in foreign currency exchange rates.
This exposure is primarily related to local currency denominated revenues and
operating expenses in the U.K. However, as of September 30, 2001, no hedging
contracts were outstanding.
We currently do not use financial instruments to hedge local currency
denominated operating expenses in the U.K. Instead, we believe that a natural
hedge exists, in that local currency revenues will substantially offset the
local currency denominated operating expenses. We assess the need to utilize
financial instruments to hedge currency exposures on an ongoing basis.
We do not use derivative financial instruments for speculative trading
purposes, nor do we hedge our foreign currency exposure in a manner that
entirely offsets the effects of changes in foreign exchange rates. We regularly
review our hedging program and may as part of this review determine at any time
to change our hedging program.
Fixed Income Investments
Our exposure to market risks for changes in interest rates relate primarily
to investments in debt securities issued by U.S. government agencies and
corporate debt securities. We place our investments with high credit quality
issuers and, by policy, limits the amount of the credit exposure to any one
issuer.
Our general policy is to limit the risk of principal loss and ensure the
safety of invested funds by limiting market and credit risk. All highly liquid
investments with less than three months to maturity are considered to be cash
equivalents; investments with maturities between three months or less are
considered cash equivalents; investments with maturities between three and
twelve months are considered to be short-term investments; investments with
maturities in excess of twelve months are considered to be long-term
investments. The weighted average pre-tax interest rate on the investment
portfolio is approximately 4.4%.
30
Item 8. Financial Statements and Supplementary Data
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
As of September 30,
------------------
2001 2000
-------- --------
ASSETS
Current assets:
Cash and cash equivalents............................................................. $138,581 $ 83,679
Short-term investments................................................................ 16,109 31,614
Billed receivables, net of allowance for doubtful accounts of $4,238 and $1,472 as of
September 2001 and 2000, respectively............................................... 31,067 17,455
Prepaid expenses and other current assets............................................. 15,656 6,487
Deferred income taxes................................................................. -- 2,100
-------- --------
Total current assets.............................................................. 201,413 141,335
Property and equipment, net........................................................... 15,221 8,495
Long-term investments................................................................. 20,891 --
Goodwill and other intangible assets, net............................................. 36,113 47,181
-------- --------
Total Assets...................................................................... $273,638 $197,011
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................................................... $ 5,686 $ 2,919
Accrued expenses...................................................................... 27,407 18,900
Income taxes payable.................................................................. 6,152 712
Deferred revenue...................................................................... 34,212 21,957
-------- --------
Total current liabilities......................................................... 73,457 44,488
Commitments and contingencies
Stockholders' equity:
Preferred stock; $0.01 par value; 5,000 shares authorized; no shares issued and
outstanding......................................................................... -- --
Common stock; $0.01 par value; 200,000 shares authorized; 73,903 and 70,520
shares issued and outstanding as of September 30, 2001 and 2000, respectively....... 739 705
Additional paid-in capital............................................................ 187,755 159,061
Treasury stock, at cost: 400 shares at September 30, 2001............................. (2,657) --
Deferred compensation................................................................. -- (47)
Accumulated other comprehensive loss.................................................. (1,317) (1,588)
Retained earnings (accumulated deficit)............................................... 15,661 (5,608)
-------- --------
Total stockholders' equity........................................................ 200,181 152,523
-------- --------
Total liabilities and stockholders equity......................................... $273,638 $197,011
======== ========
See Accompanying Notes to Consolidated Financial Statements.
31
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Year ended September 30,
--------------------------
2001 2000 1999
-------- -------- -------
Revenues:
License................................................................. $148,214 $ 90,763 $43,692
Maintenance and services................................................ 64,294 32,770 14,378
-------- -------- -------
Total revenues...................................................... 212,508 123,533 58,070
Cost of revenues:
License................................................................. 8,225 4,998 2,379
Maintenance and services................................................ 25,101 15,554 7,465
-------- -------- -------
Total cost of revenues.............................................. 33,326 20,552 9,844
-------- -------- -------
Gross profit..................................................... 179,182 102,981 48,226
-------- -------- -------
Operating expenses:
Sales and marketing..................................................... 91,797 54,039 27,420
Research and development................................................ 33,768 19,117 9,453
General and administrative.............................................. 18,455 11,104 5,998
Purchased in-process research and development........................... -- 11,406 --
Amortization of goodwill and other intangible assets.................... 11,068 5,737 --
Executive recruiting costs.............................................. -- -- 720
-------- -------- -------
Total operating expenses............................................ 155,088 101,403 43,591
-------- -------- -------
Income from operations........................................... 24,094 1,578 4,635
-------- -------- -------
Other income (expense):
Interest income......................................................... 7,112 4,762 3,480
Interest expense........................................................ -- -- (341)
Other................................................................... 74 401 952
-------- -------- -------
Income before income taxes.......................................... 31,280 6,741 8,726
Income taxes............................................................... 10,011 8,835 840
-------- -------- -------
Net income (loss)................................................... $ 21,269 $ (2,094) $ 7,886
-------- -------- -------
Per share data:
Basic net income (loss) applicable to holders of common stock........... $ 0.29 $ (0.03) $ 0.12
Diluted net income (loss) applicable to holders of common stock......... $ 0.27 $ (0.03) $ 0.11
Weighted average shares used in computing:
Basic net income (loss) per share applicable to holders of common stock. 72,500 68,586 63,636
Diluted net income (loss) per share applicable to holders of common
stock................................................................. 78,758 68,586 70,016
See Accompanying Notes to Consolidated Financial Statements.
32
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
COMPREHENSIVE INCOME (LOSS)
(In thousands)
Accumulated
Common stock Additional Treasury stock Deferred other
------------- paid-in --------------- stock comprehensive
Shares Amount capital Shares Amount compensation loss
------ ------ ---------- ------ ------- ------------ -------------
Balance as of September 30, 1998.................... 64,191 $640 78,679 -- $ -- $(159) $ (42)
Stock options exercised............................. 443 4 (5,406) 1,512 7,215 -- --
Issuance of common stock under stock
purchase plan...................................... 17 2 (875) 488 2,325 -- --
Treasury stock purchased............................ -- -- -- (2,000) (9,540) -- --
Compensation expense related to issuance of
a warrant.......................................... -- -- 462 -- -- -- --
Tax benefit related to the exercise of stock options -- -- 403 -- -- -- --
Amortization of deferred employee Compensation...... -- -- -- -- -- 56 --
Foreign currency translation adjustment............. -- -- -- -- -- -- (244)
Net income.......................................... -- -- -- -- -- -- --
------ ---- -------- ------ ------- ----- -------
Balance as of September 30, 1999.................... 64,651 646 73,263 -- -- (103) (286)
====== ==== ======== ====== ======= ===== =======
Stock options exercised............................. 3,278 33 12,478 -- -- -- --
Issuance of common stock under stock
purchase plan...................................... 453 5 3,312 -- -- -- --
Warrant exercised................................... 97 -- -- -- -- -- --
Tax benefit related to the exercise of stock options -- -- 8,878 -- -- -- --
Amortization of deferred employee compensation...... -- -- -- -- -- 56 --
Stock issued in acquisition of CAN.................. 1,755 18 42,668 -- -- -- --
Stock issued in acquisition of NetOps............... 286 3 18,462 -- -- -- --
Foreign currency translation adjustment............. -- -- -- -- -- -- (1,302)
Net loss............................................ -- -- -- -- -- -- --
------ ---- -------- ------ ------- ----- -------
Balance as of September 30, 2000.................... 70,520 705 $159,061 -- -- (47) (1,588)
====== ==== ======== ====== ======= ===== =======
Stock options exercised............................. 3,098 31 21,513 -- -- -- --
Issuance of common stock under stock
purchase plan...................................... 285 3 4,833 -- -- -- --
Treasury stock purchased............................ -- -- -- (400) (2,657) -- --
Tax benefit related to the exercise of stock options -- -- 2,348 -- -- -- --
Amortization of deferred employee compensation...... -- -- -- -- -- 47 --
Foreign currency translation adjustment............. -- -- -- -- -- -- 271
Net income.......................................... -- -- -- -- -- -- --
------ ---- -------- ------ ------- ----- -------
Balance as of September 30, 2001.................... 73,903 $739 $187,755 (400) $(2,657) $ -- $(1,317)
====== ==== ======== ====== ======= ===== =======
Retained Total
earnings stockholders' Total
(Accumulated equity comprehensive
Deficit) (deficit) income (loss)
------------ ------------- -------------
Balance as of September 30, 1998.................... $(11,400) $ 67,718 $ --
Stock options exercised............................. -- 1,813
Issuance of common stock under stock
purchase plan...................................... -- 1,452
Treasury stock purchased............................ -- (9,540)
Compensation expense related to issuance of
a warrant.......................................... -- 462
Tax benefit related to the exercise of stock options -- 403
Amortization of deferred employee Compensation...... -- 56
Foreign currency translation adjustment............. -- (244) (244)
Net income.......................................... 7,886 7,886 7,886
-------- -------- -------
Balance as of September 30, 1999.................... (3,514) 70,006 7,642
======== ======== =======
Stock options exercised............................. -- 12,511
Issuance of common stock under stock
purchase plan...................................... -- 3,317
Warrant exercised................................... -- --
Tax benefit related to the exercise of stock options -- 8,878
Amortization of deferred employee compensation...... -- 56
Stock issued in acquisition of CAN.................. -- 42,686
Stock issued in acquisition of NetOps............... -- 18,465
Foreign currency translation adjustment............. -- (1,302) (1,302)
Net loss............................................ (2,094) (2,094) (2,094)
-------- -------- -------
Balance as of September 30, 2000.................... (5,608) 152,523 (3,396)
======== ======== =======
Stock options exercised............................. -- 21,544
Issuance of common stock under stock
purchase plan...................................... -- 4,836
Treasury stock purchased............................ -- (2,657)
Tax benefit related to the exercise of stock options -- 2,348
Amortization of deferred employee compensation...... -- 47
Foreign currency translation adjustment............. -- 271 271
Net income.......................................... 21,269 21,269 21,269
-------- -------- -------
Balance as of September 30, 2001.................... $ 15,661 $200,181 21,540
======== ======== =======
See Accompanying Notes to Consolidated Financial Statements.
33
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year ended September 30,
-----------------------------
2001 2000 1999
-------- --------- --------
Cash flows from operating activities:
Net income (loss)..................................................... $ 21,269 $ (2,094) $ 7,886
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:...............................................
Depreciation and amortization..................................... 17,940 10,158 1,580
Amortization of deferred compensation............................. 47 56 56
Compensation expense related to issuance of warrant............... -- -- 462
Tax benefit related to the exercise of stock options.............. 2,348 8,878 403
Purchased in-process research and development..................... -- 11,406 --
Deferred income taxes............................................. 2,100 (1,164) (895)
Changes in operating assets and liabilities:
Billed receivables............................................. (13,107) (8,301) (3,118)
Prepaid expenses and other current assets...................... (9,684) (2,866) (2,582)
Related party loan............................................. -- -- 85
Accounts payable............................................... 2,734 (1,183) 2,137
Accrued expenses............................................... 8,362 12,656 1,471
Income taxes payable........................................... 5,440 (1,111) 1,919
Deferred revenue............................................... 12,245 12,632 2,146
-------- --------- --------
Cash provided by operating activities...................... 49,694 39,067 11,550
Cash flows from investing activities:
Capital expenditures.................................................. (13,594) (7,026) (4,596)
Acquisition of businesses, net of cash acquired....................... -- (1,621) --
Purchase of investments............................................... (50,120) (110,329) (58,552)
Proceeds from the maturity of investments............................. 44,734 113,404 70,872
-------- --------- --------
Cash provided by (used in) investing activities............ (18,980) (5,572) 7,724
Cash flows from financing activities:
Proceeds from issuance of common stock, net........................... 26,380 15,828 3,265
Purchase of treasury stock............................................ (2,657) -- (9,540)
-------- --------- --------
Cash provided by (used in) financing activities............ 23,723 15,828 (6,275)
Effects of exchange rate changes on cash and cash equivalents............ 465 (702) (739)
-------- --------- --------
Net increase in cash and cash equivalents................................ 54,902 48,621 12,260
Cash and cash equivalents at beginning of year........................... 83,679 35,058 22,798
-------- --------- --------
Cash and cash equivalents at end of year................................. $138,581 $ 83,679 $ 35,058
======== ========= ========
Supplemental disclosures of cash flow information:
Cash paid during the year -- interest................................. $ -- $ -- $ 51
Cash paid during the year -- taxes.................................... $ 16 $ 42 $ 34
Non-cash financing activities:
Common stock issued in acquisitions............................... $ -- $ 61,151 $ --
See Accompanying Notes to Consolidated Financial Statements.
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Description of Business and Summary of Significant Accounting Policies
Description of Business
Micromuse Inc. and its subsidiaries (the "Company") develops and supports a
family of scalable, highly configurable, rapidly deployable software solutions
for the effective monitoring and management of multiple elements underlying an
enterprise's information technology infrastructure. The Company maintains its
U.S. headquarters in San Francisco, California and its European headquarters in
London, England.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All significant intercompany balances and
transactions have been eliminated.
Reclassifications
Certain reclassifications, none of which effected net income, have been made
to prior amounts to conform to the current year presentation.
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from these estimates.
Cash Equivalents
The Company considers all highly liquid instruments with a purchased
maturity of 90 days or less to be cash equivalents.
Concentration of Credit Risk
Financial instruments that potentially expose the Company to credit risk
consist of cash and cash equivalents, investments and accounts receivable. The
Company is exposed to credit risk on its cash, cash equivalents and investments
in the event of default by the financial institutions or the issuers of these
investments to the extent of the amounts recorded on the balance sheet in
excess of amounts that are insured by the FDIC. Trade receivables potentially
subject the Company to concentrations of credit risk. The Company closely
monitors extensions of credit and has not experienced significant credit losses
in the past. Credit losses have been provided for in the consolidated financial
statements and have been within management's expectations. As of September 30,
2001 and 2000, the Company had unbilled receivables totaling $8.4 million and
$0.4 million, respectively, which was classified in other assets and all due
within one year. One third-party distributor customer accounted for
approximately 15% of revenues for the year ended September 30, 2001 and 22% and
15% of total receivables at September 30, 2001 and 2000, respectively. No one
third-party distributor customer accounted for greater than 10% of revenue for
the year ended September 30, 2000 and 1999. No one end-user customer accounted
for more than 10% of revenues for the years ended September 30, 2001, 2000 and
1999. One end-user customer accounted for 18% of total receivables at September
30, 2001. No one end-user customer accounted for more than 10% of total
receivables at September 30, 2000.
Fair Value of Financial Instruments
The fair value of cash and cash equivalents, investments, accounts
receivable and accounts payable for all periods presented approximates their
respective carrying amounts defined as the amount at which the instrument could
be exchanged in a current transaction between willing parties.
35
Investments
The Company has invested in certain marketable securities that are
categorized as held-to-maturity. At September 30, 2001, the Company had
invested $96.2 million in cash and money market funds, $25.7 million in debt
securities issued by U.S. government agencies and $53.6 million in corporate
notes and bonds. At September 30, 2000, the Company had invested $44.2 million
in cash and money market funds, $19.4 million in debt securities issued by U.S.
government agencies and $51.7 million in corporate notes and bonds. The
aggregate fair value of these investments, which are accounted for using the
amortized cost-basis of accounting, approximates their respective carrying
value defined as the amount at which the instrument could be exchanged in a
current transaction between willing parties. Securities with maturities between
three and twelve months are considered to be short-term investments, while
securities with maturities in excess of twelve months are considered to be
long-term investments.
As of September 30, 2001, the contractual maturities of the Company's
investment securities are as follows--$16.1 million within one year and $20.9
million between one to two years.
Property and Equipment
Property and equipment are recorded at cost less accumulated depreciation
and amortization. Depreciation is calculated using the straight-line method
over the estimated useful lives of the assets, typically two years for computer
equipment and related software and three years for furniture and fixtures.
Leasehold improvements are amortized over the shorter of the estimated useful
lives of the respective assets or the lease term.
Impairment of Long-Lived Assets
The Company evaluates its long-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying amount of such assets
may not be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of any asset to future net cash
flows expected to be generated by the asset. If such assets are considered to
be impaired, the impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceeds the fair value of the assets. Assets
to be disposed of are reported at the lower of the carrying amount or fair
value less the costs to sell.
Goodwill and Other Intangible Assets
The Company records goodwill when the cost of net identifiable assets it
acquires exceeds their fair value. Goodwill and the cost of identified
intangible assets are amortized on a straight-line basis over three to five
years. The Company regularly performs reviews to determine if the carrying
value of assets is impaired. The purpose for the review is to identify any
facts or circumstances, either internal or external, which indicate that the
carrying value of the asset cannot be recovered. No such impairment has been
indicated to date. If, in the future, management determines the existence of
impairment indicators, under the current policy, the Company would use
undiscounted cash flows to initially determine whether impairment should be
recognized. If necessary, the Company would perform a subsequent calculation to
measure the amount of the impairment loss based on the excess of the carrying
value over the fair value of the impaired assets. If quoted market prices for
the assets are not available, the fair value would be calculated using the
present value of estimated expected future cash flows. The cash flow
calculation would be based on management's best estimates, using appropriate
assumptions and projections at the time.
Revenue Recognition
The Company recognizes revenue in accordance with Statement of Position
97-2, Software Revenue Recognition (SOP 97-2), as amended by SOP 98-9, and
recognizes revenue when all of the following criteria are: (1) Persuasive
evidence of an arrangement exists, (2) delivery has occurred, (3) the vendor's
fee is fixed or determinable and (4) collectibility is probable.
The Company allocates revenue on software arrangements involving multiple
elements to each element based on the relative fair values of the elements. The
Company's determination of fair value of each element in
36
multiple-element arrangements is based on vendor-specific objective evidence
(VSOE). The Company has analyzed all of the elements and determined that it has
sufficient VSOE to allocate revenue to maintenance, consulting and training
components included in multiple-element arrangements. Accordingly, assuming all
other revenue recognition criteria are met, revenue is recognized upon delivery
using the residual method in accordance with SOP 98-9, where the fair value of
the undelivered elements is deferred and the remaining portion of the
arrangement fee is recognized as revenue. The revenue allocated to license
generally is recognized upon delivery of the products. The revenue allocated to
maintenance generally is recognized ratably over the term of the support,
typically twelve months, and revenue allocated to consulting and training
elements generally is recognized as the services are performed. If evidence of
the fair value for all element arrangement does not exist, all revenue from the
arrangement is deferred until such evidence exists or until all elements are
delivered.
When revenue is recognized in advance of contractual payment terms, it is
classified in other assets as unbilled receivables. All amounts included in
unbilled receivables are due within one year.
Cost of license revenue primarily includes license fees paid to third party
software vendors and production costs. Cost of maintenance and services revenue
consists primarily of personnel related costs incurred in providing
maintenance, consulting and training to customers.
Research and Development Cost
Research and Development costs related to software products are expensed as
incurred until the technological feasibility of the product has been
established. Technological feasibility in the Company's circumstances occurs
when a working model is completed. After technological feasibility is
established, additional costs would be capitalized. The Company believes its
process for developing software is essentially completed concurrent with the
establishment of technological feasibility, and, accordingly, no research and
development costs have been capitalized to date.
Income Taxes
Income taxes are recorded using 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 amount of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry-forwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which the temporary differences are expected to be recovered or
settled. The measurement of deferred tax assets is reduced, if necessary, by a
valuation allowance for any tax benefits that are not expected to be realized.
Stock-Based Compensation
The Company accounts for its stock-based employee compensation arrangements
using the intrinsic value method. As such, compensation expense is recorded
when on the date of grant the fair value of the underlying common stock exceeds
the exercise price for stock options or the purchase price for issuance or
sales of common stock.
Foreign Currency Translation
The functional currency of the Company's foreign subsidiaries is the local
currency. The Company translates the assets and liabilities of its foreign
subsidiaries to U.S. dollars at the rates of exchange in effect at the end of
the year. Revenues and expenses are translated at the average rates of exchange
for the year. Translation adjustments and the effects of exchange rate changes
on intercompany transactions of a long-term investment nature are included in
stockholders' equity in the consolidated balance sheets. Gains and losses
resulting from foreign currency transactions denominated in a currency other
than the functional currency are included in income and have not been
significant to the Company's consolidated operating results in any year.
37
Per Share Data
Basic per share amounts are calculated using the weighted-average number of
common shares outstanding during the period. Diluted per share amounts are
calculated using the weighted-average number of common shares outstanding
during the period and, when dilutive, the weighted-average number of potential
common shares from the exercise of outstanding options to purchase common stock
using the treasury stock method. Excluded from the computation of the diluted
loss per share for the year ended September 30, 2000 were options to acquire
13.2 million shares of common stock with a weighted-average exercise price of
$22.33 per share, because their effect would be anti-dilutive. A reconciliation
of the numerators and denominators used in the basic and diluted net income
(loss) per share amounts follows:
Year ended September 30,
------------------------
2001 2000 1999
------- ------- -------
Numerator for basic and diluted net income (loss) applicable to holders
of common stock...................................................... $21,269 $(2,094) $ 7,886
======= ======= =======
Denominator for basic net income (loss) per share--weighted-average
shares outstanding................................................... 72,500 68,586 63,636
Dilutive effect of:
Common stock options................................................ 6,258 -- 6,272
Warrant............................................................. -- -- 108
------- ------- -------
Denominator for diluted net income (loss) per share.................... 78,758 68,586 70,016
======= ======= =======
Comprehensive Income (Loss)
Comprehensive income (loss) includes net income (loss) and foreign currency
translation adjustments. The only component of accumulated other comprehensive
loss is foreign currency translation adjustments. Tax effects of other
comprehensive loss have not been material.
Recent Accounting Pronouncements
On October 1, 2000, the Company adopted Statement of Financial Accounting
Standards No. 133 (SFAS No. 133), Accounting for Derivative Instruments and
Hedging Activities. SFAS No. 133, as amended addresses the accounting for
derivative instruments, including certain derivative instruments embedded in
other contracts. Under SFAS No. 133, entities are required to carry all
derivative instruments in the balance sheet at fair value. The accounting for
changes in the fair value of a derivative instrument depends on whether it has
been designated and qualifies as part of a hedging relationship and, if so, the
reason for holding it. The adoption of SFAS No. 133 did not have a material
effect on the Company's consolidated financial position or results of
operations.
On July 1, 2001, the Company adopted Staff Accounting Bulletin No. 101 (SAB
101), Revenue Recognition in Financial Statements. SAB 101, as amended provides
guidance on applying generally accepted accounting principles to revenue
recognition issues in financial statements. The adoption of SAB 101 did not
have a material effect on the Company's consolidated financial position or
results of operations.
In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 141, Business Combinations. Under SFAS No. 141, entities are required to
account for all business combinations initiated after June 30, 2001 using one
method, the purchase method. The Company adopted SFAS No. 141 on July 1, 2001.
The adoption did not have a material effect on the Company's consolidated
financial position or results of operations.
In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 addresses financial accounting and reporting for acquired
goodwill and other intangible assets. SFAS No. 142 changes the accounting for
goodwill from an amortization method to an impairment-only approach. Goodwill
will be tested annually and whenever events or circumstances occur indicating
that goodwill might be impaired.
38
Upon adoption of SFAS No. 142, amortization of goodwill recorded for business
combinations consummated prior to July 1, 2001 will cease, and intangible
assets acquired prior to July 1, 2001 that do not meet the criteria for
recognition under SFAS No. 141 will be reclassified to goodwill. Companies are
required to adopt SFAS No. 142 for fiscal years beginning after December 15,
2001, but early adoption is permitted. The Company will adopt SFAS 142 on
October 1, 2002. As of October 1, 2002, approximately $16.4 million of goodwill
will no longer be amortized but will be tested annually for impairment.
In October 2001, the FASB issued SFAS No. 144, which is effective for fiscal
years beginning after December 15, 2001 and early adoption is permitted. SFAS
No. 144 supersedes certain provisions of APB Opinion No. 30 "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions" ("APB 30") and supersedes SFAS No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("SFAS 121"). Although SFAS No. 144 supersedes SFAS No. 121 and the provisions
of APB 30 regarding the accounting and reporting of the disposal of a segment
of a business, it retains many of the fundamental provisions of SFAS No. 121
and the requirements in APB 30 to report separately discontinued operations.
SFAS No. 144 also extends the reporting of discontinued operations to a
component of an entity that either has been disposed of (by sale, abandonment,
or in a distribution to owners) or is classified as held for sale. The Company
does not expect the adoption of SFAS No. 144 to have a material effect on its
consolidated financial position, results of operations, or cash flows.
Note 2. Acquisitions
On December 28, 1999, the Company acquired all of the outstanding common and
preferred stock of Calvin Alexander Networking, Inc. ("CAN"), a privately-held
developer of network auto-discovery technology. Under the terms of the
acquisition agreement, the Company issued approximately 1.8 million shares of
its common stock, then valued at approximately $43.0 million. The transaction
was accounted for under the purchase method of accounting with CAN's results of
operations included from the acquisition date, and was treated as a tax-free
reorganization for federal income tax purposes.
A summary of the allocation of the purchase price is as follows (in
millions):
Total tangible assets, net................................................ $ 0.2
Intangible assets:
In-process research and development.................................... 11.1
Assembled workforce.................................................... 0.3
Core technology........................................................ 5.7
Goodwill............................................................... 25.7
-----
Total intangible assets............................................ 42.8
-----
Total..................................................................... $43.0
=====
At the time of the acquisition, the estimated aggregate fair value of CAN's
research and development efforts that had not reached technological feasibility
as of the acquisition date and had no alternative future uses was estimated by
the Company's management to be $11.1 million, and was expensed at the
acquisition date. Goodwill, which represents the excess of the purchase price
over the fair value of identifiable tangible and intangible assets acquired
less liabilities assumed, is being amortized on a straight-line basis over the
estimated life of five years.
On July 18, 2000, the Company acquired all of the outstanding common and
preferred stock of NetOps Corporation ("NetOps"), a privately-held developer of
diagnostic technology. Under the terms of the acquisition agreement, the
Company issued cash and approximately 286,000 shares of its common stock, then
valued in aggregate at approximately $21.4 million. The transaction was
accounted for under the purchase method of accounting with NetOps' results of
operations included from the acquisition date, and was treated as a tax-free
reorganization for federal income tax purposes.
39
A summary of the allocation of the purchase price is as follows (in
millions):
Total tangible liabilities, net.......................................... $(0.1)
Intangible assets:
In-process research and development................................... 0.3
Assembled workforce................................................... 0.9
Trademarks............................................................ 0.9
Non-compete agreements................................................ 0.7
Core technology....................................................... 10.1
Goodwill.............................................................. 8.6
-----
Total intangible assets........................................... 21.5
-----
Total.................................................................... $21.4
=====
At the time of the acquisition, the estimated aggregate fair value of NetOps
research and development efforts that had not reached technological feasibility
as of the acquisition date and had no alternative future uses was estimated by
the Company's management to be $0.3 million, and was expensed at the
acquisition date. Goodwill, which represents the excess of the purchase price
over the fair value of identifiable tangible and intangible assets acquired
less liabilities assumed, is being amortized on a straight-line basis over the
estimated life of five years.
The following summary, which was prepared on a pro forma basis, combines the
Company's consolidated results of operations with CAN and NetOps results of
operations for the years ended September 30, 2001 and 2000, as if the
combination had occurred at the beginning of the periods presented. The table
includes the impact of certain adjustments including the elimination of the
charge for acquired in-process research and development, and the additional
amortization relating to intangible assets acquired (in thousands, except per
share amounts):
Year ended September 30,
-----------------------
2000 1999
-------- -------
Revenues.............................................. $124,319 $60,570
Net income (loss)..................................... $ 381 $(5,327)
Net income (loss) per share:
Basic.............................................. $ 0.01 $ (0.08)
Diluted............................................ $ 0.00 $ (0.08)
Shares used in per share computation:
Basic.............................................. 68,954 65,384
Diluted............................................ 79,110 65,384
40
Note 3. Balance Sheet Components (in thousands)
As of September 30,
------------------
2001 2000
-------- -------
Property and equipment:
Computer equipment and related software................. $ 21,656 $11,240
Furniture and fixtures.................................. 2,973 1,640
Leasehold improvements.................................. 3,876 1,864
Other................................................... 2,145 2,281
-------- -------
30,650 17,025
Accumulated depreciation and amortization............... (15,429) (8,530)
-------- -------
$ 15,221 $ 8,495
======== =======
Goodwill and other intangible assets:
Goodwill................................................ $ 34,334 $34,334
Core technology......................................... 15,790 15,790
Assembled workforce..................................... 1,210 1,210
Trademarks.............................................. 840 840
Non-compete agreements.................................. 710 710
-------- -------
52,884 52,884
Accumulated amortization................................ (16,771) (5,703)
-------- -------
$ 36,113 $47,181
======== =======
Accrued expenses:
Payroll and commission related.......................... $ 19,280 $ 9,992
Other................................................... 8,127 8,908
-------- -------
$ 27,407 $18,900
======== =======
Note 4. Stockholders' Equity
Common Stock
All share and per-share numbers herein reflect the two-for-one stock split
of the Company's common stock that occurred for stockholders of record on
February 3, 2000 and also on December 8, 2000, thus effecting an overall
four-for-one stock split.
Warrants
In February 1999, the Company announced that Gregory Q. Brown would join the
Company as Chairman of the Board and Chief Executive Officer and on February
17, 1999, he joined the Company as a full-time employee. The Company incurred
approximately $0.7 million of executive recruiting costs related to the hiring
of Mr. Brown. Included in this amount was a charge related to the fair value of
the warrant issued to the executive search firm to purchase 106,668 shares of
our common stock at a price of $7.41 per share, cash fees paid to the executive
search firm and certain relocation costs. The charge for the warrant was
determined in a manner consistent with SFAS No. 123, "Accounting for
Stock-Based Compensation" by using the Black-Scholes pricing model with the
following assumptions: expected dividend yield of 0.0%, risk-free interest rate
of 5.5%, expected volatility of 50%, and expected life of seven years.
Treasury Stock
In October 1998, the Board of Directors authorized the repurchase of up to
6.0 million shares, or approximately 9% of our outstanding common stock. As of
December 31, 1998, the Company had repurchased 2.0 million shares of its
outstanding common stock for approximately $9.5 million pursuant to the
repurchase program. The repurchased shares were held as treasury stock and were
available for general corporate purposes
41
including issuance under our stock option and employee stock purchase plans. In
January 1999, the Company announced the termination of the repurchase program.
As of September 30, 1999, all the shares of treasury stock had been reissued.
In September 2001, the Board of Directors authorized the repurchase of up to
1.5 million shares, or approximately 2% of our outstanding common stock. As of
September 30, 2001, the Company had repurchased 0.4 million shares of its
outstanding common stock for approximately $2.7 million pursuant to the
repurchase program. The repurchased shares are held as treasury stock and are
available for general corporate purposes including issuance under our stock
option and employee stock purchase plans.
Stock Option Plan
Under the Company's 1997 and 1998 Stock Option/Stock Issuance Plans (the
"Plans"), options to purchase shares of common stock may be granted to
employees, officers, directors and consultants (officers and directors are not
eligible for grants under the 1998 Plan). The Plans provide for the issuance of
incentive and non-statutory options that must be granted at an exercise price
not less than 100% and 85% of the fair market value of the common stock on the
date of grant, respectively (110% if the person to whom the option is granted
is a 10% stockholder). Incentive options may only be granted to employees under
the 1997 Plan. Options generally vest over four years from the date of grant.
The options expire between five and ten years from the grant date, and any
vested options must normally be exercised within three months after termination
of employment. The Plans are administered by the Company's Board of Directors
and its Compensation Committee.
A summary of the status of the Company's options under the Plans is as
follows:
Outstanding options
---------------------------------------------
Number of Weighted-average Weighted-average
shares exercise price fair value
---------- ---------------- ----------------
Balance as of September 30, 1998 5,921,564 $ 1.20 $ --
Granted at market value...... 8,967,852 6.88 3.97
Exercised.................... (1,955,440) 0.94 --
Canceled..................... (489,520) 3.03 --
---------- ------ ------
Balance as of September 30, 1999 12,444,456 5.26 --
Granted at market value...... 5,361,604 47.76 27.68
Exercised.................... (3,278,234) 3.82 --
Canceled..................... (1,334,178) 8.71 --
---------- ------ ------
Balance as of September 30, 2000 13,193,648 22.54 --
Granted at market value...... 2,696,182 45.82 30.18
Exercised.................... (3,098,274) 6.95 --
Canceled..................... (1,845,670) 42.32 --
---------- ------ ------
Balance as of September 30, 2001 10,945,886 $29.35 $ --
========== ====== ======
42
As of September 30, 2001, 2000 and 1999, there were 4,187,352, 3,523,410 and
1,896,672 fully vested and exercisable shares, with weighted-average exercise
prices of $21.51, $5.76 and $1.63, respectively. As of September 30, 2001,
approximately 3,792,198 shares were available for grant. The following table
summarizes information concerning outstanding and exercisable options under the
Plans outstanding as of September 30, 2001:
Outstanding Exercisable
-------------------------------------------- --------------------------
Weighted-average
Number of remaining life Weighted-average Number of Weighted-average
Range of exercise prices shares (in years) exercise price shares exercise price
- ------------------------ ---------- ---------------- ---------------- --------- ----------------
$ 0.58 - $ 6.56 1,430,264 5.61 $ 2.86 840,997 $ 2.58
7.00 - 16.19 3,664,280 6.81 9.10 1,938,917 8.91
16.38 - 37.44 1,682,407 8.28 28.10 405,484 28.62
37.50 - 61.00 2,798,232 8.37 47.78 621,093 50.52
61.28 - 82.75 1,129,970 7.91 70.75 327,606 68.86
83.06 - 106.22 240,733 8.67 94.83 53,255 95.54
---------- ---- ------ --------- ------
$ 0.58 - $106.22 10,945,886 7.44 $29.35 4,187,352 $21.51
========== ==== ====== ========= ======
The Company uses the intrinsic value method to account for all of its fixed
employee stock-based compensation plans. Accordingly, no compensation cost has
been recognized for its stock options in the accompanying consolidated
financial statements because the fair value of the underlying common stock
equals or exceeds the exercise price of the stock options at the date of grant,
except with respect to certain options issued in 1996 and during fiscal 1997.
The Company recorded deferred stock compensation expense of $229,000 for the
difference at the grant date between the exercise price and the fair value of
the common stock underlying the options issued in fiscal 1997 of which $47,000,
$56,000 and $56,000 was amortized in fiscal 2001, 2000, and 1999, respectively,
as the options vest over four years.
Had compensation cost for the Company's stock options and employee stock
purchase plan been determined in a manner consistent with SFAS No. 123,
"Accounting for Stock-Based Compensation", the Company's fiscal 2001 net income
would have decreased by $45.5 million, the fiscal 2000 net loss would have
increased by $11.1 million and the fiscal 1999 net income would have decreased
by $4.7. The basic and diluted earnings (loss) per share would have been
$(0.33) for both in fiscal 2001, $(0.19) for both in fiscal 2000 and $0.05 for
both in fiscal 1999.
The per share weighted-average fair value of stock options granted during
2001, 2000 and 1999 was $30.18, $27.68 and $3.97, respectively, on the date of
grant using the Black-Scholes pricing model, with the following weighted
assumptions: 2001--expected dividend yield of 0.0%, risk-free interest rate of
3.7%, expected volatility of 90% and expected life of four years;
2000--expected dividend yield of 0.0%, risk-free interest rate of 6.0%,
expected volatility of 80% and expected life of four years; 1999--expected
dividend yield of 0.0%, risk-free interest rate of 5.8%, expected volatility of
70% and expected life of four years;
The per share weighted-average fair values of Employee Stock Purchase Plan
shares granted during fiscal 2001, 2000 and 1999 were $41.17, $7.35 and $1.61,
respectively, calculated using the Black-Scholes pricing model with the
following weighted assumptions: 2001--expected dividend yield of 0.0%,
risk-free interest rate of 3.7%, expected volatility of 90%, and expected life
of 0.5 years; 2000--expected dividend yield of 0.0%, risk-free interest rate of
6.0%, expected volatility of 80%, and expected life of 0.5 years;
1999--expected dividend yield of 0.0%, risk-free interest rate of 5.3%,
expected volatility of 70%, and expected life of 0.5 years.
1998 Employee Stock Purchase Plan
In January 1998, the Board of Directors adopted the Company's 1998 Employee
Stock Purchase Plan (the "ESPP") to provide employees of the Company with an
opportunity to purchase common stock through payroll deductions. The ESPP
became effective at the time of the IPO. As of September 30, 2001,
approximately 992,133 shares of common stock have been reserved for issuance
under the ESPP.
43
All full-time regular employees who are employed by the Company are eligible
to participate in the ESPP. Eligible employees may contribute up to 15% of
their total cash compensation to the ESPP. Amounts withheld are applied at the
end of every six-month accumulation period to purchase shares of common stock,
but not more than 5,000 shares per employee per accumulation period. The value
of the common stock (determined as of the beginning of the offering period)
that may be purchased by any participant in a calendar year is limited to
$25,000. Participants may withdraw their contributions at any time before stock
is purchased.
The purchase price is equal to 85% of the lower of (a) the market price of
common stock immediately before the beginning of the applicable offering period
or (b) the market price of common stock at the time of the purchase. In
general, each offering period is 24 months long, but a new offering period
begins every six months. Thus, up to four overlapping offering periods may be
in effect at the same time. An offering period continues to apply to a
participant for the full 24 months, unless the market price of common stock is
lower when a subsequent offering period begins. In that event, the subsequent
offering period automatically becomes the applicable period for purposes of
determining the purchase price. The first accumulation and offering periods
commenced on February 13, 1998, the effective date of the IPO. The first
accumulation period ended on July 31, 1998, and the first offering period ended
on January 31, 2000. A total of 284,918, 453,296 and 505,036 shares of the
Company's common stock were issued under the ESPP in fiscal 2001, 2000, and
1999, respectively, at prices ranging from $6.49 per share to $68.69 per share.
Note 5. Income Taxes
The provision for income taxes was as follows (in thousands):
Year ended September 30,
-----------------------
2001 2000 1999
------- ------- ------
Current:
Federal............................................ $ -- $ 4,462 $ 28
State.............................................. 343 859 73
Foreign............................................ 7,568 4,678 1,634
------- ------- ------
Total Current.................................. 7,911 9,999 1,735
Deferred:
Federal............................................ -- (907) (712)
State.............................................. -- (220) (41)
Foreign............................................ 2,100 (37) (142)
------- ------- ------
Total Deferred................................. 2,100 (1,164) (895)
------- ------- ------
$10,011 $ 8,835 $ 840
======= ======= ======
The current tax benefits resulting from the exercise of employee stock
options are approximately $2.3 million, $8.9 million and $0.4 million in fiscal
2001, 2000 and 1999, respectively. These benefits are not included in the above
provision for income taxes.
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets are presented below (in thousands):
As of September 30,
------------------
2001 2000
-------- --------
Accruals and reserves not currently deductible............. $ 3,325 $ 1,006
Depreciation and amortization.............................. 26 125
State taxes................................................ (1,894) (662)
Acquired intangible property............................... (4,943) (6,788)
Tax credit carry-forwards.................................. 895 202
Other...................................................... -- --
Net operating loss carry-forwards.......................... 69,553 21,021
-------- --------
Total deferred tax assets............................... $ 66,962 14,904
Valuation allowance........................................ $(66,962) (12,804)
-------- --------
Net deferred tax assets................................. $ -- $ 2,100
======== ========
44
Included in gross deferred tax assets at September 30, 2001 is approximately
$64.5 million, which pertains to net operating loss carry-forwards from tax
deductions resulting from the exercise of employee stock options. When
recognized, the tax benefit of these losses is accounted for as a credit to
shareholders' equity rather than as a reduction of the income tax provision.
Also included in gross deferred tax assets at September 30, 2001 is
approximately $5.0 million which pertains to preacquisition net operating loss
carry-forwards of acquired companies. When recognized, the tax benefit of these
losses is accounted for as a reduction of nondeductible acquisition goodwill
rather than as a reduction of the income tax provision. The Company has
provided a valuation allowance to offset the net deferred tax assets which
primarily relate to US net operating loss carryforwards. The Company is unable
to conclude that all the deferred tax assets are more likely than not to be
realized from its US operations.
Income (loss) before income taxes was as follows (in thousands):
Year ended September 30,
------------------------
2001 2000 1999
------- ------- ------
United States......................................... $ 479 $(8,763) $1,373
International......................................... 30,801 15,504 7,353
------- ------- ------
Total.............................................. $31,280 $ 6,741 $8,726
======= ======= ======
Total income tax expense differs from expected income tax expense (computed
by applying the U.S. federal corporate income tax rate of 35% to profit before
taxes for fiscal 2001 and 34% to profit (loss) before taxes for both fiscal
2000 and 1999), as follows (in thousands):
Year ended September 30,
------------------------
2001 2000 1999
------- ------ -------
Income tax expense at federal statutory rate.......... $10,948 $2,292 $ 2,966
State income taxes, net of federal benefits........... 223 422 21
Meals and entertainment............................... 233 165 63
Nondeductible purchased research and development...... -- 3,878 --
Nondeductible goodwill from acquisitions.............. 2,335 1,426 --
Utilized losses....................................... -- -- (1,351)
Change in deferred tax asset.......................... -- -- (859)
Foreign income at other than US rates................. (3,265) 690 --
Tax credits........................................... (587) -- --
Other, net............................................ 124 (38) --
------- ------ -------
$10,011 $8,835 $ 840
======= ====== =======
As of September 30, 2001, the Company had net operating losses for federal,
state, and foreign purposes of approximately $158.4 million, $149.2 million,
and $18.7 million, respectively, available to offset taxable income in future
years. The federal net operating losses will expire, if not utilized, beginning
in 2018. The state net operating losses will expire, if not utilized, beginning
in 2003. The foreign net operating losses will expire at varying dates
depending on the laws of each country. Federal and state tax laws impose
substantial restrictions on the utilization of net operating loss
carry-forwards in the event of an "ownership change," as defined in Section 382
of the Internal Revenue Code. The Company has not yet determined whether an
ownership change occurred due to significant stock transactions in each of the
reporting years disclosed. If an ownership change has occurred, utilization of
the net operating loss carry-forwards could be significantly reduced.
U.S. Income taxes were not provided for on the undistributed earnings of
certain non-U.S. subsidiaries because the Company intends to reinvest these
earnings indefinitely in operations outside of the United States. The
cumulative total of all such undistributed earnings is $30.8 million.
45
Note 6. Defined Contribution Plan
In February 1998, the Company adopted a defined contribution plan (the
"Plan") in the United States pursuant to Section 401(k) of the Internal Revenue
Code (the "Code"). All eligible full and part-time employees of the Company who
meet certain age requirements may participate in the Plan. Participants may
contribute up to 20% of their pre-tax compensation, but not in excess of the
maximum allowable under the Code. The Plan allows for discretionary
contributions by the Company. Such discretionary contributions vest based on
the participant's length of service. In addition, the Company may make
profit-sharing contributions at the discretion of the Board of Directors. The
Company made no contributions during fiscal 2001, 2000 and 1999.
Note 7. Geographic and Segment Information
The Company's chief operating decision-maker is considered to be the
Company's Chief Executive Officer ("CEO"). The CEO reviews financial
information presented on a consolidated basis accompanied by certain geographic
information for purposes of making operating decisions and assessing financial
performance. Therefore, the Company operates as a single operating segment
fault management and service assurance software.
The Company markets its products primarily from the United States.
International sales are primarily to customers in France, Germany and the
United Kingdom. Information regarding regional revenues, which are based on the
location of the end-user, and operations in different geographic regions is as
follows (in thousands):
Year ended September 30,
-------------------------
2001 2000 1999
-------- -------- -------
Revenues:
United States................................. $130,392 $ 78,536 $41,208
United Kingdom................................ 38,242 23,477 10,725
Other International........................... 43,874 21,520 6,137
-------- -------- -------
Total..................................... $212,508 $123,533 $58,070
======== ======== =======
As of September 30,
-------------------------
2001 2000 1999
-------- -------- -------
Identifiable assets:
United States................................. $204,464 $179,715 $79,208
International................................. 69,174 17,296 11,397
-------- -------- -------
Total..................................... $273,638 $197,011 $90,605
======== ======== =======
Net assets:
United States................................. $157,426 $147,273 $68,633
International................................. 42,755 5,250 1,373
-------- -------- -------
Total..................................... $200,181 $152,523 $70,006
======== ======== =======
Note 8. Commitments
The Company leases its facilities and certain equipment under non-cancelable
operating leases. The lease agreements expire at various dates during the next
10 years.
Rent expense was approximately $4.5 million, $2.2 million and $1.4 million
for the years ended September 30, 2001, 2000 and 1999, respectively. As of
September 30, 2001, future minimum lease payments under non-cancelable
operating leases are expected to be approximately $4.5 million, $4.2 million,
$4.1 million, $3.5 million, $3.2 million and $5.6 million for each of the years
in the five-year period subsequent to September 30, 2001 and thereafter,
respectively.
46
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Micromuse Inc.
We have audited the accompanying consolidated balance sheets of Micromuse
Inc. and subsidiaries (the Company) as of September 30, 2001 and 2000, and the
related consolidated statements of operations, stockholders' equity and
comprehensive income (loss), and cash flows for each of the years in the
three-year period ended September 30, 2001. 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 Micromuse
Inc. and subsidiaries as of September 30, 2001 and 2000, and the results of
their operations and their cash flows for each of the years in the three-year
period ended September 30, 2001, in conformity with accounting principles
generally accepted in the United States of America.
/S/ KPMG LLP
Mountain View, California
October 19, 2001
47
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The following table provides certain information regarding the executive
officers of the Company:
Name Age Position
---- --- --------
Gregory Q. Brown............................. 41 Chairman of the Board and Chief Executive Officer
Michael L. Luetkemeyer....................... 52 Senior Vice President & Chief Financial Officer
Katrinka B. McCallum......................... 34 Director and Executive Vice President and Chief
Operating Officer
James B. De Golia............................ 52 Senior Vice President, General Counsel and Secretary
Michael S. Donohue........................... 42 Senior Vice President, Sales and Business Operations
Gregory Q. Brown was named Chairman and CEO of Micromuse Inc. in February
1999. His 20 years of high-tech experience includes leadership positions in the
telecommunications, data networking, cable TV and computer software industries.
From September 1996 until joining Micromuse Inc., Mr. Brown served as president
of Ameritech Custom Business Services, a unit of Ameritech Corporation that
provides large business customers with custom communications and information
technology. This $1.4 billion unit served many Fortune 500 companies as a
single source for the provisioning and management of network and desktop-based
voice, data, video, and local-access services. For the three years prior to his
position at Custom Business Services, Brown was president of Ameritech New
Media Inc. As president, Brown was responsible for all of Ameritech's consumer
cable TV operations. Additionally Mr. Brown was a member of the board of
directors of Americast, the video programming joint venture involving
Ameritech, The Walt Disney Company, GTE, Bell South, and Southern New England
Telephone. Before joining Ameritech in 1987, Mr. Brown held a variety of sales
and marketing positions with AT&T in Detroit, Michigan for five years. He also
worked for IBM in various sales and support capacities in the early 1980's. In
September 2001 Mr. Brown was appointed to the Board of Directors of R.R.
Donnelley & Sons Company and was also elected to the Board of Trustees of the
Walter Kaitz Foundation, a national organization dedicated to achieving
diversity within the cable/broadband industry. Mr. Brown received his degree in
Economics from Rutgers University in June 1982.
Michael L Luetkemeyer was named Senior Vice President and Chief Financial
Officer of Micromuse Inc. in October 2001. Mr. Luetkemeyer's experience
includes an extensive background in managing global finance organizations for
high-tech and scientific-engineering firms. Prior to Micromuse, Mr. Luetkemeyer
was the CFO at a network management software provider, Aprisma Management
Technologies Inc. Before joining Aprisma in 2000, Mr. Luetkemeyer was CFO at
Rawlings Sporting Goods, a provider of sports equipment, and at Electronic
Retailing Systems, a technology start-up. Mr. Luetkemeyer has held a variety of
senior finance positions throughout his career, including more than 10 years
with General Electric, where he served with GE Aerospace, GE Semiconductor and
GE Plastics. Mr. Luetkemeyer graduated from Southwest Missouri State in 1972
with a BS in Finance. He earned his Masters in Economics from the University of
Missouri in 1975 and a BS in Accounting from Rollins College in 1985.
Katrinka B. McCallum joined Micromuse in July 2001 as a Director and
Executive Vice President and Chief Operating Officer. Prior to Micromuse, Ms.
McCallum served as General Manager and Senior Vice President of Operations at
Aprisma Management Technologies Inc., a network management software company
being spun off from Cabletron Systems, Inc. Before joining Cabletron in 1997,
Ms. McCallum's previous positions include the Manager of Mergers & Acquisitions
for CIGNA/Healthsource, Inc. and senior financial management positions at
AlliedSignal Corporation, GE Capital Corporation and Deloitte & Touche. Ms.
McCallum became a CPA in 1992. She received her MBA from the Fuqua School of
Business at Duke University, and her BA in Economics from Wellesley College.
48
James B. De Golia became Senior Vice President in September 1999 having
joined Micromuse in January 1999 as Vice President, General Counsel and
Secretary. He has provided counsel to high tech companies for over 20 years.
For 10 years prior to joining the Company, Mr. De Golia was Vice President and
General Counsel of N.E.T. Prior to that, Mr. De Golia was Counsel at Xerox
Corporation and an attorney at the San Francisco office of Thelan Marrin
Johnson and Bridges (now Thelan Reid & Priest). He received his B.A. from the
University of California at Irvine and his J.D. from the University of
California, Hastings College of the Law.
Michael S. Donohue, joined Micromuse as Vice President, Western Region Sales
in December 1998. He was promoted to his present position to Senior Vice
President, World-Wide Sales in March 1999. Before joining Micromuse, Mr.
Donohue held senior vice president and corporate officer positions at Computer
Associates. At Computer Associates, Mr. Donohue was responsible for selling to
organizations with revenues in excess of $100 million in the western states. In
addition, he was part of the sales team that launched the CA Unicenter(R)
enterprise management software line. Prior to Computer Associates, Mr. Donohoe
held sales, technical and management positions at Texas Instruments and Storage
Technology Corporation over a 10 year period from 1981 - 1991. Mr. Donohoe
received his degree in Operations Management from the University of Arizona in
1981.
The information regarding directors and Section 16 reporting compliance
required by Item 10 is incorporated herein by reference from the sections
entitled "Proposal No. 1 -- Election of Directors" and "Section 16(a)
Beneficial Ownership Reporting Compliance" of the Proxy Statement.
Item 11. Executive Compensation
The information required by Item 11 is incorporated herein by reference from
the section entitled "Executive Compensation" and other relevant portions of
the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 12 is incorporated herein by reference from
the section entitled "Security Ownership of Certain Beneficial Owners and
Management" of the Proxy Statement.
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is incorporated herein by reference from
the section entitled "Compensation Committee Interlocks and Insider
Participation" of the Proxy Statement.
PART IV
Item 14. Exhibits, Financial Statements Schedule, and Reports on Form 8-K
(a)(1) Financial Statements
See the Consolidated Statements beginning on page 31 of this Form
10-K.
(2) Financial Statement Schedule
See the Financial Statement Schedule at page 51 of this Form 10-K.
(3) Exhibits
See Exhibit Index at page 52 of this Form 10-K.
(b) Reports on Form 8-K. There were no reports on form 8-K filed during the
quarter ended September 30, 2001.
(c) See Exhibit Index at page 52 of this Form 10-K.
(d) See the Consolidated Financial Statements beginning on page 31 and
Financial Statement Schedule at page 51 of this Form 10-K.
49
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
MICROMUSE INC.
/S/ MICHAEL L. LUETKEMEYER
By: _________________________________
Michael L. Luetkemeyer
Senior Vice President and
Chief Financial Officer
Date: December 21, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons, on behalf of the
Registrant in the capacities and on the dates indicated:
Name Title Date
/S/ GREGORY Q. BROWN Chairman and Chief Executive December 21, 2001
- -------------------------- Officer (Principal Executive
(Gregory Q. Brown) Officer)
/S/ MICHAEL L. LUETKEMEYER Senior Vice President and Chief December 21, 2001
- -------------------------- Financial Officer (Principal
(Michael L. Luetkemeyer) Financial and Accounting
Officer)
/S/ MICHAEL E.W. JACKSON Director December 21, 2001
- --------------------------
(Michael E.W. Jackson)
/S/ KATRINKA B. MCCALLUM Director December 21, 2001
- --------------------------
(Katrinka B. McCallum)
/S/ DAVID C. SCHWAB Director December 21, 2001
- --------------------------
(David C. Schwab)
/S/ KATHLEEN M.H. WALLMAN Director December 21, 2001
- --------------------------
(Kathleen M.H. Wallman)
50
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
Years Ended September 30, 2001, 2000 and 1999
(In thousands)
Balance at Charged to Balance at
Beginning Costs and End of
Description of Period Expenses Deductions Period
- ----------- ---------- ---------- ---------- ----------
Allowance for doubtful accounts:
Year Ended September 30, 2001... $1,472 3,156 (390) $4,238
Year Ended September 30, 2000... $ 282 1,217 (27) $1,472
Year Ended September 30, 1999... 153 411 (282) 282
51
STOCKHOLDERS INFORMATION
BOARD OF DIRECTORS
Gregory Q. Brown
Chairman of the Board & Chief Executive Officer
Michael E.W. Jackson
Chairman, Elderstreet Investments
Chairman, The Sage Group
Deputy Chairman, British Thornton Holdings, plc
Katrinka B. McCallum
Executive Vice President & Chief Operating Officer
David C. Schwab
Venture Partner, Sierra Ventures
Kathleen M.H. Wallman
Wallman Strategic Consulting, LLC
SENIOR EXECUTIVES
Gregory Q. Brown
Chairman of the Board & Chief Executive Officer
Katrinka B. McCallum
Executive Vice President & Chief Operating Officer
Michael L. Luetkemeyer
Senior Vice President & Chief Financial Officer
James B. De Golia
Senior Vice President, General Counsel & Secretary
Michael S. Donohue
Senior Vice President, Sales & Business Operations
Timothy N. Heywood
Senior Vice President, Technical Services
Alan D. Williams
Senior Vice President, Human Resources
MICROMUSE WEB SITE
www.micromuse.com
Click "Investors"
INDEPENDENT ACCOUNTANT
KPMG LLP
Mountain View, California
TRANSFER AGENT AND REGISTRAR
Mellon Investor Services LLC
San Francisco, California
INVESTOR RELATIONS
investor.relations@micromuse.com
Micromuse Inc.
139 Townsend St.
San Francisco,California 94107
Tel - (415) 538-9090
Fax - (415) 538-9091
ANNUAL MEETING
We cordially invite you to attend the Annual Meeting of Stockholders of
Micromuse Inc., which will be held at the Palace Hotel, 2 New Montgomery
Street, San Francisco, California 94105 on Thursday, January 31, 2002, at 10:00
a.m., Pacific Standard Time.
TRADEMARK INFORMATION
Netcool(R) is a registered trademark of Micromuse. All other trademarks or
service marks appearing in this report are trademarks or service marks of the
respective companies that utilize them.
[LOGO] MicroMuse_OBC
EXHIBIT INDEX
Exhibit
Number Description
- ------ -----------
3.1 Restated Certificate of Incorporation of the Registrant
3.2(2) Amended and Restated Bylaws of the Registrant.
10.1(1) Form of Indemnity Agreement entered into between the Registrant and its directors and officers.
10.2(1) 1997 Stock Option/Stock Issuance Plan and forms of agreements thereunder, as amended.*
10.3(1) 1997 Employee Stock Purchase Plan.*
10.4(1) Amended and Restated Investors' Rights Agreement by and among the Registrant and certain
stockholders of the Registrant, dated as of September 8, 1997.
10.5(1) Office lease dated as of March 25, 1997, by and between the Registrant and SOMA Partners, L.P.
10.6(1) Office lease dated as of March 3, 1997, by and between Micromuse plc, Marldown Limited and
Christopher J. Dawes.
10.7(1) Office lease dated as of March 3, 1993, by and between Micromuse plc, Guildquote Limited and
Christopher J. Dawes.
10.10 Employment Agreement as of February 17, 1999, by and between Gregory Q. Brown and
Micromuse Inc.*
10.11(3) Agreement and Plan of Reorganization by and among Micromuse Inc., CAN Acquisition
Corporation. and Calvin Alexander Networking, Inc.
10.12(4) Agreement and Plan of Reorganization by and among Micromuse Inc., Salamander Acquisition
Corporation and NetOps, Corporation.
10.13 First amendment to office lease, dated as of October 25, 2000, by and between the Registrant and
SOMA Partners, L.P.
10.14 Offer of employment as of July 12, 2001, by and between Katrinka B. McCallum and
Micromuse Inc.*
21.1 Subsidiaries of the Registrant.
23.1 Report on Schedule and Consent of Independent Auditors
- --------
(1) Incorporated by reference from the exhibit of the same number in the
Registrant's Registration Statement on Form S-1 (Registration No.
333-42177) as filed with the SEC on February 12, 1998.
(2) Incorporated by reference from the exhibit of the same number in the
Registrant's Registration Statement on Form S-1 (Registration No.
333-58975) as filed with the SEC on July 13, 1998.
(3) Incorporated by reference from the exhibit of the same number in the
Registrant's Form 10-K for the fiscal year ended September 30, 1999, as
filed with the SEC on December 28,1999.
(4) Incorporated by reference from exhibit 2.1 to the Registrant's Form 8-K as
filed with the SEC on August 2, 2000.
* Indicates management contracts.
52