0000950135-01-503347.txt : 20011128 0000950135-01-503347.hdr.sgml : 20011128 ACCESSION NUMBER: 0000950135-01-503347 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011107 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CONCORD COMMUNICATIONS INC CENTRAL INDEX KEY: 0000915290 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 042710876 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-23067 FILM NUMBER: 1776828 BUSINESS ADDRESS: STREET 1: 600 NICKERSON RD CITY: MARLBORO STATE: MA ZIP: 01752 BUSINESS PHONE: 5084604646 MAIL ADDRESS: STREET 1: 600 NICKERSON RD CITY: MARLBORO STATE: MA ZIP: 01752 10-Q 1 b40859cce10-q.txt CONCORD COMMUNICATIONS INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended September 30, 2001. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from ____________ to ______________. COMMISSION FILE NUMBER 0-23067 CONCORD COMMUNICATIONS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MASSACHUSETTS 04-2710876 (State of incorporation) (IRS Employer Identification Number) 600 NICKERSON ROAD MARLBORO, MASSACHUSETTS 01752 (508) 460-4646 (ADDRESS AND TELEPHONE OF PRINCIPAL EXECUTIVE OFFICES) ---------------- INDICATE BY CHECK MARK WHETHER REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS, AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS; YES X NO 16,727,333 SHARES OF THE REGISTRANT'S COMMON STOCK, $0.01 PAR VALUE, WERE OUTSTANDING AS OF NOVEMBER 5, 2001. THIS DOCUMENT CONTAINS 32 PAGES. THE EXHIBIT INDEX IS ON PAGE 26. CONCORD COMMUNICATIONS, INC. FORM 10-Q, SEPTEMBER 30, 2001 CONTENTS
Item Number Page PART I: FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements (unaudited) Condensed Consolidated Balance Sheets: September 30, 2001 and December 31, 2000 3 Condensed Consolidated Statements of Operations: Three and nine months ended September 30, 2001 and September 30, 2000 4 Consolidated Statements of Cash Flows: Nine months ended September 30, 2001 and September 30, 2000 5 Notes to Condensed Consolidated Financial Statements 6-9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10-21 Item 3. Quantitative and Qualitative Disclosures about Market Risk 22 PART II: OTHER INFORMATION Item 1. Legal Proceedings 23 Item 2. Changes in Securities and Use of Proceeds 23 Item 3. Defaults Upon Senior Securities 23 Item 4. Submission of Matters to a Vote of Security Holders 23 Item 5. Other Information 24 Item 6. Exhibits and Reports on Form 8-K 24 SIGNATURE 25 EXHIBIT INDEX 26
2 PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONCORD COMMUNICATIONS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30, DECEMBER 31, 2001 2000 ------------- ------------- ASSETS Current Assets: Cash, cash equivalents and marketable securities $ 68,373,391 $ 63,251,427 Accounts receivable, net of allowance of $1,458,786 and $1,525,965 in 2001 and 2000, respectively 15,423,424 20,000,193 Prepaid expenses and other current assets 3,069,808 2,409,350 ------------- ------------- Total current assets 86,866,623 85,660,970 ------------- ------------- Equipment and Improvements, at cost: Equipment 19,366,597 16,085,465 Leasehold improvements 6,018,960 6,080,105 ------------- ------------- 25,385,557 22,165,570 Less -- Accumulated depreciation and amortization 13,409,335 9,140,170 ------------- ------------- Equipment and Improvements, net 11,976,222 13,025,400 ------------- ------------- Deferred Tax Asset 3,500,000 3,500,000 Other Long-term Assets 102,849 89,689 ------------- ------------- $ 102,445,694 $ 102,276,059 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable $ 3,265,942 $ 3,117,627 Accrued expenses 14,118,964 11,108,921 Deferred revenue 22,345,491 17,303,928 ------------- ------------- Total current liabilities 39,730,397 31,530,476 ------------- ------------- Stockholders' Equity: Common Stock, $0.01 par value: Authorized -- 50,000,000 shares Issued and outstanding -- 16,704,489 and 16,554,944 shares, in 2001 and 2000 respectively 167,045 165,549 Additional paid-in capital 95,129,414 95,479,340 Deferred compensation (98,604) (1,509,880) Accumulated other comprehensive income 2,224,255 135,159 Accumulated deficit (34,706,813) (23,524,585) ------------- ------------- Total stockholders' equity 62,715,297 70,745,583 ------------- ------------- $ 102,445,694 $ 102,276,059 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. 3 CONCORD COMMUNICATIONS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED ----------------------------------- ----------------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2001 2000 2001 2000 ------------- ------------- ------------- ------------- Revenues: License revenues $ 13,207,481 $ 17,514,786 $ 39,759,656 $ 49,875,324 Service revenues 8,632,804 5,873,824 24,125,715 15,592,033 ------------ ------------ ------------ ------------ Total revenues 21,840,285 23,388,610 63,885,371 65,467,357 Cost of Revenues 4,103,474 3,882,222 13,460,338 8,884,291 ------------ ------------ ------------ ------------ Gross profit 17,736,811 19,506,388 50,425,033 56,583,066 ------------ ------------ ------------ ------------ Operating Expenses: Research and development 6,030,382 5,116,687 18,716,078 14,587,693 Sales and marketing 12,872,464 11,591,202 38,178,493 31,417,074 General and administrative 2,029,605 2,172,194 6,821,317 5,292,020 Stock-based compensation 41,360 163,061 281,790 632,232 Acquisition-related charges -- -- -- 4,300,000 ------------ ------------ ------------ ------------ Total operating expenses 20,973,811 19,043,144 63,997,678 56,229,019 ------------ ------------ ------------ ------------ Operating (loss) income (3,237,000) 463,244 (13,572,645) 354,047 Other income net 865,865 723,765 2,390,416 2,275,139 ------------ ------------ ------------ ------------ (Loss) income before income taxes and extraordinary items (2,371,135) 1,187,009 (11,182,229) 2,629,184 Provision for income taxes -- 286,853 -- 774,083 ------------ ------------ ------------ ------------ (Loss) income before extraordinary items (2,371,135) 900,156 (11,182,229) 1,855,100 Extraordinary loss upon early retirement of debt, net of tax benefit of $72,000 -- -- -- (216,010) ------------ ------------ ------------ ------------ Net (loss) income $ (2,371,135) $ 900,156 $(11,182,229) $ 1,639,093 ============ ============ ============ ============ Net (loss) income per common and potential common share: Basic $ (0.14) $ 0.06 $ (0.67) $ 0.10 ============ ============ ============ ============ Diluted $ (0.14) $ 0.05 $ (0.67) $ 0.10 ============ ============ ============ ============ Weighted average common and potential commons shares outstanding: Basic 16,699,679 16,358,289 16,644,181 16,027,204 ============ ============ ============ ============ Diluted 16,699,679 16,781,328 16,644,181 16,584,995 ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 4 CONCORD COMMUNICATIONS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED ------------------------------------ SEPTEMBER 30, SEPTEMBER 30, 2001 2000 ------------- ------------- Cash Flows from Operating Activities: Net (loss) income $(11,182,229) $ 1,639,093 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Depreciation and amortization 4,612,633 3,123,403 Stock-based compensation 281,790 632,232 Changes in current assets and liabilities: Accounts receivable 4,576,769 (6,016,273) Prepaid expenses and other assets (673,618) (588,991) Accounts payable 148,315 (745,137) Accrued expenses 3,010,043 (64,460) Deferred revenue 5,041,563 5,231,761 ------------ ------------ Net cash provided by operating activities 5,815,266 3,211,627 ------------ ------------ Cash Flows from Investing Activities: Purchases of equipment and improvements (3,563,454) (8,507,689) Net (investments in) proceeds from marketable securities (5,191,516) 2,511,674 ------------ ------------ Net cash used in investing activities (8,754,970) (5,996,015) ------------ ------------ Cash Flows from Financing Activities: Repayments of bank borrowings -- (2,962,466) Proceeds from shares issued in connection with employee stock plans and warrants exercised 781,055 2,042,860 ------------ ------------ Net cash provided by (used in) financing activities 781,055 (919,606) ------------ ------------ Net Decrease in Cash and Cash Equivalents (2,158,649) (3,703,994) Cash and Cash Equivalents, beginning of period 10,725,265 10,629,528 ------------ ------------ Cash and Cash Equivalents, end of period $ 8,566,616 $ 6,925,534 ============ ============ Supplemental Disclosure of Cash Flow Information: Cash paid for interest $ -- $ 33,592 ============ ============ Cash paid for taxes $ 245,602 $ 558,770 ============ ============ Supplemental Disclosure of Noncash Transactions: Reversal of deferred compensation related to forfeited stock options $ (1,129,486) $ -- ============ ============ Retirement of fully depreciated assets $ 343,467 $ -- ============ ============ Conversion of redeemable convertible preferred stock to common stock $ -- $ 11,723,017 ============ ============ Unrealized gain on available-for-sale securities $ 2,089,097 $ 595,597 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 5 CONCORD COMMUNICATIONS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FORM 10-Q, SEPTEMBER 30, 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying consolidated financial statements have been presented by Concord Communications, Inc. (the "Company") unaudited (except the balance sheet information as of December 31, 2000 which has been derived from audited financial statements) in accordance with accounting principles generally accepted in the United States for interim financial statements and with the instructions to Form 10-Q and Regulation S-X pertaining to interim financial statements. Accordingly, these interim financial statements do not include all information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The financial statements reflect all adjustments and accruals which management considers necessary for a fair presentation of financial position as of September 30, 2001 and the results of operations for the three and nine months ended September 30, 2001 and 2000. The results for the interim periods presented are not necessarily indicative of results to be expected for any future period. The financial statements should be read in conjunction with the audited financial statements and the notes thereto included in the Company's 2000 Annual Report on Form 10-K filed with the Securities and Exchange Commission in March 2001. REVENUE RECOGNITION The Company's revenues consist of software license revenues and service revenues. Software license revenues are recognized in accordance with the American Institute of Certified Public Accountants' Statement of Position ("SOP") 97-2, Software Revenue Recognition, as modified by SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition with respect to Certain Transactions. Under SOP 97-2, software license revenues are recognized upon execution of a contract and delivery of software, provided that the license fee is fixed and determinable, no significant production, modification or customization of the software is required and collection is considered probable by management. Revenues under multiple element arrangements, which typically include software products and maintenance sold together, are allocated to each element using the residual method in accordance with SOP 98-9. Service revenues are recognized as the services are performed. Maintenance revenues are derived from customer support agreements generally entered into in connection with initial license sales and subsequent renewals. Maintenance revenues are recognized ratably over the term of the maintenance period. Payments for maintenance fees are generally made in advance. RECLASSIFICATIONS Certain amounts in the prior year's financial statements have been reclassified to conform to the current year's presentation. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 2. BASIC AND DILUTED INCOME/LOSS PER COMMON SHARE The Company follows the provisions of Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share. SFAS No. 128 establishes standards for computing and presenting earnings per share and applies to entities with publicly held common stock or potential common stock. Basic net (loss) income per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of common and dilutive common-equivalent shares outstanding during the period. Dilutive common-equivalent shares primarily consist 6 of employee stock options. Diluted loss per share is the same as basic loss per share for the three and nine month periods ended September 30, 2001, as the effects of potential common stock are antidilutive. For the three and nine months ended September 30, 2001, employee stock options to purchase 2,318,735 and 2,436,069 shares, respectively, were outstanding but not included in the diluted weighted-average share calculation as the effect would have been antidilutive. Calculations of the basic and diluted net income/(loss) per share and potential common share are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED -------------------------------- -------------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2001 2000 2001 2000 ------------- ------------- ------------- ------------- Net (loss) income available to common stockholders ...................................... $ (2,371,135) $ 900,156 $(11,182,229) $ 1,639,093 ============ ============ ============ ============ Weighted average common shares outstanding .......... 16,699,679 16,358,289 16,644,181 16,027,204 Potential common shares pursuant to stock options and warrants ...................................... -- 423,039 -- 557,791 Diluted weighted average shares ..................... 16,699,679 16,781,328 16,644,181 16,584,995 ------------ ------------ ------------ ------------ Basic net (loss) income per common share ............ $ (0.14) $ 0.06 $ (0.67) $ 0.10 ============ ============ ============ ============ Diluted net (loss) income per common and potential common share ........................ $ (0.14) $ 0.05 $ (0.67) $ 0.10 ============ ============ ============ ============
3. COMPREHENSIVE (LOSS) INCOME Comprehensive (loss) income for the three months and nine months ended September 30, 2001 and 2000 is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED ------------------------------------ ------------------------------------ SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2001 2000 2001 2000 ------------- ------------- ------------- ------------- Net (loss) income .............. $ (2,371,135) $ 900,156 $(11,182,229) $ 1,639,093 Unrealized gain on marketable securities ................... 1,434,424 543,097 2,089,097 595,597 ------------ ------------ ------------ ------------ Comprehensive (loss) income .... $ (936,711) $ 1,443,253 $ (9,093,133) $ 2,234,690 ============ ============ ============ ============
4. ACQUISITIONS On February 4, 2000, the Company consummated a transaction pursuant to which it acquired FirstSense Software, Inc. ("FirstSense"). Under the terms of the agreement, the shareholders and option holders of FirstSense received an aggregate of 1,940,000 equivalent Concord shares to effect the business combination. The transaction has been accounted for as a pooling of interests. Accordingly, all prior period financial statements presented have been restated to reflect the combination of the respective companies, as required by APB Opinion No. 16, "Accounting for Business Combinations". All inter-company transactions have been eliminated as a result of the business combination. As a part of the transaction, the Company incurred direct, acquisition-related charges of approximately $4,300,000. All such costs have been charged to operations in fiscal 2000 upon consummation of the FirstSense acquisition in February 2000. 7 5. SEGMENT REPORTING AND INTERNATIONAL INFORMATION The Company follows the provisions of SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. SFAS No. 131 also establishes standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise about which separate, discrete financial information is available for evaluation by the chief operating decision maker, or decision making group, in making decisions on how to allocate resources and assess performance. The Company's chief decision making group, as defined under SFAS 131, is the Executive Management Committee. The following table presents the approximate revenue by major geographical regions:
THREE MONTHS ENDED NINE MONTHS ENDED ---------------------------------- ---------------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2001 2000 2001 2000 ------------- ------------- ------------- ------------- United States ........ $12,951,000 $15,590,000 $39,545,000 $44,844,000 Europe ............... 6,197,000 3,938,000 15,234,000 12,223,000 Rest of the World..... 2,692,000 3,861,000 9,106,000 8,400,000 ----------- ----------- ----------- ----------- Total ................ $21,840,000 $23,389,000 $63,885,000 $65,467,000 =========== =========== =========== ===========
For the three month period ending September 30, 2001, the United States and France each accounted for greater than 10% of total revenues. Except for the United States, no one country accounted for greater than 10% of total revenues in the three months ended September 30, 2000 or the nine months ended September 30, 2001 and 2000 respectively. Substantially all of the Company's assets are located in the United States. The Company's reportable segments are determined by customer type: service providers/telecommunications companies (SP/T) and enterprise. The accounting policies of the segments are the same as those described in Note 1. The Executive Management Committee evaluates segment performance based on revenue. Accordingly, all expenses are considered corporate level activities and are not allocated to segments. Also, the Executive Management Committee does not assign assets to these segments. The following table presents the approximate revenue by reportable segment:
THREE MONTHS ENDED NINE MONTHS ENDED ---------------------------------- ---------------------------------- SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2001 2000 2001 2000 ------------- ------------- ------------- ------------- SP/T .......... $10,461,000 $11,797,000 $29,362,000 $29,570,000 Enterprise..... 11,379,000 11,592,000 34,523,000 35,897,000 ----------- ----------- ----------- ----------- Total ......... $21,840,000 $23,389,000 $63,885,000 $65,467,000 =========== =========== =========== ===========
8 6. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("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 as either assets or liabilities in the balance sheet and measure those instruments 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. Pursuant to SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, SFAS 133 is effective for all quarters of fiscal years beginning after June 15, 2000. The adoption did not have a material effect on the Company's consolidated financial position or results of operations. On June 30, 2001, the FASB issued SFAS No. 141, Accounting for Business Combinations, and SFAS No. 142, Accounting for Goodwill and Other Intangible Assets. SFAS 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method. Upon adoption of SFAS No. 142, goodwill will no longer be subject to amortization over its estimated useful life. Rather, goodwill will be subject to at least an annual assessment of impairment by applying a fair-value based test. The Company does not anticipate that the adoption of these statements will have a material impact on the financial position or results of operations or cash flows. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 144 further refines the requirements of SFAS No. 121 that companies (1) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable based on its undiscounted future cash flows and (2) measure an impairment loss as the difference between the carrying amount and fair value of the asset. In addition, SFAS No. 144 provides guidance on accounting and disclosure issues surrounding long-lived assets to be disposed of by sale. The Company does not anticipate that the adoption of this statement will have a material impact on its financial position or results of operations or cash flows. 9 CONCORD COMMUNICATIONS, INC. FORM 10-Q, SEPTEMBER 30, 2001 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Concord develops, markets and supports a suite of highly scalable software solutions, our eHealth(TM) Suite family of products, which maximizes the availability and performance of networks, systems, and applications that form the critical underlying IT infrastructure on which businesses depend for their operations. Concord's software solutions monitor fault conditions throughout the infrastructure in real time; test availability and responsiveness of critical services; collect, consolidate, normalize and analyze high volumes of data from the IT infrastructure; alert IT personnel to faults and potential outages and automatically execute corrective action to restore availability and maximize uptime of the IT infrastructure, if desired. This document contains forward-looking statements. Any statements contained herein that do not describe historical facts are forward-looking statements. Concord makes such forward-looking statements under the provisions of the "safe harbor" section of the Private Securities Litigation Reform Act of 1995. The forward-looking statements contained herein are based on current expectations, but are subject to a number of risks and uncertainties. Concord's actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed elsewhere in this Form 10-K under the heading "Risk Factors". RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain financial data as percentages of the Company's total revenues:
UNAUDITED THREE MONTHS ENDED NINE MONTHS ENDED ------------------------------ ------------------------------ SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 2001 2000 2001 2000 ------------- ------------- ------------- ------------- Revenues: License revenues 60.5% 74.9% 62.2% 76.2% Service revenues 39.5 25.1 37.8 23.8 ----- ----- ----- ----- Total revenues 100.0 100.0 100.0 100.0 Cost of Revenues 18.8 16.6 21.1 13.6 ----- ----- ----- ----- Gross profit 81.2 83.4 78.9 86.4 Operating Expenses: Research and development 27.6 21.9 29.3 22.3 Sales and marketing 58.9 49.6 59.8 48.0 General and administrative 9.3 9.3 10.7 8.1 Stock-based compensation 0.2 0.7 0.4 1.0 Acquisition-related charges 0.0 0.0 0.0 6.6 ----- ----- ----- ----- Total operating expenses 96.0 81.4 100.2 85.9 ----- ----- ----- ----- (Loss) income from Operations (14.8) 2.0 (21.1) 0.5 Other income, net 4.0 3.1 3.7 3.5 ----- ----- ----- ----- (Loss) income before taxes and extraordinary items (10.8) 5.1 (17.4) 4.0 Provision for income taxes 0.0 1.2 0.0 1.2 ----- ----- ----- ----- (Loss) income before extraordinary items (10.8) 3.8 (17.4) 2.8 Extraordinary items 0.0 0.0 0.0 (0.3) ----- ----- ----- ----- Net (loss) income (10.8)% 3.8% (17.4)% 2.5% ----- ----- ----- -----
10 TOTAL REVENUES. The Company's total revenues decreased 6.6% to $21.8 million in the three months ended September 30, 2001 from $23.4 million in the three months ended September 30, 2000. Total revenue decreased 2.4% to $63.9 million in the nine months ended September 30, 2001 from $65.5 million in the nine months ended September 30, 2000. LICENSE REVENUES. The Company's license revenues, which are derived from the licensing of software products, decreased 24.6% to $13.2 million, or 60.5% of total revenues, in the three months ended September 30, 2001, from $17.5 million, or 74.9% of total revenues in the three months ended September 30, 2000. License revenues decreased 20.3% to $39.8 million, or 62.2% of total revenues, in the nine months ended September 30, 2001, from $49.9 million, or 76.2% of total revenues in the nine months ended September 30, 2000. The decrease of license revenues is due to the general slowdown of the economy in the United States and abroad which negatively affected IT infrastructure spending. The decrease in license revenues as a percent of total revenues was, in part, due to a significant increase in service revenues. SERVICE REVENUES. The Company's service revenues, which consist of fees earned for maintenance, training and professional services, increased 47% to $8.6 million, or 39.5% of total revenues, in the three months ended September 30, 2001 from $5.9 million, or 25.1% of total revenues, in the three months ended September 30, 2000. Service revenues increased 54.7% to $24.1 million, or 37.8% of total revenues, in the nine months ended September 30, 2001 from $15.6 million, or 23.8% of total revenues, in the nine months ended September 30, 2000. The increase in service revenues was attributed to an increase of our customer base and the resulting demand for services by these customers. COST OF REVENUES. Cost of revenues includes expenses associated with royalty costs, production, fulfillment and product documentation, along with personnel costs associated with providing customer support in connection with maintenance, training and professional service contracts. Royalty costs are composed of third party software costs. Cost of revenues increased 5.7% to $4.1 million, or 18.8% of total revenues, in the three months ended September 30, 2001 from $3.9 million, or 16.6% of total revenues, in the three months ended September 30, 2000, resulting in gross margins of 81.2% and 83.4% in each respective period. Cost of revenues increased 50.3% to $13.5 million, or 21.1% of total revenues, in the nine months ended September 30, 2001 from $8.9 million, or 13.6% of total revenues, in the nine months ended September 30, 2000, resulting in gross margins of 78.9% and 86.4% in each respective period. The increase in cost of revenues as a percent of total revenues was primarily driven by the increased spending in customer support to be more responsive to growing customer needs. We expect to decrease our cost of revenues as a percentage of total revenues; however, this will depend on our royalty costs and our growth, among other factors. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses consist primarily of personnel costs associated with software development. Research and development expenses increased 17.9% to $6.0 million, or 27.6% of total revenues, in the three months ended September 30, 2001 from $5.1 million, or 21.9% of total revenues, in the three months ended September 30, 2000. Research and development expenses increased 28.3% to $18.7 million, or 29.3% of total revenues, in the nine months ended September 30, 2001 from $14.6 million, or 22.3% of total revenues, in the nine months ended September 30, 2000. The increase in absolute dollars in research and development expenses was primarily due to increased headcount in research and development from 129 to 145 people for the period from September 30, 2000 to September 30, 2001. We intend to decrease our research and development expenses as a percentage of total revenues; however, this depends on our growth, among other factors. SALES AND MARKETING EXPENSES. Sales and marketing expenses consist primarily of salaries, commissions to sales personnel and agents, travel, tradeshow participation, public relations, advertising and other promotional expenses. Sales and marketing expenses increased 11.1% to $12.9 million, or 58.9% of total revenues, in the three months ended September 30, 2001 from $11.6 million, or 49.6% of total revenues, in the three months ended September 30, 2000. Sales and marketing expenses increased 21.8% to $38.2 million, or 59.8% of total revenues, in the nine months ended September 30, 2001 from $31.4 million, or 48.0% of total revenues, in the nine months ended September 30, 2000. The increase in absolute dollars was primarily the result of increased headcount to continue to build the direct sales force along with additional marketing and promotional activities to penetrate the market. Headcount in sales and marketing increased from 163 to 195 people from September 30, 2000 to September 30, 2001. We intend to decrease our sales and marketing expenses as a percentage of total revenues; however, this depends on our growth, among other factors. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist primarily of salaries for financial, administrative and management personnel and related travel expenses, as well as legal, bad debt and other accounting expenses. General and administrative expenses decreased 6.6% to $2.0 million, or 9.3% of total revenues, in the three months ended September 30, 2001 from $2.2 million, or 9.3% of total revenues, in the three months ended September 30, 2000. The decrease in absolute dollars quarter over quarter is due mainly to a reduction in discretionary expenses. General and administrative expenses increased 28.9% to $6.8 million, or 10.7% of total revenues, in the nine months ended September 30, 2001 from $5.3 million, or 8.1% 11 of total revenues, in the nine months ended September 30, 2000. The increase in absolute dollars year over year is associated with an increase of costs in general support areas, such as human resources, finance and legal services, which will enable the Company to scale its infrastructure in anticipation of future growth. Headcount in general and administrative functions increased from 37 to 40 people from September 30, 2000 to September 30, 2001. We intend to continue to decrease our general and administrative expenses as a percentage of total revenues; however, this depends on our growth, among other factors. ACQUISITION-RELATED EXPENSES. Acquisition-related expenses of approximately $4.3 million were incurred in the nine months ended September 30, 2000 related to accounting, legal and investment banking fees associated with the acquisition of FirstSense Software, Inc. in February 2000. OTHER INCOME. Other income consists of interest earned on funds available for investment, net of interest expense in connection with the financing of capital equipment and interest expense paid by FirstSense on a term loan obtained by FirstSense prior to its acquisition by Concord. The Company had net other income of $866,000 for the three months ended September 30, 2001 and net other income of $724,000 for the three months ended September 30, 2000. The Company had net other income of $2.4 million for the nine months ended September 30, 2001 and net other income of $2.3 million for the nine months ended September 30, 2000. EXTRAORDINARY ITEMS. The Company recognized an extraordinary loss of $216,000 (net of the tax benefit of $72,000) related to the early extinguishment of certain debt that the Company assumed as part of the FirstSense acquisition. BENEFIT FROM INCOME TAXES. The Company did not record any income tax benefit in the nine months ended September 30, 2001 versus an income tax expense of $287,000 and $774,000 in the three and nine months ended September 30, 2000, respectively. The Company did not record such a benefit in 2001 based on its estimate of its year-end tax position. LIQUIDITY AND CAPITAL RESOURCES The Company financed its operations, prior to its initial public offering, primarily through the private sales of equity securities and a credit line for equipment purchases. On October 24, 1997, the Company completed its initial public offering yielding the Company net proceeds of approximately $34.7 million. The Company had working capital of $47.1 million at September 30, 2001. Net cash provided by operating activities was $5.8 million and $3.2 million for the nine months ended September 30, 2001 and 2000, respectively. Cash, cash equivalents and marketable securities were $68.4 million and $63.2 million at September 30, 2001 and December 31, 2000, respectively. Accounts receivable decreased $4.6 million due to lower license revenue for the nine months ended September 30, 2001. Investing activities have consisted of the acquisition of property and equipment, most notably computer and networking equipment to support the growing employee base and corporate infrastructure and also investments in marketable securities. The Company manages its market risk on its investment securities by selecting investment grade securities with the highest credit ratings and relatively short duration that trade in highly liquid markets. Financing activities consisted primarily of the issuance of common stock and exercise of options during the nine months ended September 30, 2001 and 2000 and from the repayments in 2000 of borrowings on a subordinated debt financing by FirstSense. Pursuant to the Tax Reform Act of 1986, the utilization of net operating loss carryforwards for tax purposes may be subject to an annual limitation if a cumulative change of ownership of more than 50% occurs over a three-year period. As a result of the Company's 1995 preferred stock financings, such a change in ownership has occurred. As a result of this ownership change, the use of the net operating loss (NOL) carryforwards is limited. The Company has determined that its initial public offering did not cause another ownership change. In addition, NOL carryforwards acquired as a result of the FirstSense acquisition are also restricted as a result of a prior ownership change. The Company had deferred tax assets of approximately $14.9 million composed primarily of net operating loss carryforwards and research and development credits at December 31, 2000. The Company has partially reserved for these deferred tax assets by recording a valuation allowance of $11.4 million at December 31, 2000. The net deferred tax asset is based on the Company's estimate of NOL carryforwards it expects to use in the next two years; all other tax assets have been fully reserved. Pursuant to paragraphs 20 to 25 of SFAS No. 109, the Company considered both positive and negative evidence in assessing the need for a valuation allowance. The factors that weighed most heavily on the Company's decision to record a valuation allowance 12 were (i) the substantial restrictions on the use of certain of its existing NOL carryforwards and (ii) the uncertainty of future profitability. As a result of the Company's ownership change described above, the future use of approximately $6.6 million of the Company's NOL carryforwards are limited to only $330,000 per year; the substantial majority of such NOL carryforwards will expire before they can be used. The FirstSense NOL carryforwards are limited to $4.2 million per year. Pursuant to the provisions of SFAS No. 109, the Company used all of its remaining unrestricted NOL and credit carryforwards in computing the 1998 tax provision. As a part of restating its financial statements to reflect the FirstSense acquisition, the Company determined that approximately $3.0 million of valuation allowance previously recorded by FirstSense prior to the acquisition was not necessary, given the Company's estimates of future taxable income. Accordingly, pursuant to SFAS No. 109, the Company recorded an asset and reduced its provision for income taxes in the period in which such NOL carryforwards were generated by FirstSense. The Company is also subject to rapid technological change, competition from substantially larger competitors, a limited family of products and other related risks, as more thoroughly described in the "Risk Factors" section beginning on page 14 and in the "Risk factors" section of the Company's Form 10-K, for the fiscal year ended December 31, 2000. The Company's dependence on a single product family in an emerging market makes the prediction of future results difficult, if not impossible, especially in the highly competitive software industry. As a result, the Company found the evidence described above to be the most reliable objective evidence available in determining that a valuation allowance against its tax assets would be necessary. The Company's net operating loss deferred tax asset includes approximately $3.75 million pertaining to the benefit associated with the exercise and subsequent disqualifying disposition of incentive stock options by the Company's employees. When and if the Company realizes this asset, the resulting change in the valuation allowance will be credited directly to additional paid-in capital, pursuant to the provisions of SFAS No. 109. 13 RISK FACTORS References in these risk factors to "we," "our" the "Company" and "us" refer to Concord Communications, Inc., a Massachusetts corporation. Any investment in our common stock involves a high degree of risk. If any of the following risks actually occur, our business, results of operations and financial condition would likely suffer. This document contains forward-looking statements. Any statements contained herein that do not describe historical facts are forward-looking statements. Concord makes such forward-looking statements under the provisions of the "safe harbor" section of the Private Securities Litigation Reform Act of 1995. The forward-looking statements contained herein are based on current expectations, but are subject to a number of risks and uncertainties. Concord's actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed below. OUR FUTURE OPERATING RESULTS ARE UNCERTAIN. We changed our focus to network management software in 1991 and commercially introduced our first Network Health(R) product in 1995. We acquired Empire Technologies in October 1999 and FirstSense Software in February 2000, enabling our products to cover IT management across networks, systems and applications. Simultaneously, we have internally developed products and capabilities that brought us into the broader performance, availability and fault management market. Accordingly, we have a relatively limited operating history in these broader markets upon which you can evaluate our business and prospects can be based. We incurred significant net losses in each of the five fiscal years prior to recording a small loss in 1997, and turning profitable in 1998, 1999 and 2000. As of September 30, 2001, we had accumulated net losses of approximately $34.7 million. Our limited operating history makes the prediction of future results of operations difficult or impossible. Our prospects must be considered in light of the risks, costs and difficulties frequently encountered by emerging companies, particularly companies in the competitive software industry. WE CANNOT ENSURE THAT OUR REVENUES WILL GROW OR THAT WE WILL BE PROFITABLE. Although we have achieved revenue growth and profitability for the fiscal years ended 2000, 1999, and 1998, we cannot ensure that we can generate revenue growth on a quarterly or annual basis, or that we can achieve or sustain any revenue growth in the future. In 2001, our annual revenue may be lower than in 2000. We may increase in the future, our operating expenses in order to: - fund higher levels of research and development; - increase our sales and marketing efforts; - develop new distribution channels; - broaden our customer support capabilities; and - expand our administrative resources in anticipation of future growth. To the extent that increases in our expenses precede or are not followed by increased revenue, our profitability will continue to suffer. Our revenue must grow substantially in order for us to become profitable on a quarterly or annual basis. In addition, in view of the rapidly evolving nature of our business and markets, our recent acquisitions and our limited operating history in our current market, we believe that one should not rely on period-to-period comparisons of our financial results as an indication of our future performance. In light of our strong performance in 1998, we used all of our remaining unrestricted tax net operating loss and credit carryforwards in 1998. Accordingly, we recorded a tax benefit of $986,000 during 1998, a tax provision of $4.3 million during 1999 and a tax provision of $375,000 during 2000. The continuing restrictions on our future use of our net operating loss carryforwards will severely limit the benefit, if any, we will attribute to this asset. 14 OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE. We are likely to experience significant fluctuations in our quarterly operating results caused by many factors, including, but not limited to: - changes in the demand for our products by customers or group of customers; - the timing, composition and size of orders from our customers, including the tendency for significant bookings to occur in the last month of each fiscal quarter; - our customers' spending patterns and budgetary resources for fault and performance management software solutions; - the success of our new customer generation activities; - introductions or enhancements of products, or delays in the introductions or enhancements of products, by us or our competitors; - changes in our pricing policies or those of our competitors; - changes in the distribution channels through which products are sold; - our success in anticipating and effectively adapting to developing markets and rapidly changing technologies; - changes in networking or communications technologies; - our success in attracting, retaining and motivating qualified personnel; - changes in the mix of products sold by us and our competitors; - the publication of opinions about us and our products, or our competitors and their products, by industry analysts or others; - changes in general economic conditions; and - geopolitical conditions in the world. Though our services revenue has been increasing as a percentage of total revenues, we do not have a significant ongoing revenue stream that may mitigate quarterly fluctuations in operating results as do other software companies with a longer history of operations. Increases in our revenues will also depend on our successful implementation of our distribution strategy as we attempt to expand our channels of distribution. Due to the buying patterns of certain of our customers and also to our own sales incentive programs focused on annual sales goals, revenues in our fourth quarter could be higher than revenues in our first quarter of the following year. There also may be other factors, such as seasonality and the timing of receipt and delivery of orders within a fiscal quarter, that significantly affect our quarterly results, which are difficult to predict given our limited operating history. Our quarterly sales and operating results depend generally on: - the volume and timing of orders within the quarter; - the tendency of sales to occur late in fiscal quarters; and - our fulfillment of orders received within the quarter. In addition, our expense levels are based in part on our expectations of future orders and sales, which are extremely difficult to predict. A substantial portion of our operating expenses are related to personnel, facilities and sales and marketing programs. Accordingly, we may not be able to adjust our fixed expenses quickly enough to address any significant shortfall in demand for our products in relation to our expectations. Due to all of the foregoing factors, we believe that our quarterly operating results are likely to vary significantly in the future. Therefore, in some future quarter our results of operations may fall below the expectations of securities analysts and investors. In such event, the trading price of our common stock would likely suffer. 15 THE MARKET FOR INTEGRATED FAULT AND PERFORMANCE MANAGEMENT SOFTWARE IS EMERGING. The market for our integrated end-to-end solution is in an early stage of development. Although the rapid expansion and increasing complexity of computer networks, systems and applications in recent years has increased the demand for fault and performance management software products, the awareness of and the need for an integrated fault and performance solution is a recent development. Because the market for this solution 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. The development of this market and our growth will depend significantly upon the desire and success of telecommunication carriers, managed services providers and enterprises to integrate fault and performance management for their applications, systems and networks. Moreover, it will depend on the willingness of telecommunications carriers, ISPs, systems integrators and outsourcers to integrate fault and performance management software into their product and service offerings. The market for integrated fault and performance management software may not grow or we may fail to assess and address the needs of this market. OUR SUCCESS IS DEPENDENT UPON SALES TO TELECOMMUNICATIONS CARRIERS, SERVICE PROVIDERS AND ENTERPRISE CUSTOMERS. We derive and likely will continue to derive a significant portion of our revenues from the sales of our products to telecommunications carriers, service providers and enterprise customers. These markets worldwide have suffered from a turbulent economy during 2000 and 2001, turbulence that has been exacerbated by the tragic events of September 11, 2001 and their aftermath. Concord has been negatively affected by the downturn in capital spending within this market. The volume of sales of our products and services to telecommunications carriers, service providers and enterprise customers may increase slower than we expect or may decrease. MARKET ACCEPTANCE OF OUR eHEALTH(TM) PRODUCT FAMILY IS CRITICAL TO OUR SUCCESS. We currently derive substantial product revenues from our eHealth(TM) product family, and we expect that revenues from these products will continue to account for almost all of our product revenues in the foreseeable future. Broad market acceptance of these products is critical to our future success. We cannot ensure that market acceptance of our eHealth(TM) Suite of products will increase or even remain at current levels. Factors that may affect the market acceptance of our integrated solution include: - the availability and price of competing solutions, products and technologies; and - the success of our sales efforts and those of our marketing partners. Moreover, if demand for integrated fault and performance management software products increases, we anticipate that our competitors will introduce additional competitive products and new competitors could enter our market and offer alternative products. Product and integrated solution introductions by our competitors may also reduce future market acceptance of our products. OUR INDUSTRY IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE. OUR SUCCESS DEPENDS UPON MAINTENANCE OF STANDARD PROTOCOLS. The software industry is characterized by: - rapid technological change; - frequent introductions of new products; - changes in customer demands; and - evolving industry standards. 16 The introduction of products embodying new technologies and the emergence of new industry standards can render existing products and integrated solutions obsolete and unmarketable. Our eHealth(TM)-Network product's analysis and reporting, as well as the quality of its reports, depends upon its utilization of the industry-standard Simple Network Management Protocol (SNMP) and the data resident in conventional Management Information Bases (MIBs). Any change in these industry standards, the development of vendor-specific proprietary MIB technology, or the emergence of new network technologies could affect the compatibility of our eHealth(TM)-Network products with these devices, which in turn could affect its analysis and generation of comprehensive reports or the quality of the reports. Similarly, Live Health(TM) - Fault Manager product receives only SNMP traps from failing devices, systems and applications. Any change in these industry standards could hinder the effectiveness of this product. Furthermore, although our eHealth(TM) Suite of products currently run on industry-standard UNIX operating systems and Windows NT, any significant change in industry-standard operating systems could affect the demand for, or the pricing of, our products and solutions. WE MUST INTRODUCE PRODUCT ENHANCEMENTS AND NEW PRODUCTS ON A TIMELY BASIS. Because of rapid technological change in the software industry and potential changes in the IT infrastructure fault and performance management software market and industry standards, the life cycle of versions of our eHealth(TM) products is difficult to estimate. We cannot ensure that: - we will successfully develop and market enhancements to our eHealth(TM) products or successfully develop new products that respond to technological changes, evolving industry standards or customer requirements; - we will not experience difficulties that could delay or prevent the successful development, introduction and sale of such enhancements or new products; or - that such enhancements or new products will adequately address the requirements of the marketplace and achieve any significant degree of market acceptance. OUR ACQUISITIONS MAY NEGATIVELY IMPACT OUR RESULTS OF OPERATIONS. In October 1999, we acquired Empire Technologies, Inc. Empire is a provider of solutions for proactive self-management of UNIX, Linux and Windows NT systems, as well as mission-critical applications. In February 2000, we acquired FirstSense Software, Inc. FirstSense is a provider of application response management solutions. Because these acquisitions have been recorded as "pooling-of-interests" for accounting and financial reporting purposes, we recorded the expenses of these acquisitions, which are substantial, in the period in which each acquisition occurred. THE MARKET FOR OUR PRODUCTS IS INTENSELY COMPETITIVE. The market for our products is new, intensely competitive, rapidly evolving and subject to technological change. Our current and future competitors include: - fault management vendors; - element management software vendors; - systems management software vendors; - other performance analysis and reporting vendors; - companies offering network performance reporting services; - large network management platform vendors which may bundle their products with other hardware and software in a manner that may discourage users from purchasing our products; and - developers of network element management solutions. We expect competition to persist, increase and intensify in the future with possible price competition developing in our markets. Many of our current and potential competitors have longer operating histories and significantly greater financial, technical and marketing resources and name recognition than us. We do not believe our market will support a large number of competitors and their products. In the past, a number of software markets have become dominated by one or a small number of suppliers, and a small 17 number of suppliers or even a single supplier may dominate our market. If we do not provide products that achieve success in our market in the short term, we could suffer an insurmountable loss in market share and brand name acceptance. We cannot ensure that we will compete effectively with current and future competitors. OUR FAILURE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS MAY HARM OUR COMPETITIVE POSITION IN THE NETWORK MANAGEMENT SOFTWARE MARKET. Our success depends significantly upon our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, non-disclosure agreements and other contractual provisions to establish, maintain and protect our proprietary rights. These means afford only limited protection. We have ten issued U.S. patents, seven pending U.S. patent applications, and various foreign counterparts. We cannot ensure that patents will issue from our pending applications or from any future applications or that, if issued, any claims allowed will be sufficiently broad to protect our technology. In addition, we cannot ensure that any patents that have been or may be issued will not be challenged, invalidated or circumvented, or that any rights granted thereunder would protect our proprietary rights. Failure of any patents to protect our technology may make it easier for our competitors to offer equivalent or superior technology. We have registered or applied for registration for certain trademarks, and will continue to evaluate the registration of additional trademarks as appropriate. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or services or to obtain and use information that we regard as proprietary. Third parties may also independently develop similar technology without breach of our proprietary rights. In addition, the laws of some foreign countries do not protect proprietary rights to as great an extent as do the laws of the United States. In addition, many of our products are licensed under shrinkwrap license agreements that are not signed by licensees. The law governing the enforceability of shrinkwrap license agreement is not settled in most jurisdictions. There can be no guarantee that we would achieve success in enforcing one or more shrinkwrap license agreements if we sought to do so in a court of law. WE LICENSE CERTAIN TECHNOLOGIES FROM THIRD PARTIES. We license from third parties, generally on a non-exclusive basis, certain technologies used in our products. The termination of any such licenses, or the failure of the third-party licensors to adequately maintain or update their products, could result in delay in our shipment of certain of our products while we seek to implement technology offered by alternative sources, and any required replacement licenses could prove costly. While it may be necessary or desirable in the future to obtain other licenses relating to one or more of our products or relating to current or future technologies, we cannot ensure that we will be successful in doing so on commercially reasonable terms or at all. INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS WOULD HARM OUR BUSINESS. Although we do not believe that we are infringing the intellectual property rights of others, claims of infringement are becoming increasingly common as the software industry develops and legal protections, including patents, are applied to software products. Litigation may be necessary to protect our proprietary technology, and third parties may assert infringement claims against us with respect to their proprietary rights. Any claims or litigation can be time-consuming and expensive regardless of their merit. Infringement claims against us can cause product release delays, require us to redesign our products or require us to enter into royalty or license agreements, which agreements may not be available on terms acceptable to us or at all. PRODUCT DEFECTS COULD RESULT IN LOSS OR DELAY IN MARKET ACCEPTANCE OF OUR PRODUCTS. As a result of their complexity, software products may contain undetected errors or failures when first introduced or as new versions are released. We cannot ensure that, despite testing by us and testing and use by current and potential customers, errors will not be found in new products we ship or, if discovered, that we will successfully correct such errors in a timely manner or at all. The occurrence of errors and failures in our products could result in loss of or delay in market acceptance of our products, and alleviating such errors and failures could require significant expenditure of capital and other resources by us. WE MAY NOT HAVE SUFFICIENT PROTECTION AGAINST PRODUCT LIABILITY CLAIMS. Because our products are used by our customers to predict future network, system and application problems and to avoid failures of the network to support critical business functions, design defects, software errors, misuse of our products, incorrect data from network elements or other potential problems within or out of our control may arise from the use of our products and could result in financial or other damages to our customers. While we do not maintain product liability insurance, our license agreements with our customers typically contain provisions designed to limit our exposure to potential claims as well as any liabilities arising from such 18 claims. We provide warranties for our products for a period of time (currently three months) after purchase. Our license agreements do not permit product returns by the customer, and product returns for fiscal 2000, 1999 and 1998 represented less than 1.0% of total revenues during each of such periods. We cannot ensure that product returns will not increase as a percentage of total revenues in future periods. WE RELY ON STRATEGIC PARTNERS AND OTHER EVOLVING DISTRIBUTION CHANNELS. Our distribution strategy is to develop multiple distribution channels, including sales through: - strategic marketing partners, such as Cisco Systems; - value added resellers, such as Empowered Networks; - telecommunications carriers, such as MCI WorldCom; - OEMs, such as Micromuse; and - independent software vendors and international distributors. We have developed a number of these relationships and intend to continue to develop new "channel partner" relationships. Our success will depend in large part on our development of these additional distribution relationships and on the performance and success of these third parties, particularly telecommunications carriers and other network service providers. We have recently established many of our channel partner relationships. Accordingly, we cannot predict the extent to which our channel partners will be successful in marketing our products. We generally expect that our agreements with our channel partners may be terminated by either party without cause. None of our channel partners are required to purchase minimum quantities of our products and none of these agreements contain exclusive distribution arrangements. We may: - fail to attract important and effective channel partners; - fail to penetrate the market segments of our channel partners; or - lose any of our channel partners, as a result of competitive products offered by other companies, products developed internally by these channel partners or otherwise. WE MAY FAIL TO MANAGE SUCCESSFULLY OUR GROWTH. We have experienced significant growth in our sales and operations and in the complexity of our products and product distribution channels. We have increased and are continuing to increase the size of our sales force and coverage territories. Furthermore, we have established and are continuing to establish additional distribution channels through third party relationships. Our growth, coupled with the rapid evolution of our markets, has placed, and is likely to continue to place, significant strains on our administrative, operational and financial resources and increase demands on our internal systems, procedures and controls. OUR SUCCESS DEPENDS ON OUR RETENTION OF KEY PERSONNEL. Our performance depends substantially on the performance of our key technical and senior management personnel, none of whom is bound by an employment agreement. We may lose the services of any of such persons. We do not maintain key person life insurance policies on any of our employees. Our success depends on our continuing ability to identify, hire, train, motivate and retain highly qualified management, technical, and sales and marketing personnel, including recently hired officers and other employees. We experience intense competition for such personnel. We cannot ensure that we will successfully attract, assimilate or retain highly qualified technical, managerial or sales and marketing personnel in the future. 19 OUR FAILURE TO EXPAND INTO INTERNATIONAL MARKETS COULD HARM OUR BUSINESS. We intend to continue to expand our operations outside of the United States and enter additional international markets, primarily through the establishment of additional reseller arrangements. We expect to commit additional time and development resources to customizing our products and services for selected international markets and to developing international sales and support channels. We cannot ensure that such efforts will be successful. We face certain difficulties and risks inherent in doing business internationally, including, but not limited to: - costs of customizing products and services for international markets; - dependence on independent resellers; - multiple and conflicting regulations; - exchange controls; - longer payment cycles; - unexpected changes in regulatory requirements; - import and export restrictions and tariffs; - difficulties in staffing and managing international operations; - greater difficulty or delay in accounts receivable collection; - potentially adverse tax consequences; - the burden of complying with a variety of laws outside the United States; - the impact of possible recessionary environments in economies outside the United States; and - political and economic instability. Our successful expansion into certain countries will require additional modification of our products, particularly national language support. Our current export sales are denominated in United States dollars and we currently expect to largely continue this practice as we expand internationally. To the extent that international sales do continue to be denominated in U.S. dollars, an increase in the value of the United States dollar relative to other currencies could make our products and services more expensive and, therefore, potentially less competitive in international markets. In certain European Union countries, however, we expect to introduce pricing in Euros in the near future. To the extent that future international sales are denominated in foreign currency, our operating results will be subject to risks associated with foreign currency fluctuation. We would consider entering into forward exchange contracts or otherwise engaging in hedging activities. To date, as all export sales are denominated in U.S. dollars, we have not entered into any such contracts or engaged in any such activities. As we increase our international sales, seasonal fluctuations resulting from lower sales that typically occur during the summer months in Europe and other parts of the world may affect our total revenues. OUR COMMON STOCK PRICE COULD EXPERIENCE SIGNIFICANT VOLATILITY. We completed an initial public offering of our common stock during October 1997. The market price of our common stock may be highly volatile and could be subject to wide fluctuations in response to: - variations in results of operations; - announcements of technological innovations or new products by us or our competitors; - changes in financial estimates by securities analysts; or - other events or factors. 20 In addition, the financial markets have experienced significant price and volume fluctuations that have particularly affected the market prices of equity securities of many high technology companies and that often have been unrelated to the operating performance of such companies or have resulted from the failure of the operating results of such companies to meet market expectations in a particular quarter. Broad market fluctuations or any failure of our operating results in a particular quarter to meet market expectations may adversely affect the market price of our common stock. In the past, following periods of volatility in the market price of a company's securities, securities class action litigation has often been instituted against such a company. Such litigation could result in substantial costs and a diversion of our attention and resources. WE MAY NEED FUTURE CAPITAL FUNDING. We plan to continue to expend substantial funds on the continued development, sales and marketing of the eHealth(TM) product family. We cannot ensure that our existing capital resources, the proceeds from our initial public offering during October 1997 and any funds that may be generated from future operations together will be sufficient to finance our future operations or that other sources of funding will be available on terms acceptable to us, if at all. In addition, future sales of substantial amounts of our securities in the public market could adversely affect prevailing market prices and could impair our future ability to raise capital through the sale of our securities. 21 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK DERIVATIVE FINANCIAL INSTRUMENTS, OTHER FINANCIAL INSTRUMENTS AND DERIVATIVE COMMODITY INSTRUMENTS. The Company does not invest in derivative financial instruments, other financial instruments or derivative commodity instruments for which fair value disclosure would be required under SFAS No. 107. All of the Company's investments are in investment grade securities with high credit ratings of relatively short duration that trade in highly liquid markets and are carried at fair value on the Company's books. Accordingly, the Company has no quantitative information concerning the market risk of participating in such investments. PRIMARY MARKET RISK EXPOSURES. The Company's primary market risk exposure is in the area of interest rate risk. The Company's investment portfolio of cash equivalents and marketable securities is subject to interest rate fluctuations, but the Company believes this risk is immaterial due to the short-term nature of these investments. Substantially all of the Company's business outside the United States is conducted in U.S. dollar-denominated transactions, whereas the Company's operating expenses in its international branches are denominated in local currency. The Company has no foreign exchange contracts, option contracts or other foreign hedging arrangements. The Company believes that the operating expenses of its foreign operations are immaterial, and therefore any associated market risk is unlikely to have a material adverse effect on the Company's business, results of operations or financial condition. The Company's current export sales are denominated in United States dollars. To the extent that international sales continue to be denominated in United States dollars, an increase in the value of the United States dollar relative to other currencies could make the Company's products and services more expensive and, therefore, potentially less competitive in international markets. 22 CONCORD COMMUNICATIONS, INC. FORM 10-Q, SEPTEMBER 30, 2001 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is not a party to any litigation that it believes could have a material adverse effect on the business, results of operations and financial condition of the Company. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (a) Issuance of Securities On February 4, 2000, the Company completed a merger with FirstSense Software, Inc. The Company has reserved for issuance in connection with the merger, 1,940,000 shares of Concord Common Stock. The Company issued the shares in a private placement transaction pursuant to Section 4(2) under the Securities Act of 1933. The merger was accounted for as a pooling of interests. The Company has filed a Form S-3 Registration Statement to cover the resale of the securities issued in the merger. (b) Use of Proceeds On October 16, 1997, the Company commenced an initial public offering ("IPO") of 2,900,000 shares of common stock, par value $.01 per share (the "Common Stock"), of the Company pursuant to the Company's final prospectus dated October 15, 1997 (the "Prospectus"). The Prospectus was contained in the Company's Registration Statement on Form S-1, which was declared effective by the Securities and Exchange Commission (SEC File No. 333-33227) on October 15, 1997. Of the 2,900,000 shares of Common Stock offered, 2,300,000 shares were offered and sold by the Company and 600,000 shares were offered and sold by certain shareholders of the Company. As part of the IPO, the Company granted the several underwriters an overallotment option to purchase up to an additional 435,000 shares of Common Stock (the "Underwriters' Option"). The IPO closed on October 21, 1997 upon the sale of 2,900,000 shares of Common Stock to the underwriters. On October 24, 1997, the Representatives, on behalf of the several underwriters, exercised the Underwriters' Option, purchasing 435,000 additional shares of Common Stock from the Company. The aggregate offering price of the shares of Common stock in the IPO to the public was $40,600,000 (exclusive of the Underwriters' Option), with proceeds to the Company and selling shareholders, after deduction of the underwriting discount, of $29,946,000 (before deducting offering expenses payable by the Company) and $7,812,000 respectively. The aggregate offering price of the Underwriters' Option exercised was $6,090,000, with proceeds to the Company, after deduction of the underwriting discount, of $5,663,700 (before deducting offering expenses payable by the Company). The aggregate amount of expenses incurred by the Company in connection with the issuance and distribution of the shares of Common Stock offered and sold in the IPO were approximately $3.6 million, including $2.7 million in underwriting discounts and commissions and $950,000 in other offering expenses. The net proceeds to the Company from the IPO, after deducting underwriting discounts and commissions and other offering expenses were approximately $34.7 million. To date, the Company has not utilized any of the net proceeds from the IPO. The Company has invested all such net proceeds primarily in US treasury obligations and other interest bearing investment grade securities. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable 23 ITEM 5. OTHER INFORMATION On October 29, 2001, the Board of Directors of the Company adopted the 2001 Non-Executive Employee Stock Purchase Plan (the "Plan"). The stockholders of the Company will consider approval of the Plan at the Company's next annual meeting. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The exhibit listed in the accompanying Exhibit Index on page 26 is filed or incorporated by reference as part of this Report. 24 CONCORD COMMUNICATIONS, INC. FORM 10-Q, SEPTEMBER 30, 2001 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Concord Communications, Inc. /s/ Melissa H. Cruz ---------------------------------------- Date: November 7, 2001 Name: Melissa H. Cruz Title: Executive Vice President of Business Services and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) 25 CONCORD COMMUNICATIONS, INC. FORM 10-Q, SEPTEMBER 30, 2001 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION SEC DOCUMENT REFERENCE ----------- ----------- ---------------------- *10.31 2001 Non-Executive Employee Stock Purchase Plan Exhibit No. 10.31 to Current Report on Form 10-Q
* filed herewith 26 EX-10.31 3 b40859ccex10-31.txt 2001 NON-EXECUTIVE EMPLOYEE STOCK PURCHASE PLAN EXHIBIT 10.31 CONCORD COMMUNICATIONS, INC. 2001 NON-EXECUTIVE EMPLOYEE STOCK PURCHASE PLAN ARTICLE 1 - PURPOSE. This 2001 Non-Executive Employee Stock Purchase Plan (the "Plan") is intended to encourage stock ownership by all eligible employees of CONCORD COMMUNICATIONS, INC. (the "Company"), a Massachusetts corporation, and its participating subsidiaries (as defined in Article 17) so that they may share in the growth of the Company by acquiring or increasing their proprietary interest in the Company. The Plan is designed to encourage eligible employees to remain in the employ of the Company and its participating subsidiaries. The Plan is intended to constitute an "employee stock purchase plan" within the meaning of Section 423(b) of the Internal Revenue Code of 1986, as amended (the "Code"). ARTICLE 2 - ADMINISTRATION OF THE PLAN. The Plan may be administered by the Compensation Committee of the Board of Directors or a committee appointed by the Board of Directors of the Company (the "Committee"). The Committee shall consist of not less than two members of the Company's Board of Directors. The Board of Directors may from time to time remove members from, or add members to, the Committee. Vacancies on the Committee, howsoever caused, shall be filled by the Board of Directors. The Committee may select one of its members as Chairman, and shall hold meetings at such times and places as it may determine. Acts by a majority of the Committee, or acts reduced to or approved in writing by a majority of the members of the Committee, shall be the valid acts of the Committee. The interpretation and construction by the Committee of any provisions of the Plan or of any option granted under it shall be final, unless otherwise determined by the Board of Directors. The Committee may from time to time adopt such rules and regulations for carrying out the Plan as it may deem best, provided that any such rules and regulations shall be applied on a uniform basis to all employees under the Plan. No member of the Board of Directors or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any option granted under it. In the event the Board of Directors fails to appoint or refrains from appointing a Committee, the Board of Directors shall have all power and authority to administer the Plan. In such event, the word "Committee" wherever used herein shall be deemed to mean the Board of Directors. ARTICLE 3 - ELIGIBLE EMPLOYEES. All employees, (excluding Officers and Directors as described below), of the Company or any of its participating subsidiaries whose customary employment is more than 20 hours per week and for more than five months in any calendar year shall be eligible to receive options under the Plan to purchase common stock of the Company, and all eligible employees shall have the same rights and privileges hereunder. Persons who are eligible employees on the first business day of any Payment Period (as defined in Article 5) shall receive their options as of such day. Persons who become eligible employees after any date on which options are granted under the Plan shall be granted options on the first day of the next succeeding Payment Period on which options are granted to eligible employees under the Plan. In no event, however, may an employee be granted an option if such employee, immediately after the option was granted, would be treated as owning stock possessing five percent or more of the total combined voting power or value of all classes of stock of the Company or of any parent corporation or subsidiary corporation, as the terms "parent corporation" and "subsidiary corporation" are defined in Section 424(e) and (f) of the Code. For purposes of determining stock ownership under this paragraph, the rules of Section 424(d) of the Code shall apply, and stock which the employee may purchase under outstanding options shall be treated as stock owned by the employee. Notwithstanding the foregoing, Officers and Directors of the Company, who are "highly compensated employees" (within the meaning of Section 414(q) of the Code), shall not be eligible employees and shall not be eligible to receive options under the Plan. For purpose of the Plan, (a) "Officers" shall mean a person who is an officer of the Company within the meaning of the interpretations of the National Association of Securities Dealers, Inc. ("NASD") under Section 4350(i)(1)(a) of the NASD Marketplace Rules and (b) "Director" shall mean a member of the Board of Directors of the Company. ARTICLE 4 - STOCK SUBJECT TO THE PLAN. The stock subject to the options under the Plan shall be shares of the Company's authorized but unissued common stock, par value $0.01 per share (the "Common Stock"), or shares of Common Stock reacquired by the Company, including shares purchased in the open market. The aggregate number of shares which may be issued pursuant to the Plan is 500,000, subject to adjustment as provided in Article 12. If any option granted under the Plan shall expire or terminate for any reason without having been exercised in full or shall cease for any reason to be exercisable in whole or in part, the unpurchased shares subject thereto shall again be available under the Plan. ARTICLE 5 - PAYMENT PERIOD AND STOCK OPTIONS. The first Payment Period during which payroll deductions will be accumulated under the Plan shall commence on the later to occur of November 1, 2001 and the first day of the first calendar month following effectiveness of the Form S-8 registration statement filed with the Securities and Exchange Commission covering the shares to be issued pursuant to the Plan and shall end on April 30, 2002. For the remainder of the duration of the Plan, Payment Periods shall consist of the six-month periods commencing on May 1 and November 1, respectively, and ending on October 31 and April 30, respectively, of each calendar year. Twice each year, on the first business day of each Payment Period, the Company will grant to each eligible employee an option to purchase on the last day of such Payment Period, at the Option Price hereinafter provided for, a maximum of 20,000 shares, on condition that such employee remains eligible to participate in the Plan throughout the remainder of such Payment Period. The employee shall be entitled to exercise the option so granted only to the extent of the employee's accumulated payroll deductions on the last day of such Payment Period. If the participant's accumulated payroll deductions on the last day of the Payment Period would enable the participant to purchase more than 20,000 shares except for the 20,000-share limitation, the excess of the amount of the accumulated payroll deductions over the aggregate purchase price of the 20,000 shares shall be promptly refunded to the participant by the Company, without interest. The Option Price per share for each Payment Period shall be the lesser of (i) 85% of the average market price of the Common Stock on the first business day of the Payment Period and (ii) 85% of the average market price of the Common Stock on the last business day of the Payment Period, in either event rounded up to the nearest cent. The foregoing limitation on the number of shares subject to option and the Option Price shall be subject to adjustment as provided in Article 12. For purposes of the Plan, the term "average market price" on any date means (i) the average (on that date) of the high and low prices of the Common Stock on the principal national securities exchange on which the Common Stock is traded, if the Common Stock is then traded on a national securities exchange; or (ii) the last reported sale price (on that date) of the Common Stock on the NASDAQ National Market, if the Common Stock is not then traded on a national securities exchange; or (iii) the average of the closing bid and asked prices last quoted (on that date) by an established quotation service for over-the-counter securities, if the Common Stock is not reported on the NASDAQ National Market; or (iv) if the Common Stock is not publicly traded, the fair market value of the Common Stock as determined by the Committee after taking into consideration all factors which it deems appropriate, including, without limitation, recent sale and offer prices of the Common Stock in private transactions negotiated at arm's length. For purposes of the Plan, the term "business day" means a day on which there is trading on the NASDAQ National Market or the aforementioned national securities exchange, whichever is applicable pursuant to the preceding paragraph; and if neither is applicable, a day that is not a Saturday, Sunday or legal holiday in the Commonwealth of Massachusetts. No employee shall be granted an option which permits the employee's right to purchase stock under the Plan, and under all other Section 423(b) employee stock purchase plans of the Company and any parent or subsidiary corporations, to accrue at a rate which exceeds $25,000 of fair market value of such stock (determined on the date or dates that options on such stock were granted) for each calendar year in which such option is outstanding at any time. The purpose of the limitation in the preceding sentence is to comply with Section 423(b)(8) of the Code. If the participant's accumulated payroll deductions on the last day of the Payment Period would otherwise enable the participant to purchase Common Stock in excess of the Section 423(b)(8) limitation described in this paragraph, the excess of the amount of the accumulated payroll deductions over the aggregate purchase price of the shares actually purchased shall be promptly refunded to the participant by the Company, without interest. ARTICLE 6 - EXERCISE OF OPTION. Each eligible employee who continues to be a participant in the Plan on the last day of a Payment Period shall be deemed to have exercised his or her option on such date and shall be deemed to have purchased from the Company such number of full shares of Common Stock reserved for the purpose of the Plan as the participant's accumulated payroll deductions on such date will pay for at the Option Price, subject to the 20,000-share limit of the option and the Section 423(b)(8) limitation described in Article 5. If the individual is not a participant on the last day of a Payment Period, then he or she shall not be entitled to exercise his or her option and the amount of his or her payroll deduction shall be refundable without interest. Only full shares of Common Stock may be purchased under the Plan. Unused payroll deductions remaining in a participant's account at the end of a Payment Period by reason of the inability to purchase a fractional share shall be carried forward to the next Payment Period. ARTICLE 7 - AUTHORIZATION FOR ENTERING THE PLAN. An employee may elect to authorize payroll deductions under the Plan by filling out, signing and delivering to the Company an authorization: A. Stating the percentage to be deducted regularly from the employee's pay; B. Authorizing the purchase of stock for the employee in each Payment Period in accordance with the terms of the Plan; and C. Specifying the exact name or names in which stock purchased for the employee is to be issued as provided under Article 11 hereof. Such authorization must be received by the Company at least ten days before the first day of the next succeeding Payment Period and shall take effect only if the employee is an eligible employee on the first business day of such Payment Period. Notwithstanding the foregoing, solely for purposes of the first Payment Period under the Plan, an employee who is an eligible employee on the first business day of such Payment Period may elect to authorize payroll deductions under the Plan by filling out, signing, and delivering to the Company the written authorization described above so that the Company receives such authorization no later than November 8, 2001. Unless a participant files a new authorization or withdraws from the Plan, the deductions and purchases under the authorization the participant has on file under the Plan will continue from one Payment Period to succeeding Payment Periods as long as the Plan remains in effect. The Company will accumulate and hold for each participant's account the amounts deducted from his or her pay. No interest will be paid on these amounts. ARTICLE 8 - MAXIMUM AMOUNT OF PAYROLL DEDUCTIONS. An employee may authorize payroll deductions in an amount (expressed as a whole percentage) not less than one percent (1%) but not more than ten percent (10%) of the employee's total compensation, including base pay or salary and any overtime, bonuses or commissions. ARTICLE 9 - CHANGE IN PAYROLL DEDUCTIONS. Deductions may not be increased or decreased during a Payment Period. However, a participant may withdraw in full from the Plan in which event the Company will promptly refund (without interest) the entire balance of the employer's deduction not previously used to purchase stock under the Plan. ARTICLE 10 - WITHDRAWAL FROM THE PLAN. A participant may withdraw from the Plan (in whole but not in part) at any time prior to the last day of a Payment Period by delivering a withdrawal notice to the Company. To re-enter the Plan, an employee who has previously withdrawn must file a new authorization at least ten days before the first day of the next Payment Period in which he or she wishes to participate. The employee's re-entry into the Plan becomes effective at the beginning of such Payment Period, provided that he or she is an eligible employee on the first business day of the Payment Period. ARTICLE 11 - ISSUANCE OF STOCK. Certificates for stock issued to participants shall be delivered as soon as practicable after each Payment Period by the Company's transfer agent. Stock purchased under the Plan shall be issued only in the name of the participant, or if the participant's authorization so specifies, in the name of the participant and another person of legal age as joint tenants with rights of survivorship. ARTICLE 12 - ADJUSTMENTS. Upon the happening of any of the following described events, a participant's rights under options granted under the Plan shall be adjusted as hereinafter provided: A. In the event that the shares of Common Stock shall be subdivided or combined into a greater or smaller number of shares or if, upon a reorganization, split-up, liquidation, recapitalization or the like of the Company, the shares of Common Stock shall be exchanged for other securities of the Company, each participant shall be entitled, subject to the conditions herein stated, to purchase such number of shares of Common Stock or amount of other securities of the Company as were exchangeable for the number of shares of Common Stock that such participant would have been entitled to purchase except for such action, and appropriate adjustments shall be made in the purchase price per share to reflect such subdivision, combination or exchange; and B. In the event the Company shall issue any of its shares as a stock dividend upon or with respect to the shares of stock of the class which shall at the time be subject to option hereunder, each participant upon exercising such an option shall be entitled to receive (for the purchase price paid upon such exercise) the shares as to which the participant is exercising his or her option and, in addition thereto (at no additional cost), such number of shares of the class or classes in which such stock dividend or dividends were declared or paid, and such amount of cash in lieu of fractional shares, as is equal to the number of shares thereof and the amount of cash in lieu of fractional shares, respectively, which the participant would have received if the participant had been the holder of the shares as to which the participant is exercising his or her option at all times between the date of the granting of such option and the date of its exercise. Upon the happening of any of the foregoing events, the class and aggregate number of shares set forth in Article 4 hereof which are subject to options which have been or may be granted under the Plan and the limitations set forth in the second paragraph of Article 5 shall also be appropriately adjusted to reflect the events specified in paragraphs A and B above. Notwithstanding the foregoing, any adjustments made pursuant to paragraphs A or B shall be made only after the Committee, based on advice of counsel for the Company, determines whether such adjustments would constitute a "modification" (as that term is defined in Section 424 of the Code). If the Committee determines that such adjustments would constitute a modification, it may refrain from making such adjustments. If the Company is to be consolidated with or acquired by another entity in a merger, a sale of all or substantially all of the Company's assets or otherwise (an "Acquisition"), the Committee or the board of directors of any entity assuming the obligations of the Company hereunder (the "Successor Board") shall, with respect to options then outstanding under the Plan, either (i) make appropriate provision for the continuation of such options by arranging for the substitution on an equitable basis for the shares then subject to such options either (a) the consideration payable with respect to the outstanding shares of the Common Stock in connection with the Acquisition, (b) shares of stock of the successor corporation, or a parent or subsidiary of such corporation, or (c) such other securities as the Successor Board deems appropriate, the fair market value of which shall not materially exceed the fair market value of the shares of Common Stock subject to such options immediately preceding the Acquisition; or (ii) terminate each participant's options in exchange for a cash payment equal to the excess of (a) the fair market value on the date of the Acquisition, of the number of shares of Common Stock that the participant's accumulated payroll deductions as of the date of the Acquisition could purchase, at an option price determined with reference only to the first business day of the applicable Payment Period and subject to the 20,000-share, Code Section 423(b)(8) and fractional-share limitations on the amount of stock a participant would be entitled to purchase, over (b) the result of multiplying such number of shares by such option price. The Committee or Successor Board shall determine the adjustments to be made under this Article 12, and its determination shall be conclusive. ARTICLE 13 - NO TRANSFER OR ASSIGNMENT OF EMPLOYEE'S RIGHTS. An option granted under the Plan may not be transferred or assigned to or availed by, any other person than by will or the laws of descent and distribution and may be exercised only by the employee during the employee's lifetime. ARTICLE 14 - TERMINATION OF EMPLOYEE'S RIGHTS. Whenever a participant ceases to be an eligible employee because of retirement, voluntary or involuntary termination, resignation, layoff, discharge, death or for any other reason, his or her rights under the Plan shall immediately terminate, and the Company shall promptly refund, without interest, the entire balance of his or her payroll deduction account under the Plan. Notwithstanding the foregoing, eligible employment shall be treated as continuing intact while a participant is on military leave, sick leave or other bona fide leave of absence, for up to 90 days, or for so long as the participant's right to re-employment is guaranteed either by statute or by contract, if longer than 90 days. ARTICLE 15 - TERMINATION AND AMENDMENTS TO PLAN. The Plan may be terminated at any time by the Company's Board of Directors but such termination shall not affect options then outstanding under the Plan. It will terminate in any case when all or substantially all of the unissued shares of stock reserved for the purposes of the Plan have been purchased. If at any time shares of stock reserved for the purpose of the Plan remain available for purchase but not in sufficient number to satisfy all then unfilled purchase requirements, the available shares shall be apportioned among participants in proportion to the amount of payroll deductions accumulated on behalf of each participant that would otherwise be used to purchase stock, and the Plan shall terminate. Upon such termination, all payroll deductions not used to purchase stock will be refunded, without interest. The Committee or the Board of Directors may from time to time adopt amendments to the Plan provided that, without the approval of the stockholders of the Company, no amendment may (i) increase the number of shares that may be issued under the Plan; (ii) change the class of employees eligible to receive options under the Plan, if such action would be treated as the adoption of a new plan for purposes of Section 423(b) of the Code; or (iii) cause Rule 16b-3 under the Securities Exchange Act of 1934 to become inapplicable to the Plan. ARTICLE 16 - LIMITS ON SALE OF STOCK PURCHASED UNDER THE PLAN. The Plan is intended to provide shares of Common Stock for investment and not for resale. The Company does not, however, intend to restrict or influence any employee in the conduct of his or her own affairs. An employee may, therefore, sell stock purchased under the Plan at any time the employee chooses, subject to compliance with any applicable federal or state securities laws and subject to any restrictions imposed under Article 21 to ensure that tax withholding obligations are satisfied. THE EMPLOYEE ASSUMES THE RISK OF ANY MARKET FLUCTUATIONS IN THE PRICE OF THE STOCK. ARTICLE 17 - PARTICIPATING SUBSIDIARIES. The term "participating subsidiary" shall mean any present or future subsidiary of the Company, as that term is defined in Section 424(f) of the Code, which is designated from time to time by the Board of Directors to participate in the Plan. The Board of Directors shall have the power to make such designation before or after the Plan is approved by the stockholders. ARTICLE 18 - OPTIONEES NOT STOCKHOLDERS. Neither the granting of an option to an employee nor the deductions from his or her pay shall constitute such employee a stockholder of the shares covered by an option until such shares have been actually purchased by the employee. ARTICLE 19 - APPLICATION OF FUNDS. The proceeds received by the Company from the sale of Common Stock pursuant to options granted under the Plan will be used for general corporate purposes. ARTICLE 20 - NOTICE TO COMPANY OF DISQUALIFYING DISPOSITION. By electing to participate in the Plan, each participant agrees to notify the Company in writing immediately after the participant transfers Common Stock acquired under the Plan, if such transfer occurs within two years after the first business day of the Payment Period in which such Common Stock was acquired. Each participant further agrees to provide any information about such a transfer as may be requested by the Company or any subsidiary corporation in order to assist it in complying with the tax laws. Such dispositions generally are treated as "disqualifying dispositions" under Sections 421 and 424 of the Code, which have certain tax consequences to participants and to the Company and its participating subsidiaries. ARTICLE 21 - WITHHOLDING OF ADDITIONAL INCOME TAXES. By electing to participate in the Plan, each participant acknowledges that the Company and its participating subsidiaries are required to withhold taxes with respect to the amounts deducted from the participant's compensation and accumulated for the benefit of the participant under the Plan, and each participant agrees that the Company and its participating subsidiaries may deduct additional amounts from the participant's compensation, when amounts are added to the participant's account, used to purchase Common Stock or refunded, in order to satisfy such withholding obligations. Each participant further acknowledges that when Common Stock is purchased under the Plan the Company and its participating subsidiaries may be required to withhold taxes with respect to all or a portion of the difference between the fair market value of the Common Stock purchased and its purchase price, and each participant agrees that such taxes may be withheld from compensation otherwise payable to such participant. It is intended that tax withholding will be accomplished in such a manner that the full amount of payroll deductions elected by the participant under Article 7 will be used to purchase Common Stock. However, if amounts sufficient to satisfy applicable tax withholding obligations have not been withheld from compensation otherwise payable to any participant, then, notwithstanding any other provision of the Plan, the Company may withhold such taxes from the participant's accumulated payroll deductions and apply the net amount to the purchase of Common Stock, unless the participant pays to the Company, prior to the exercise date, an amount sufficient to satisfy such withholding obligations. Each participant further acknowledges that the Company and its participating subsidiaries may be required to withhold taxes in connection with the disposition of stock acquired under the Plan and agrees that the Company or any participating subsidiary may take whatever action it considers appropriate to satisfy such withholding requirements, including deducting from compensation otherwise payable to such participant an amount sufficient to satisfy such withholding requirements or conditioning any disposition of Common Stock by the participant upon the payment to the Company or such subsidiary of an amount sufficient to satisfy such withholding requirements. ARTICLE 22 - GOVERNMENTAL REGULATIONS. The Company's obligation to sell and deliver shares of Common Stock under the Plan is subject to the approval of any governmental authority required in connection with the authorization, issuance or sale of such shares. Government regulations may impose reporting or other obligations on the Company with respect to the Plan. For example, the Company may be required to identify shares of Common Stock issued under the Plan on its stock ownership records and send tax information statements to employees and former employees who transfer title to such shares. ARTICLE 23 - GOVERNING LAW. The validity and construction of the Plan shall be governed by the laws of Commonwealth of Massachusetts, without giving effect to the principles of conflicts of law thereof. ARTICLE 24 - APPROVAL OF BOARD OF DIRECTORS AND STOCKHOLDERS OF THE COMPANY. The Plan was adopted by the Board of Directors on October 29, 2001 and will be considered for approval by the stockholders of the Company on or before October 29, 2002.