Item 1 - Business.
General
NetManage, Inc. was incorporated in 1990 as a California corporation and we reincorporated in Delaware in 1993 in connection with our initial public offering. References in this Annual Report on Form 10-K to “NetManage,”, “the Company”, “we”, “our”, and “us” collectively refer to NetManage, Inc., a Delaware corporation, its subsidiaries and its California predecessor.
NetManage®, OnWeb®, RUMBA®, ViewNow®, OnNet®, Chameleon®, SupportNow®, InterDrive®, the NetManage logo, NetManage partner logo and the lizard logo are registered trademarks, registered service marks, trademarks or service marks of NetManage, Inc., its subsidiaries and its affiliates in the United States and/or other countries. UNIX is a registered trademark in the United States and other countries, licensed exclusively through X/Open Company Limited. Windows and ActiveX are registered trademarks in the United States and other countries of Microsoft Corporation. AIX and AS/400 are registered trademarks in the United States and other countries of International Business Machines Corporation (IBM). Java is a trademark of Sun Microsystems, Inc. All other trademarks are the property of their respective owners.
Overview
We develop and market software and service solutions that allow our customers to access and leverage their considerable investment in host-based business applications, processes and data.
Our business is primarily focused on providing a broad spectrum of specific personal computer and network or application server-based software and tools. These products allow our customers to access and use their mission-critical line-of-business host applications and resources. Through a single platform approach called the Host Access Platform, or HAP, our products allow our customers to access their host applications in traditional ways through “green-screen” terminal emulation on personal computers or from within web browsers; to publish information from existing host systems in a web presentation, particularly to new users and particularly via the Internet; to create new web-based applications that leverage their existing business processes and applications; and to present existing business processes in a reusable component form, for example as Web Services, which can be consumed by new applications being built with modern application frameworks such as Microsoft’s .Net or the various Java (J2EE) environments such as IBM’s WebSphere or BEA’s WebLogic. We add value to the software and solutions we supply within our single platform. Consistency and compatibility between the various
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elements of this platform, the use of common technologies and tools, all allow our customers easy migration between the various host-based applications our customers have installed.
Our business is targeted at taking advantage of the trend of major corporations worldwide to adopt Business-to-Business, or B2B, or Business-to-Consumer, or B2C, initiatives and the significant drive in major corporations towards a Services Oriented Architecture, or SOA, for their future Enterprise IT architecture. Our products help enable our customers to bridge between their existing access systems and technologies (Business-to-Employee, or B2E) and those required to compete in the B2B, and B2C marketplaces or those required for the delivery of existing business processes as part of a services oriented enterprise solution. The corporate resources internal to the organization, those behind existing B2E solutions, are generally the system of record for the business and are therefore the basis of any new initiatives or applications now being considered by the enterprise marketplace both for internal use and for inter-company business-to-business communication. Alongside these solutions, we are focused on providing products that allow existing corporate business processes to be componentized and to be extended to business partners in the supply and demand chains where the new SOA has a significant role to play. We also focus on taking advantage of major current industry trends: the expansion of the Internet and its adoption as the B2B infrastructure for both medium and large enterprises; the continued mobilization of personal computer users and the adoption of mobile information access and display devices; and the availability of broader access to corporate data and information for people internal and external to an organization.
We develop and market these software solutions to allow our customers to access and leverage applications, business processes and data on IBM corporate mainframe computers, and IBM midrange computers such as AS/400 or iSeries and on UNIX-based servers. We provide professional support, maintenance, and technical consultancy services to our customers in association with the products we develop and market. We also provide professional applications and management consultation to our customers in association with the server-based products we deliver that allow customers to develop and deploy new web-based applications and to deliver existing host-based business processes in an industry standard component form to new application frameworks.
Our principal products are compatible with Microsoft, Windows .NET, Windows XP, Windows 2000, Windows NT and Windows 98, operating systems; IBM mainframe and mid-range host operating systems, Novell, Inc.’s, network operating systems and various implementations of the industry standard UNIX operating system such as IBM’s AIX, Hewlett-Packard Company’s (HP) HP/UX, Sun Microsystems, Inc.’s (Sun) SolarisTM, and the open source Linux system.
We market our range of solutions for the Host Access and Host Integration markets under our Host Access Platform (HAP) which include:
Access Services products enable end-user devices, including personal computers, to communicate with large centralized corporate computer systems and the applications that are hosted on them (PC-to-host solutions). Access Services products are marketed and sold under the brand name RUMBA.
Presentation Services products allow devices running web browsers to communicate with large centralized corporate computer systems through either software downloaded into the client browser (web-to-host solutions) or through solutions that deliver connectivity for web browser users without the requirement for software on the user’s device other than the browser itself (collectively known as “zero footprint” solutions or browser-to-host solutions). Presentation Services solutions also allow single or multiple host applications to be completely re-presented with a web look and feel so that the old “green screen” presentation is completely hidden. Presentation Services products are marketed and sold under the brand name OnWeb.
Integration Services products (framework-to-host) provide server-side solutions that allow the integration of single or multiple existing host-based business processes into reusable software components (such as Web Services, Microsoft .Net Assemblies or Enterprise Java Beans) that can be incorporated into new applications
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being built on the major application frameworks including .Net and J2EE. Integration Services products allow our customers to integrate existing legacy applications with new platform solutions such as those built using IBM’s WebSphere, BEA Systems’ (BEA) WebLogic or Microsoft’s .NET. Integration Services products are marketed and sold under the OnWeb brand name.
We believe our customers benefit from the fact that the underlying technology, employed by our HAP solutions, is the same.
Industry background
Four important industry trends have had strong influences on our business strategy during the past three years: (1) the rapid adoption of eBusiness and electronic trading approaches by major corporations worldwide and the spread of these approaches to mid-tier and mid-sized companies; (2) the continuing development of the Internet, intranets and extranets for delivery of mission-critical business applications in large and mid-sized companies; (3) an increased desire on the part of corporations to make business processes and information stored in mainframes and midrange computers (legacy systems) broadly accessible internally and externally to their employees and business partners; and (4) the continued mobilization of users of personal computers and the proliferation of wireless and handheld devices requiring corporate host access on a global basis.
We use the term internetworking to describe the technology of global connectivity. Internetworking had its origins in the Internet, a worldwide network of networks that allows communication between different organizations and locations, each with their own individual network of computers. With the rapid development of the Internet, the breadth of the connectivity industry has quickly expanded beyond proprietary-based solutions to Web-based technologies and other open protocol solutions. The application of this same internetworking technology within a company on its own computer networks is known as an intranet to distinguish it from the larger public Internet. When companies use internetworking technology for connecting to their partners (i.e. outside customers and suppliers) it is known as an extranet. An extranet is a network upon which all users are known and authenticated as opposed to the Internet where the identities of users are generally anonymous. Importantly, internetworking is comprised of many different applications which must communicate with one another, each according to its function, and which must follow certain standards or conventions to ensure interoperability.
The number and variety of applications and services that utilize the internetworking infrastructure is growing rapidly-pushed along by the Internet and corporate eBusiness initiatives. We are focused on several levels of product that utilize the internetworking infrastructure. These include traditional host access products for corporate desktops and servers, which provide users with the ability to communicate with corporate host systems; products that allow organizations to transform legacy applications into systems that can service external users, partners and customers-particularly through the Web; and development platforms that allow organizations to leverage and augment their existing Legacy applications and draw one or more existing applications, and information sources together to create new applications for new internal and external users. In addition to this, we provide products that allow access to and use of existing business processes and transactions for customers using application server development platforms such as IBM’s WebSphere, BEA’s WebLogicTM and Microsoft’s .NET. These products are referred to as “connectors” or “adaptors” and allow legacy applications to be presented as new technologies in formats such as Web Services. These products address the Host Access and Host Integration markets which over time appear to be converging as both customers and the industry call for a more integrated set of solutions.
The personal computer has continued to be an important tool for facilitating communications, information sharing, and group productivity in large companies. As professional workers have become more mobile, there is an accelerated effort to connect personal computers easily and reliably to corporate networks to improve communication and organizational productivity. As a result, the personal computer has become an important tool to connect workers to shared repositories of information and to other people, regardless of location, network or
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type of computer. Internetworking also facilitates activities such as mobile computing by allowing users to use and to access more effectively all of a company’s computer systems from a remote location within the confines of an organization’s security and access-control policies. As the Internet grows, the number of different communication and internetworking options required by major corporations to support their businesses is increasing. The number and type of mobile computing and communication devices is also increasing and now includes wireless handheld devices, Personal Digital Assistants, or PDAs, and Internet and Web-enabled cellular phones.
Within organizations, personal computers must connect not only to other personal computers via Local Area Networks, or LANs, but also to workstations, servers, minicomputers and mainframes, many of which may run different operating system software, and are connected to different physical networks. In addition, more companies are seeking ways to link their computer systems directly with those of vendors, customers and other business partners to enhance the flow of information and reduce expenses. This major move, utilizing the Internet as the internetworking solution, is termed eBusiness or eCommerce. eBusiness covers the full migration of business processes to the web and the sharing of those business processes with partners. eCommerce covers the elements that allow electronic selling, trading and transactions on the Web. These two terms are now augmented by specific terms that incorporate the advent of the wireless Internet. eMobile or mCommerce describes the use of a wide range of handheld, mobile and wireless devices as a part of an overall eBusiness or eCommerce solution.
For a network to function properly, all connected devices must follow rules or protocols that govern access to the network and communication with other devices. Transmission Control Protocol/Internet Protocol, or TCP/IP, is the name of the data communications protocol family that has become the de facto networking standard application because it is an open or non-proprietary protocol capable of linking disparate environments. We were one of the first software vendors to deliver the TCP/IP protocol and related applications for the Microsoft Windows platform. Selling primarily to the business user, we have promoted standards based on our implementation of TCP/IP that have been adopted by the industry at large. The most notable example is the Windows Sockets, or WinSock, interface, which is used today by a wide range of Windows internetworking software vendors including Microsoft.
We believe that the open and interoperable characteristics of internetworking technology, the use of intranets and the software that enables them, will continue to grow within organizations. The software required to implement an internetworking solution includes applications for the desktop, the software that transports information over the wires, the servers at the other end, and management support and development tools to create and administer a network of this type. Additionally, an easy-to-use, intuitive interface can extend the use of these software components to a non-technical audience and facilitates adoption by such an audience.
We believe that the future adoption of SOA approaches to the overall enterprise IT architecture will drive the requirement to incorporate existing host applications as key components in the new services approach to corporate IT systems. The ability to “componentize” existing business processes in an industry standard way and deliver those components to new applications and frameworks easily and quickly will ensure that corporations get new and increased value from their existing IT assets.
Our vision is to provide the Host Access Platform, along with solutions built with that platform that greatly improve and extend the reach of existing corporate host-centric systems-regardless of what the end-user devices are and regardless of where the end-user devices are located. As we continue to deliver on our vision, we intend to support our customers in implementing B2E, B2B, and B2C business solutions and adopting SOA.
Products and technology
Our broad suite of products provides organizations with cost-effective solutions for connecting people, their computers and their businesses. Our products extend the functionality of these organizations’ technology
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investments by providing essential services that are not included in desktop and network operating systems. Our solutions are designed to streamline communication, reduce the total cost of ownership, and increase productivity throughout an organization.
Our Host Access Platform products include the RUMBA and OnWeb product families. We also continue to market select UNIX connectivity products under our ViewNowTM brand. Our current products include:
A significant portion of our net revenues has been derived from the sale of products that provide host access, presentation and integration solutions for the Microsoft Windows environment (clients and servers), and are marketed primarily to Windows users. As a result, sales of our products might be negatively impacted by developments adverse to Microsoft’s Windows products. In addition, our strategy of developing products based on the Windows operating environment is substantially dependent on our ability to gain pre-release access to, and to develop expertise in, current and future Windows developments by Microsoft. We have no agreement with Microsoft giving us pre-release access to future Window products. No assurance can be given as to our ability to
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provide, on a timely basis, products compatible with future Windows releases. For a summary of net revenues for Host Access and Host Integration, see Note 8 “Segment information” of the Notes to Consolidated Financial Statements included herein. Also, we have products which are similar to functionality included in some Microsoft products. Microsoft is expected to increase development of such products, which could have a material adverse effect on our business, financial condition or results of operations.
Some of our newer OnWeb products have been developed to run on the UNIX operating system, including Linux and Solaris and are marketed primarily to the Fortune 1000 companies running UNIX platforms as their servers. As a result, sales of our products might be negatively impacted by developments adverse to the UNIX operating system or developments in the Open Source community based around Linux adverse to our own Linux- based products. In addition, our strategy of developing products based on the UNIX operating environment is substantially dependent on our ability to gain pre-release access to, and to develop expertise in, current and future UNIX developments by Sun, IBM, HP and others. No agreement between a developer of UNIX operating systems and us exists to provide pre-release access to future UNIX products. No assurance can be given as to our ability to provide, on a timely basis, products compatible with future UNIX releases.
Our competitors could seek to expand their product offerings by designing and selling similar or new technology that could render our products obsolete or adversely affect sales of our products. These developments may adversely affect the sales of our own products either by directly affecting customer-purchasing decisions or by making potential customers delay their purchases of our products. See “Competition” below.
Backlog
Since we generally ship software products within a short period after receipt of an order, we do not typically have a material backlog of unfilled orders, and our revenues in any one quarter are substantially dependent on orders booked in that quarter and particularly in the last month of that quarter.
Sales and marketing
We participate in two markets which have been referred to as Host Access and Host Integration. It is our understanding that our customers require a single approach that addresses the traditional need for Host Access combined with the need for the presentation of existing host systems with a web application look and feel, and the delivery of existing host processes and transactions as reusable programmatic components such as Web Services. In assessing the change in the market place, we have focused our sales and marketing efforts both in our organization and resources to meet the needs of our customers. NetManage’s Host Access Platform products offer Access Services, Presentation Services and Integration Services built from common components and technologies and utilize common underlying services such as user management, system management, security, auditing and reporting. Our Access, Presentation and Integration Services offerings consist of a range of products that are designed to allow IT departments to provide end users access to applications running on IBM Mainframes, iSeries (AS/400), and Unix systems. Three primary technologies are employed to provide the solution; these include traditional Fat Client or Desktop solutions, Thin Client or browser-based solutions, and Zero Footprint or Server-based solutions. Within this market place, we believe the trend is away from Desktop solutions toward Zero Footprint solutions. We believe this movement is primarily driven by a desire to reduce the total cost of ownership associated with deploying these solutions but we also believe that a major element of our customer base will deploy a mixture of all types of solutions. The market is also made up of a number of products that allow organizations to reduce costs or increase revenue by allowing them or their business partners to interact via the Internet, with legacy (Mainframe or iSeries) business applications that are the backbone of their business processes. A primary example of this kind of solution is found in call center applications. Companies are building solutions that allow customers to determine order status over the Internet without involving a customer support representative. This approach simultaneously minimizes staffing costs and improves customer service. Our goal is to assist our customers in building solutions that quickly transform host applications into Web-based solutions.
Index to Financial Statements We have developed products that allow our customers to deploy solutions across a wide range of industries. Successful installations can be found in government agencies, as well as companies in the finance, health care, manufacturing and insurance industries. Our products are designed to improve business processes throughout these organizations.
To bring our products to market in the United States, we use a combination of telesales and direct sales personnel specifically assigned to meet the needs of major accounts. As part of our continuing strategy to develop multiple distribution channels, we expect to continue our use of indirect channels, such as resellers, particularly value added resellers and systems integrators, distributors and original equipment manufacturers, both in the United States and internationally. Any material increase in our indirect sales may adversely affect our average selling prices and gross margins due to the lower unit costs that are typically charged when selling through indirect channels. There can be no assurance that we will be able to attract or retain resellers and distributors who will be able to market our products effectively or will be qualified to provide timely and cost effective customer support and service. We ship products to resellers and distributors on a purchase order basis, and many of our resellers and distributors carry competing product lines. Therefore, there can be no assurance that any reseller or distributor will continue to effectively sell or represent our products, and the inability to recruit or retain important resellers or distributors could adversely affect our results of operations. See “Factors that may affect our future results and financial condition” under Item 7 below.
In the United States, we have 12 sales offices, and internationally, we have sales offices in Canada, France, Germany, Israel, Italy, the Netherlands, Spain, and the United Kingdom. We also utilize local distributors and resellers internationally. We support the sales activity of these sales offices and distributors in target countries through localization of products and sales material, local training, and participation in local trade shows.
In 2003, 2002 and 2001 respectively, we derived approximately 28%, 28% and 29% of net revenues from sales outside of North America (United States and Canada). We believe that the potential international markets for our products are substantial, based on the extent to which Windows, UNIX and internetworking products are used internationally. Accordingly, we localize many of our products for use in the native language of target countries. We intend to continue to target major European countries for additional sales and marketing activity, and expand our Israel subsidiary in the support of our international sales. For a summary of international operations by geographic area, see Note 8 of the Notes to Consolidated Financial Statements included herein. While we expect that international sales will continue to account for a significant portion of our net revenues, there can be no assurance that we will be able to maintain or increase international market demand for our products, or that our international distributors and resellers will be able to effectively meet that demand.
Risks inherent in our international business activities generally include unexpected changes in regulatory requirements, tariffs, and other trade barriers, costs and risks of localizing products for foreign countries, longer accounts receivable payment cycles, weak or unenforced international intellectual property laws, difficulties in managing international operations, currency fluctuations, potentially adverse tax consequences, repatriation of earnings, and the burdens of complying with a wide variety of foreign laws. There can be no assurance that such factors will not have an adverse effect on our future international sales, and consequently, on our results of operations.
Customer support
Our North America support organization consists of a staff of engineers and other professionals providing support by telephone from our facilities in Ottawa, Ontario, Canada. Both telephone support and regular update releases of our products are provided to customers that purchase an annual or multi-year maintenance agreement. Our sales and customer support organizations work together closely to provide customer satisfaction. Our customers outside North America are supported by our personnel located in Haifa, Israel, by various international sales offices and by local distributors and resellers who are trained by us.
Index to Financial Statements Research and development
We believe that our future success will depend on our ability to enhance our existing products and to develop and introduce new products providing access, presentation and integration services, which address customer needs in the areas of B2B, B2C, B2E and SOA. Our research and development expenses for the years ended December 31, 2003, 2002 and 2001 were $8.3 million, $13.1 million and $18.0 million, respectively.
Competition
The market for our products is intensely competitive and characterized by rapidly changing technology, evolving industry standards, changes in customers’ needs, and frequent new product introductions. To maintain or improve our position in this industry, we must continue to successfully develop, introduce and market new products and product enhancements on a timely and cost-effective basis. Three key factors will contribute to the continued growth of our marketplace: the proliferation of Microsoft Windows client and server technology, the proliferation of the use of the UNIX operating system-particularly the UNIX Open Source version, and the continued implementation of Web-based access to corporate mainframe and midrange computer systems.
If we fail to anticipate or respond adequately to changes in technology and customer preferences, or experience any significant delay in product development or introduction, our results of operations could be materially adversely affected. The failure to develop on a timely basis new products and product enhancements incorporating new functionality could cause customers to delay purchase of our current products or cause customers to purchase products from our competitors; either of which would adversely affect our results of operations. There can be no assurance that we will be successful in developing new products or enhancing our existing products on a timely basis, or that such new products or product enhancements will achieve market acceptance.
We compete directly with providers of Windows internetworking applications, such as IBM, Attachmate Corporation, WRQ, Inc. and Hummingbird Ltd. as well as other major PC connectivity vendors. We also compete with companies such as Jacada Ltd., Seagull Holding NV, IBM, BEA, and Computer Associates International, Inc. with respect to web integration server products. It is imperative that our development efforts remain competitive in this marketplace, particularly given that the market is rapidly evolving, and subject to rapid technological change. There is no assurance that we will be successful in our efforts to do so.
Many of our competitors have substantially greater financial, technical, sales, marketing, personnel, and other resources, as well as greater name recognition and a larger customer base, than we do. Significant price competition characterizes the markets for our products and we anticipate that we will face increasing pricing pressures from competitors in the future. Moreover, given that there are low barriers to entry into the software market, and the market is rapidly evolving and subject to rapid technological change, we believe that competition will persist and intensify in the future. Accordingly, there can be no assurance that we will be able to provide products that compare favorably with the products of our competitors or that competitive pressures will not require us to reduce our prices. We experienced price declines over the last several years. Any further reduction in the price of our products would continue to negatively affect gross margins as a percentage of net revenues, and would require us to further increase software unit sales, in order to maintain net revenues at existing levels.
Proprietary rights
We rely on a combination of copyright and trademark laws, trade secrets, confidentiality procedures, and contractual provisions to protect our proprietary rights. However, the basic TCP/IP protocols on which our products are based are non-proprietary, and other companies have developed their own versions. We seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection, and to a lesser extent, patent laws. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we
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regard as proprietary. Policing unauthorized use of our products is difficult, and while we are unable to determine the extent to which piracy of our software products exists, software piracy can be expected to be a persistent problem. In selling our products, we rely primarily on shrink-wrap or click-wrap licenses that are not signed by licensees, and may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. There can be no assurance that our means of protecting our proprietary rights will be adequate, or our competitors will not independently develop similar technology. In addition, the number of patents applied for and granted for software inventions is increasing. Consequently, there is a growing risk of third parties asserting patent claims against us. We have received, and may receive in the future, communications from third parties asserting that our products infringe, or may infringe, the proprietary rights of third parties, seeking indemnification against such infringement or indicating that we may be required to obtain a license or royalty from such third parties. There can be no assurance that any such claims would not result in protracted and costly litigation or that additional claims will not be made in the future, or that we will not be required to enter into a costly license agreement.
We believe that, due to the rapid pace of innovation within our industry, factors such as the technological and creative skills of our personnel are more important to establishing and maintaining a technology leadership position within the industry than are the various legal means of protecting our technology.
Employees
As of December 31, 2003, we had a total of 236 regular full-time employees, of whom 112 were engaged in sales, marketing, technical support and consulting, 62 in general management, administration and finance, 58 in software development and engineering and 4 in production. None of our employees are subject to a collective bargaining agreement, and we have not experienced any work stoppage.
The majority of our workforce is located in the competitive employment markets of the Silicon Valley in California; the suburban Boston area; Ottawa, Ontario, Canada, and Haifa, Israel. Prior to 2002, we experienced high attrition at all levels and across all functions. The attrition experienced by us was attributable to various factors including, among others, industry-wide demand exceeding supply for experienced engineering and sales professionals, the effects of our restructurings and acquisitions, and our results of operations. Our future operating results will be dependent in part on our ability to attract and retain key employees, and to train and manage our management and employee base. There can be no assurance that we will be able to manage such challenges successfully.
Executive officers of the registrant
The executive officers, their ages and their positions as of March 23, 2004 are as follows:
Zvi Alon is the founder of NetManage, Inc. and has served as our Chairman of the Board, President and Chief Executive Officer since our formation in 1990. From 1986 to 1989, Mr. Alon was the President of Halley
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Systems, a manufacturer of networking equipment including bridges and routers. He also has served as Manager, Standard Product Line at Sytek, Inc., a networking company, and Manager of the Strategic Business Group for Architecture, Graphics and Data Communications at Intel Corporation, a semiconductor manufacturer. Mr. Alon received a B.S. degree in electrical engineering from the Technion-Israel Institute of Technology in Haifa, Israel. Mr. Alon is the former son-in-law of Mr. Uzia Galil, a director of the Company.
Michael R. Peckham joined us in November 1999 as Senior Vice President, Finance, Chief Financial Officer, and Secretary. From February 1993 until November 1999, Mr. Peckham was Vice President, Finance and Administration for Simware Inc., an international software development company. Prior to that, he served as Chief Financial Officer for NORR Partnership Limited, architects and engineers from June 1987 to February 1993. Mr. Peckham holds a Bachelor of Commerce (Honors Degree) from the University of Ottawa in Ottawa, Canada. Mr. Peckham is also a Chartered Accountant in the Province of Ontario, Canada.
Ido Hardonag re-joined us in October 2002 as Senior Vice President, Worldwide Engineering. Mr. Hardonag is responsible for worldwide engineering and R&D for the company’s current and future product lines and was previously employed by NetManage from July 1992 to January 2000 in several engineering management positions, the most recent as Vice President, Research and Development. He comes to NetManage from TeleKnowledge Group, a start-up company in Israel where he served as Vice President, Research and Development from January 2000 to September 2001. He was responsible for core product development, new product releases and customer-related projects for its Total e-billing product. Mr. Hardonag received a B.S. in computer science from Tel-Aviv University in Tel-Aviv, Israel and a M.S. in computer science from the University of Southern California.
Peter R. Havart-Simkin joined us in August 1998 as Senior Vice President of Marketing. In November 1999, he was appointed as Senior Vice President, Worldwide Strategic Development. Mr. Havart-Simkin came to NetManage as part of the FTP Software acquisition, where he had served as Chief Technology Officer since July 1996, when FTP acquired Firefox Communications Inc., a networking software company. Prior to joining FTP, Mr. Havart-Simkin served with Firefox as Vice President and Chief Technical Officer from January 1994 to July 1996, and as Vice President of Marketing and Product Strategy from August 1989 until January 1994. As the original founder of Firefox, Mr. Havart-Simkin also served as a director of Firefox from August 1989 to February 1995. Mr. Havart-Simkin studied physics and mathematics at Windsor College in the United Kingdom. Mr. Havart-Simkin is also a Fellow of the Institute of Sales and Marketing Management (FInstFMM) and a registered Consultant in Information Technology (CIT).
Carol Montgomery-Adams joined us in April 2003 as Vice President, Worldwide Marketing. Prior to joining us, Ms. Montgomery-Adams was a senior Marketing Consultant for 3SixtyMarketView, from September 2002 to April 2003, providing strategic marketing consulting to both consumer and technology-based businesses. Prior to that Ms. Montgomery-Adams worked from March 1997 to March 2001 at Netscape, an internet service provider, as the Vice President of Marketing. Ms. Montgomery-Adams received a Bachelor of Music degree from Temple University in Philadelphia, Pennsylvania and studying for a Masters degree in Business Administration from Heriot-Watt University in Edinburgh, Scotland.
David P. Desjardins joined us in November 1999 as part of the acquisition of Simware. Mr. Desjardins was appointed Vice President, Worldwide Consulting in January 2001 after acting as Vice President, OnWeb since March 2000. While with Simware, Mr. Desjardins was appointed Vice President, Solutions Group in June 1998 after acting as Director, Solutions Group since joining Simware in January 1997. From November 1995 until December 1997, Mr. Desjardins was Vice President Operations for Appian Interactive Corporation, a software company selling web-publishing solutions. Mr. Desjardins served as an independent systems and technology consultant on large-scale projects in the energy industry from April 1994 until September 1997. From February 1993 to March 1994, Mr. Desjardins held various positions, the most recent of which was Chief Operating Officer, with Intera Tydac Technologies Inc., a provider of geographic information software and services. Mr. Desjardins studied Computer Sciences at McGill University, Montreal and the University of Ottawa. He also studied RIA (CMA) at Concordia University, Montreal and the University of Calgary.
Index to Financial Statements Ibrahim (Abe) Ayat joined NetManage in October 2003. Prior to joining us, Mr. Ayat worked as a consultant from October 2002 to October 2003 specializing in the area of mergers and acquisitions. Mr. Ayat served as Vice President, Americas Field Operations with ON Technology Corporation, a company specializing in asset management software from June 2001 to September 2002. From January 2001 to June 2001, Mr. Ayat worked as an independent consultant. Previously, Mr. Ayat served as vice president of North American Field Services and Sales Support with Novadigm, Inc., a software company that provides IT infrastructure and management solutions for the enterprise, from July 1995 to January 2001. Mr. Ayat held various sales and management positions at OpenVision Technologies, Inc. and Ingres Corporation. Mr. Ayat holds a BS degree in Computer Science from University of San Francisco, California.
Alf Goebel joined us in December 2003 as Vice President of Partnerships and Alliances. From June 2003 to November 2003, Mr. Goebel carried out a number of sales and marketing related consulting assignments for several software companies. Prior to that, Mr. Goebel was Chief Executive Officer of Ipedo, a leading XML server company from October 2002 to May 2003. Prior to joining Ipedo, Mr. Goebel acted as a consultant, from March 2002 to September 2002, working with software companies on their sales and marketing strategies. Mr. Goebel was an officer of Software AG from January 1999 to February 2002, serving as Vice President of Global Alliances. During his time with Software AG, Mr. Goebel also acted as Chief Executive Officer of Software AG U.S.A., Inc., the U.S. subsidiary of Software AG from April 2000 to March 2001, which focused on enterprise systems software and electronic business products. In February 1997, Mr. Goebel helped found BridgePoint and acted as the Vice President of Sales and Marketing until January 1999. Mr. Goebel holds a degree in Economics from the University of Cologne, Germany.
Ronald Rudolph joined us in April 2003. Mr. Rudolph worked as a consultant from August 2001 to March 2003. Mr. Rudolph was the Senior Vice President of Administration at Infogrames Interactive Software, Inc., an interactive software manufacturer, from December 1999 to July 2001. Prior to that, he was the Vice President of Administration at Wyse Technology, Inc, a thin-client computer manufacturer, from August 1998 to December 1999. Mr. Rudolph worked at 3COM Corporation, a computer-networking manufacturer, from October 1994 to August 1998 as Vice President of Human Resources Operations. Mr. Rudolph holds a MS and Ph.D in Psychology from California Coast University, Santa Ana, CA, and a B.A. in Psychology from University of California, Santa Cruz. Mr. Rudolph also studied Increasing Human Resources Effectiveness at Harvard University and received a Certificate in Executive Management from the Wharton School, University of Pennsylvania.
Steve Mitchell joined us in October 2002 as General Counsel. Prior to joining us, Mr. Mitchell served from January 1990 to July 2002 in increasingly responsible positions for Hitachi Data Systems Corporation (Hitachi), a supplier of large and medium scale servers and data storage devices. While with Hitachi, Mr. Mitchell was President and Chief Operating Officer from June 2001 to April 2002 and Vice President, General Counsel and Secretary from October 2000 to June 2001 of its subsidiary, Hitachi Innovative Solutions Corporation, a systems integrator and CRM software implementer. From January 1990 until October 2000, Mr. Mitchell held a number of responsible legal positions at Hitachi and assisted with patent infringement litigation and other legal matters. Mr. Mitchell initiated his career with sales and contracts management positions with Sears, Radionix Corp., and Fujitsu America, Inc. Mr. Mitchell holds a B.S. in Organizational Psychology from the University of San Francisco and a J.D. from the Monterey College of Law. Mr. Mitchell is admitted to practice law in California and before the U.S. Supreme Court.
Item 2
Item 2 - Properties.
Substantially all of our office space is leased. We have approximately 154,000 square feet of total leased space in North America including our 40,000 square foot headquarters building in Cupertino, California. This location supports executive, legal, finance, human resources, marketing, sales, and administration. Other primary sites are located in Kirkland, Washington, which supports sales, support, and marketing, and Andover, Massachusetts which supports the east coast of the U.S. with sales and support. Ottawa, Ontario, Canada supports
Index to Financial Statements
the consulting, technical support, and research and development groups primarily for the presentation and integration services products. Regional sales offices are located in New York, New York and Reston, Virginia with local sales offices throughout the United States.
Internationally, we lease approximately 31,000 square feet of office space in Haifa, Israel for the purpose of international sales, marketing, technical support, administration, and research and development. We also lease sales office space in France, Germany, Italy, Spain, the Netherlands, and the United Kingdom. We also own an approximately 6,000 square foot office facility in Mevaseret Zion, Israel that is leased to a third party through December 2004.
Item 3
Item 3 - Legal proceedings.
On November 22, 1999, Kenneth Fisher filed a complaint alleging violations of the False Claims Act, 31 U.S.C. § 3729 et seq., against the Company and its affiliates Network Software Associates, Inc., or NSA, and NetSoft Inc., or NetSoft, in the United States District Court of the District of Columbia. Mr. Fisher purported to file the action on behalf of himself and the United States federal government. NetManage acquired NSA and NetSoft in 1997. The United States government declined to pursue the action on its own behalf and, therefore, the action was pursued by Kenneth Fisher, as relator, on behalf of himself and the government. NetManage, and its affiliates, first learned of the action when the Company was served with the amended complaint in May 2001. On September 5, 2001, Mr. Fisher agreed to voluntarily dismiss the Company from this action, without prejudice, in exchange for an agreement to suspend applicable statutes of limitation as to Mr. Fisher’s claims.
On January 31, 2002, on an order of the court granting in part and denying in part the defendant’s motion to dismiss the May 2001 amended complaint, Mr. Fisher filed a Second Amended Complaint, or Second Complaint, in the United States District Court of the District of Columbia against NSA and NetSoft among numerous other defendants. On May 13, 2002, on an order of the court following defendants’ successful motion to strike the Second Complaint, Mr. Fisher filed a Third Amended Complaint, or complaint, in the United States District Court of the District of Columbia against NSA and NetSoft among numerous other defendants. Mr. Fisher is asserting the claims in the present complaint solely in his capacity as Relator on behalf of the United States. The complaint alleges that NSA, NetSoft and the other defendants made false claims to the government to obtain government contracts set aside for entities owned and controlled by disadvantaged persons admitted to the Section 8(a) Minority Small Business Development Program. Specifically, the complaint alleges that from 1993 to 1997, NSA, NetSoft, and the other defendants presented false or fraudulent claims for payment or approval to the government in violation of 31 U.S.C. § 3729 (a)(1), and used false records or statements to get claims paid or approved by the government in violation of 31 U.S.C. § 3729 (a) (2). In addition, the complaint alleges that NSA, NetSoft and the other defendants conspired to defraud the government by working to fraudulently continue NSA’s certification as a Section 8 (a) entity for alleged use by NSA’s Federal Systems Division and by getting fraudulent claims allowed and paid by virtue of the alleged fraudulent Section 8(a) status, in violation of 31 U.S.C. § 3729 (a) (3). NetManage did not acquire NSA until July 1997 and had no involvement with the events alleged by Mr. Fisher. According to the earlier amended complaint (although not alleged in the current complaint), Mr. Fisher’s theory was that the liabilities of NSA and NetSoft, including alleged liability in this suit, passed to NetManage. On May 31, 2002, NSA and NetSoft and the other defendants answered the complaint. The Company and its affiliates, dispute Mr. Fisher’s allegations and discovery is presently continuing in this matter. The Company has insufficient information at this time to estimate the possible loss, if any, which might result from this lawsuit.
In addition, the Company may be contingently liable with respect to certain asserted and unasserted claims that arise during the normal course of business. Management believes the impact, if any, resulting from these matters would not have a material impact on the Company’s financial statements.
Item 4
Item 4 - Submission of matters to a vote of security holders.
Not applicable.
Index to Financial Statements
PART II
Item 5
Item 5 - Market for registrant’s common equity and related stockholder matters.
Market price of common stock
Our common stock is traded on the Nasdaq National Market under the symbol NETM. As of March 15, 2004, there were 958 stockholders of record and approximately 15,900 beneficial owners of our common stock.
On August 28, 2002, our stockholders approved a one-for-seven reverse split of our common stock for stockholders of record on July 15, 2002. The reverse stock split became effective at the close of business on September 3, 2002. The following table of high and low closing sales prices of our common stock has been adjusted to reflect the reverse stock split. The high and low closing sales prices of our common stock as reported on the Nasdaq National Market for each quarter of 2003 and 2002 were as follows:
We have not declared or paid cash dividends on our common stock and do not currently intend to pay any cash dividends in the foreseeable future. There are no restrictions on the payment of cash dividends.
Item 6
Item 6 - Selected financial data.
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements. The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with Item 7, “Management’s discussion and analysis of financial condition and results of operations” and the consolidated financial statements and notes to those financial statements included in Item 8 of this Form 10-K.
(1) We acquired several companies as part of our acquisition activity in 2000 and 1999.
Index to Financial Statements
(2) Net revenues have been revised to reflect a reclassification from cost of goods to net revenues related to shipping costs.
(3) Loss from operations includes write-offs of in-process research and development of $1.7 million and $19.1 million for the years ended December 31, 2000 and 1999, respectively. Additionally, loss from operations includes restructuring charges of $1.8 million, $4.7 million, $5.6 million, and $3.8 million for the years ended December 31, 2003, 2002, 2000, and 1999, respectively. Also, loss from operations includes asset impairment charges of approximately $5.6 million and $39.8 million for the years ended December 31, 2002 and 2000, respectively and an insurance recovery of $3.8 million for the year ended December 31, 2000. See further discussion in Item 7, “Management’s discussion and analysis of financial condition and results of operations.”
(4) All share and per share data has been retroactively adjusted to give effect to our one-for-seven reverse stock split that became effective at the close of business on September 3, 2002.
(5) Working capital has been changed to reflect a reclassification from accrued liabilities to long-term liabilities of restructuring obligations of $1.0 million, $0.8 million, $1.6 million and $2.3 million for the years ended December 31, 2002, 2001, 2000 and 1999, respectively.
Index to Financial Statements
Item 7
Item 7 - Management’s discussion and analysis of financial condition and results of operations.
Some of the statements contained in this Annual Report on Form 10-K are forward-looking statements, including but not limited to those specifically identified as such, that involve risks and uncertainties. The statements contained in this Annual Report on Form 10-K that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results to differ materially from those implied by the forward-looking statements, including those described in this report under the caption “factors that may affect our future results and financial conditions”. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. All forward-looking statements included in this Annual Report on Form 10-K are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements.
Overview
We develop and market software and service solutions that are designed to enable our customers to access and leverage the considerable investment they have in their host-based business applications, processes and data. Our business is primarily focused on providing a broad spectrum of specific personal computer and network or application server-based software and tools. These products allow our customers to access and leverage applications, business processes and data on IBM, corporate mainframe computers, and IBM midrange computers such as the iSeries or A/S 400TM series and on UNIX based servers through a single platform approach called the Host Access Platform (HAP). We provide professional support, maintenance, and technical consultation services to our customers in association with the products we develop and market. We provide professional applications and management consultancy to our customers in association with the server-based products we deliver that are designed to allow customers to develop and deploy new web-based applications and services.
Four important industry trends have had strong influences on our business strategy during the past three years: (1) the rapid adoption of eBusiness and electronic trading approaches by major corporations worldwide and the spread of these approaches to mid-tier and mid-sized companies; (2) the continuing development of the Internet, intranets and extranets for delivery of mission-critical business applications in large and mid-sized companies; (3) an increased desire on the part of corporations to make business processes and information stored in mainframes and midrange computers (legacy systems) broadly accessible internally and externally to their employees and business partners; and (4) the continued mobilization of users of personal computers and the proliferation of wireless and handheld devices requiring corporate host access on a global basis.
Application of critical accounting policies
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. Our preparation of these consolidated financial statements requires us to make judgments and estimates that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net revenues and expenses during the reporting period. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from such estimates under different assumptions or conditions. The following summarizes our critical accounting policies used in preparing our consolidated financial statements:
Revenue Recognition: We derive revenue from primarily two sources: (1) product revenue, which includes software license and royalty revenue, and (2) services and support revenue, which includes software license
Index to Financial Statements
maintenance and consulting. We license our software products on a term basis and on a perpetual basis. Our term based arrangements are primarily for a period of 12 months. We apply the provisions of the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, and related amendments and interpretations to all transactions involving the sale of software products and to hardware transactions where the software is not incidental.
We recognize revenue from the sale of software licenses to end users and resellers when persuasive evidence of an arrangement exists, such as when the product has been delivered, the fee is fixed and determinable and collection of the resulting receivable is reasonably assured. Delivery occurs when product is delivered to a common carrier or when a soft key has been transmitted to our customer.
Product is sold without the right of return, except for distributor inventory rotation of old or excess product. Certain of our sales are made to domestic distributors under agreements allowing rights of return and price protection on unsold merchandise. Accordingly, we defer recognition of such sales until the distributor sells the merchandise. We recognize sales to international distributors upon shipment, provided all other revenue recognition criteria as mentioned above have been met. We give rebates to customers on a limited basis. These rebates are presented in our Consolidated Statement of Operations as a reduction of revenue.
At the time of the transaction, we assess whether the fee associated with our revenue transactions is fixed and determinable and whether or not collection is reasonably assured. We assess whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after our normal payment terms, we account for the fee as not being fixed and determinable. In these cases, we recognize revenue as the fees become due.
We assess collectability based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. We do not request collateral from our customers. If we determine that collection of a fee is not reasonably assured, we recognize revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.
For all sales, except those completed over the Internet, we use either a binding purchase order or signed license agreement as evidence of a contractual arrangement. For sales over the Internet, we use a credit card authorization as evidence of an arrangement. Sales through our distributors are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction-by-transaction basis.
For arrangements with multiple elements (for example, undelivered maintenance and support), we allocate revenue to each component of the arrangement using the residual value method based on vendor-specific objective evidence (VSOE) of the fair value of the undelivered elements. This means that we defer revenue from the arrangement fee equivalent to the fair value of the undelivered elements. Fair values for the ongoing maintenance and support obligations are generally based upon separate sales of renewals to other customers or upon renewal rates quoted in the contracts. Fair value of services, such as training or consulting, is based upon separate sales by us of these services to other customers. However, if an arrangement includes an acceptance provision, acceptance occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.
Service revenues are derived from providing our customers with software updates for existing software products, user documentation and technical support, under annual service agreements. These revenues are recognized ratably over the terms of such agreements. If such services are included in the initial licensing fee, the value of the services determined based on VSOE of fair value is unbundled and recognized ratably over the related service period. Service revenues derived from consulting and training are deferred and recognized when the services are performed and the collectability is deemed probable. To date, consulting revenue has not been significant.
Index to Financial Statements Allowance for doubtful accounts, sales returns and rebates: In establishing our sales return and rebate allowance, we must make estimates of potential future product returns related to current period product revenue, including analyzing historical returns, current economic trends, and changes in customer demand and acceptance of our products. We apply a significant number of judgments in connection with assessing the collectability of our accounts receivable. We analyze historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms. Our accounts receivable balance was $12.8 million and $18.3 million, net of our allowance for doubtful accounts of $0.9 million and $0.8 million as of December 31, 2003 and 2002, respectively.
If we were to assume that our future product returns were changed to the upper end or lower end of the range we developed in the course of formulating our estimate, the estimate of future returns as of December 31, 2003 would range from approximately $10,000 to $40,000. In each of the years in the three-year period ended December 31, 2003, our actual returns have not deviated significantly from our estimates. Our actual product returns for 2003 and 2002 were approximately $157,000 and $387,000, respectively. If we were to change our estimate of future product returns to the high end of the range, there would be no material impact on our liquidity or capital resources. The estimates for returns represented approximately less than 0.1%, and 0.2% of our total net revenues, or approximately $15,000 and $0.1 million for 2003 and 2002, respectively.
In preparing our financial statements for the year ended December 31, 2003, we estimated rebate reserves for the few distributors who receive rebates. Our rebate reserves for 2003 and 2002 were approximately $40,000 and $0.1 million, respectively.
Restructuring reserves: We accrue for restructuring costs when we make a commitment to a firm exit plan that specifically identifies all significant actions to be taken in conjunction with our response to a change in our strategic plan, product demand, expense structure or other factors such as the date we cease using a facility. We reassess our prior restructuring accruals on a quarterly basis to reflect changes in the costs of our restructuring activities, and we record new restructuring accruals as commitments are made. Estimates are based on anticipated costs of such restructuring activities and are subject to change. Our restructuring reserves balance was $1.8 million and $4.6 million as of December 31, 2003 and 2002, respectively.
On January 30, 2003 we announced a restructuring of NetManage in response to the sluggish North America and European economies. We believe it was necessary to refocus our operations and reduce our operating expenses to bring them in line with our revised anticipated revenue levels. We implemented a reduction in our workforce of more than 30% and recorded a restructuring charge as required by SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, in the first quarter of 2003. For further discussion please see Note 3 to the Notes to Consolidated Financial Statements.
Accounting for income taxes: As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the Consolidated Statement of Operations.
Significant judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our net deferred tax assets. As of December 31, 2003, we had a net deferred tax asset of approximately $74.5 million, consisting primarily of net operating losses. Realization of such carryforwards before they expire is dependent on our generating sufficient future taxable income. We recorded a valuation allowance for the entire balance of the net deferred tax assets at December 31,
Index to Financial Statements
2003 due to uncertainties related to our ability to utilize the carryforwards before they expire. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates, we will adjust these estimates in future periods.
Valuation of long-lived and intangible assets and goodwill: We believe that the accounting estimate related to asset impairment is a “critical accounting estimate” because: (1) it is highly susceptible to change from period to period as it requires us to make assumptions about future revenues over the life of our software products and services; and (2) the impact that recognizing an impairment has on the assets reported on our Consolidated Balance Sheet and the net loss reported in our Consolidated Statement of Operations could be material.
Our assumptions about future revenues and sales volumes require significant judgment because actual sales prices and volumes have fluctuated significantly in the past and are expected to continue to do so. In estimating future revenues, we use our sales performance, planned levels of product development, planned new product launches, our internal budgets and industry market estimates of planned market size and growth rates to assist us.
We assess the impairment of identifiable intangibles, long-lived assets and related goodwill and enterprise level goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable and at a minimum annually. SFAS No. 142, Goodwill and Other Intangible Assets requires that if the fair value of a company’s individual reporting unit is less than the reported value of the individual reporting unit, an asset impairment charge must be recognized in the financial statements. The amount of the impairment is calculated by subtracting the fair value of the asset from the reported value of the asset. We measure impairment based on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in our current business model. Upon adoption of SFAS No. 142 on January 1, 2002, we reclassified the net carrying amount of assembled workforce of $224,000 to goodwill and ceased amortization of goodwill.
Factors we consider important which could trigger an impairment review include the following:
• significant underperformance relative to expected historical or projected future operating results;
• significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
• significant negative industry or economic trends; and
• our market capitalization relative to net book value.
We reviewed our Host Access and Host Integration reporting units for impairment at December 31, 2002. The indicated fair value of the goodwill and intangible assets pertaining to our Host Access business was substantially greater than the carrying value, which had been reduced from its original recorded value, in large part due to an impairment charge taken in 2000 against these assets. We concluded that the overall size of the Host Integration business would not be as large as we previously forecasted. As a result we reduced our growth estimate of projected future revenues from this business, which reduced our anticipated discounted cash flows as well. We determined that the fair value of our assets related to the Host Integration business were less than the recorded value of those assets. Consequently, we determined that an asset impairment in the amount of $4.9 million had occurred as of December 31, 2002 and recorded a charge in our Consolidated Statement of Operations in the fourth quarter of 2002. In addition, we recorded an impairment of developed technology of $0.7 million in the fourth quarter of 2002
We reviewed our Host Access reporting unit for impairment at December 31, 2003. The indicated fair value of the goodwill and intangible assets pertaining to our Host Access business was substantially greater than the carrying value, and we determined that there was no impairment of the remaining long-lived assets.
Index to Financial Statements Restructurings
During the past several years, we have undertaken a number of initiatives intended to control costs and reduce operating expenses, including the discontinuance of several low revenue-generating products and the implementation of worldwide restructurings of our operations as a result of acquisitions and prevailing market conditions.
On January 30, 2003 we announced a restructuring of NetManage in response to the sluggish North America and European economies. We believe it was necessary to refocus our operations and reduce our operating expenses to bring them in line with our revised anticipated revenue levels. We implemented a reduction in our workforce of more than 30% and recorded a $2.0 million restructuring charge, consisting of $1.6 million relating to employee and other-related expenses for employee terminations and approximately $0.4 million related to facilities no longer needed for company operations as required by SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, in the first quarter of 2003. Additional restructuring charges and credits, related to the January 2003 restructuring, of $0.9 million, $0.4 million and $(0.1) million were recorded in the second, third and fourth quarters of 2003, respectively. We anticipate that the execution of the restructuring actions will require total cash expenditures of $3.2 million, which is expected to be funded from internal operations and existing cash balances. As of December 31, 2003, $2.7 million has been paid, leaving a remaining restructuring liability of $0.5 million which is included in accrued liabilities.
In fiscal 2002, we experienced a continuing reduction in revenues, which we believe related primarily to the worsening North American and European economies. Customers were postponing or canceling decisions to purchase technology products because of uncertainties within their own businesses. We believed it was necessary to refocus our operations and reduce our operating expenses to bring them more in line with our revised anticipated revenue levels. Consequently, on August 8, 2002, we announced a restructuring of our operations designed to re-align our core business functions and reduce operating expenses. As part of the restructuring, we reduced our workforce by approximately 26% and recorded a $4.6 million charge to operating expenses in the third quarter of 2002. The restructuring charge included approximately $2.6 million of expenses related to facilities no longer needed for company operations, and $2.0 million of employee and other-related expenses for employee terminations. Approximately $0.2 million of this restructuring activity relates to write-off of excess equipment, furniture, software and leasehold improvements and is included in the approximately $2.6 million related to facilities. In 2003, based on a review of current operations, a decision was made to revise the original restructuring plan by retaining certain personnel in European locations who had been identified for termination and certain related offices that had been identified for closure. This decision resulted in an approximately $0.9 million reduction in accrued severance costs and approximately $0.4 million reduction in accrued facility costs. We anticipate that the execution of the restructuring actions will require total cash expenditures of $3.1 million, which is expected to be funded from internal operations and existing cash balances. As of December 31, 2003, $2.3 million has been paid, leaving a remaining restructuring liability of approximately $0.8 million.
In prior years, we have recorded restructuring charges related to current economic pressures or as a result of business acquisitions. As of December 31, 2003, the remaining restructuring reserves related to these restructurings total $0.4 million and are included in accrued liabilities.
Reverse stock split
On August 28, 2002, our stockholders approved a one-for-seven reverse stock split of our common stock for stockholders of record on July 15, 2002, which became effective at the close of business on September 3, 2002.
Stock repurchase program
Our Board of Directors has authorized the repurchase from time to time of up to 2,142,857 shares of our common stock through open market purchases. During 2003, we purchased 71,931 shares of our common stock on the open market at an average purchase price of $2.44 per share for a total cost of approximately $0.2 million. Cumulatively, as of December 31, 2003, we had repurchased 2,076,848 shares of our common stock at an average price of $10.02 per share for a total cost of approximately $20.8 million.
Index to Financial Statements Year ended December 31, 2003 compared to year ended December 31, 2002
Index to Financial Statements Net revenues
Historically, a majority of our net revenues have been derived from software license fees. Service revenues have been primarily attributable to maintenance agreements associated with product licenses.
Net revenues decreased 23% during the year ended December 31, 2003 as compared to the year ended December 31, 2002. The decline in net revenues resulted from a decline in license revenues of $10.7 million, or 34% and a decline in services revenues of $4.3 million, or 12% from 2002. The decreases resulted from continued customer decisions to cancel or postpone purchases of our Host Access products, due to the slow North American (including Latin America), and European economies, and ongoing pressures on average selling prices. We experienced a relatively flat level of incoming orders during the first three quarters of 2003. Incoming orders increased in the fourth quarter of 2003. In the first three quarters of 2002 we experienced a declining trend in orders with a typical seasonal increase in the fourth quarter of 2002. We generally ship software products within a short period after receipt of an order, and therefore we do not have a material backlog of unfilled orders. Rumba product revenues in 2003 declined approximately 26% from 2002 with declines in both license revenues and service revenues across all geographic territories. OnWeb product revenues in the Host Integration market in 2003 grew approximately 44% from 2002 primarily because of a 49% growth in OnWeb license revenues and a 34% increase in services revenues. Combined Rumba and OnWeb service revenues increased as a percentage of total revenues to just over 59% due to the larger percentage decline in license revenues in 2003.
We have operations worldwide, with sales offices located in the United States, Europe, Canada, and Israel. Revenues outside of North America (United States and Canada) as a percentage of total net revenues were approximately 29% and 28% for the years ended December 31, 2003 and 2002, respectively.
No customer accounted for more than 10% of net revenues during the years ended December 31, 2003 and 2002.
Gross margin
Gross margin for both license fees and services decreased in absolute dollars for the year ended December 31, 2003 as compared to the year ended 2002, primarily because of the decline in net revenues of 22.8%, but was offset in part by cost reductions associated with the reduction in headcount of 20 full time employees in the Operations, Customer Support, and Consulting groups, the consolidation in the number of software distribution centers, and the implementation of electronic distribution initiatives.
Gross margin for license fees as a percentage of net revenues decreased from 44.3% to 37.1% in 2003 as compared to 2002 primarily because of the above noted expense reduction measures and the 34.1% reduction in license fees. The gross margin for services increased from 42.5% to 50.1% due to cost reductions and offset in part by a reduction in services revenues of 12.5%.
Gross margin for amortization of intangibles consists of the amortization of developed technology recorded as a result of software and developed technology acquired during several acquisitions. Amortization of developed technology is recorded on a straight-line basis over the estimated life of five years.
Research and development
Research and development, or R & D, expenses consist primarily of salaries and benefits, occupancy and travel expenses, and fees paid to outside consultants. R & D expenses decreased, in absolute dollars and as a percentage of net revenues for 2003 as compared to 2002, primarily as a result of the reduction in headcount of 35 full time employees as the R & D operations were consolidated from three facilities to two facilities. As a result of the reduced headcount, both facilities and travel costs were reduced as well.
Software development costs are accounted for in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, under which we are required to capitalize software development costs after technological feasibility is established which we define as a working model and further define as a beta version of the software. The establishment of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by us with respect to certain
Index to Financial Statements
external factors, including, but not limited to, anticipated future gross product revenue, estimated economic life, and changes in technology. Costs that do not qualify for capitalization are charged to R&D expense when incurred. We did not capitalize any software development costs in 2003.
Sales and marketing
Sales and marketing expenses consist primarily of salaries and commissions of sales, and marketing personnel, advertising and promotional expenses, occupancy and related costs. Sales and marketing expenses decreased $9.9 million, or 28.0%, as a percentage of net revenues for the year 2003, as compared to the year 2002, primarily as a result of the reduction in sales and sales support staff by 43 full time employees as part of our restructuring in January 2003. Also directly related to the reduction in headcount, benefits and travel, commission expense, and occupancy costs were lower in 2003 than 2002.
During fiscal 2003, the Company accrued $0.8 million relating to a company-wide incentive. In the fourth quarter of 2003, the Company determined that the underlying goal would not be achieved and the $0.8 million was reversed in the fourth quarter. The reversal of this incentive in the fourth quarter was offset in large part by the accrual of a corporate bonus of $0.6 million resulting from obtaining profitability in the fourth quarter. These incentives are allocated to functional areas of the Company based on headcount.
General and administrative
General and administrative, or G & A, expenses consist primarily of salaries, benefits, accounting, travel, legal, and occupancy expenses. General and administrative expenses decreased $0.7 million for 2003 as compared to 2002. The decrease in costs resulted from lower salary and benefits costs related to the reduction in staff of 16 full time employees offset in part by higher bonus incentives and consulting costs. G & A expenses increased as a percentage of net revenues, primarily because the decline in net revenues in 2003 was greater than the decrease in G & A expenses.
Restructuring charges
On January 30, 2003 NetManage announced a restructuring of its operations in response to the sluggish North America and European economies. It was necessary to refocus our operations and reduce our operating expenses to bring them in line with our revised anticipated revenue levels. The company implemented a reduction in our workforce of more than 30% and recorded a $3.2 million restructuring charge related to expenses for employee terminations and expenses related to facilities no longer needed for company operations as required by SFAS No. 146, Accounting for Costs Associated with exit or Disposal Activities, during 2003. NetManage anticipates that the execution of the restructuring actions will require total cash expenditures of $3.2 million, which is expected to be funded from internal operations and existing cash balances. As of December 31, 2003, restructuring costs totaling $3.2 million required $2.7 million in cash expenditures, leaving a remaining restructuring liability of $0.5 million which is included in accrued liabilities. NetManage anticipates additional restructuring expenses and cash expenditures of less than $0.1 million in 2004 as required under SFAS No. 146. The change in estimate of $0.1 million reflects additional bonuses for longer than anticipated employee transitions, decisions to retain a small number of employees deemed to be originally terminated and additional funds to close a European sales office.
Goodwill and other intangible assets impairment
In the fourth quarter of 2002, based on our analysis of revised product directions, revenue forecasts and future cash flows, taking into account the estimated impact on product development and customer support resulting from the reductions in personnel, we determined that there was a permanent impairment of the long-lived assets related to certain acquisitions. We re-evaluated the fair value of these long-lived assets and intangibles using primarily the estimated discounted cash flows method. We used the same methodology to
Index to Financial Statements
evaluate the fair value of our long-lived assets and intangibles to allocate purchase price at the time of acquisition. As a result, we wrote off $5.6 million of goodwill and intangible assets, consisting of $4.9 million of goodwill and $0.7 million of other intangibles, through a charge to operations. There were no such impairment charges during 2003.
Amortization of goodwill and other intangible assets
On January 1, 2002, NetManage implemented SFAS No. 142 Goodwill and Other Intangible Assets that requires that goodwill no longer be amortized. In 2003, no goodwill and $1.8 million of other intangibles were amortized. In 2002, no goodwill and $3.0 million of other intangibles were amortized. Amortization of other intangibles is recorded on a straight-line basis over an estimated useful life of five years.
Loss on investments, net
In the third quarter of 2002, we determined that our investment in easyBASE Ltd. and fusionOne, Inc. was permanently impaired, as a result of continued weakness in the software development industry and our analysis of data provided to us by both companies. In the past, we had invested in a number of companies that had developed technologies that we felt had related use with our products, and had significant opportunity in their own markets. In large part as a result of the current economy, we had determined that these investments in easyBASE and fusionOne were permanently impaired and wrote them down by $1.5 million and $0.3 million, respectively, to expected realizable values. In addition, we realized a loss of approximately $0.8 million on our investment in Kana Software, Inc. In the fourth quarter of 2002, as a result of our determination of further deterioration in their business outlook, we wrote off a bridge loan to easyBASE in the amount of $0.3 million that we believe will not be collectible. As a result, we recorded an aggregate loss on investments of approximately $2.8 million in 2002. There were no similar investment write-offs in 2003.
Interest income and other, net
The decrease of $0.3 million, or 75.0%, in interest income and other, net for 2003 as compared to 2002, is primarily the result of the reduction in our cash accounts from $24.0 million to $20.1 million and the lower money market interest rates in 2003.
Foreign currency transaction losses
We are exposed to foreign currency exchange rate risk inherent in our sales commitments, anticipated sales, anticipated purchases and assets and liabilities in currencies other than the U.S. dollar. We transact business in approximately ten foreign currencies worldwide, of which the most significant to our operations are the euro, the Canadian dollar, the Israeli shekel, and the British pound. For most currencies, we are the net receiver of foreign currencies and therefore benefit from a weaker U.S. dollar and are adversely affected by a stronger U.S. dollar relative to those foreign currencies in which we transact significant amounts of business. In 2003, we recorded a foreign currency transaction gain of $0.6 million as compared to a foreign currency transaction loss of approximately $1.6 million in 2002, resulting primarily from fluctuations in the euro, Israeli Shekel and Canadian dollar.
Provision for income taxes
We recorded a net income tax benefit for the year ended December 31, 2003 of approximately $1.3 million, which consisted primarily of refunds of foreign income taxes paid in prior years, offset in part by domestic state income taxes and foreign income taxes. Our effective tax rate for 2003 is approximately 33%, primarily because of the inclusion of $1.6 million in tax benefits recorded during 2003. Excluding the tax benefits, the effective tax rate for 2003 would be less than 1% due to our current consolidated loss position.
As of December 31, 2003, we had a gross deferred tax asset of approximately $74.5 million. Realization of the gross deferred tax asset is dependent on our generating sufficient future taxable income. We have fully reserved the gross deferred tax asset, because the realization of the deferred tax assets is uncertain.
Index to Financial Statements Year ended December 31, 2002 compared to year ended December 31, 2001
Net revenues
License fees and service revenues decreased 17% during the year ended December 31, 2002 as compared to the year ended December 31, 2001. This decrease resulted from customer decisions to cancel or postpone purchases of our products, due to the slowing North American (including Latin America), and European economies, and pressures on our selling prices. We experienced a decrease in incoming orders for 2002
Index to Financial Statements
that began in the first quarter and continued through the third quarter. Incoming orders increased in the fourth quarter of 2002. This trend was identical to the trend experienced in 2001. Because we generally ship software products within a short period after receipt of an order, we do not have a material backlog of unfilled orders. Host Access revenues in 2002 declined approximately 17% from 2001 with declines in both license revenues and service revenues across all geographic territories. Host Integration revenues in 2002 declined approximately 25% from 2001 primarily because of a decline in consulting revenues, offset in part by a 55% growth in Host Integration license revenues and a 5% increase in maintenance revenues. Combined Host Access and Host Integration service revenues increased as a percentage of total revenues to just over 52% due to the larger percentage decline in license revenues in 2002.
We have operations worldwide, with sales offices located in the United States, Europe, Canada, and Israel. Revenues outside of North America (United States and Canada) as a percentage of total net revenues were approximately 28% and 29% for the years ended December 31, 2002 and 2001. No customer accounted for more than 10% of net revenues during the years ended December 31, 2002 and 2001.
Gross margin
Gross margin decreased in absolute dollars for the year ended December 31, 2002 as compared to the year ended 2001, primarily because of the decline in net revenues of 17%, offset in part by cost reductions associated with the reduction in headcount of 23 full time employees and to more cost effective software procurement and distribution initiatives.
Gross margin as a percentage of net revenues remained relatively constant in 2002 as compared to 2001 primarily as a result of the greater reduction in costs compared to the reduction of revenues.
Research and development
R & D expenses decreased, in absolute dollars and as a percentage of net revenues for 2002 as compared to 2001, primarily as a result of the reduction in headcount of 32 full time employees for research and development activities in our Host Access product line. We did not capitalize any software development costs in 2002.
Sales and marketing
Sales and marketing expenses decreased in absolute dollars and as a percentage of net revenues for the year 2002, as compared to the year 2001, primarily as a result of lower sales levels, the reduction in sales and sales support staff by 50 full time employees as part of our ongoing cost reduction efforts, and to a lesser extent, actions as a result of our restructuring in August 2002.
General and administrative
General and administrative expenses increased in absolute dollars and as a percentage of net revenues for 2002 as compared to 2001 primarily as a result of higher professional fees related to the re-audit of our 2000 and 2001 fiscal years and for various litigation matters in which NetManage is involved. The increase in costs was partially offset as a result of the reduction in staff of 13 full time employees.
Restructuring charges
In fiscal 2002, we experienced a continued reduction in revenues, which we believed related primarily to the worsening North American and European economies. Customers postponed or canceled decisions to purchase technology products because of uncertainties within their own businesses. We believed it was necessary to refocus our operations and reduce our operating expenses to bring them more in line with our revised anticipated revenue levels, which we expected to be comparable or less than those of the previous year. Consequently, on
Index to Financial Statements
August 8, 2002, we announced a restructuring of our operations designed to re-align our core business functions and reduce operating expenses. As part of the restructuring, we reduced our workforce by approximately 26% and recorded a $4.6 million charge to operating expenses in the third quarter of 2002. The restructuring charge included approximately $2.6 million of expenses related to facilities no longer needed for company operations, and $2.0 million of employee and other-related expenses for employee terminations.
An additional charge of $0.1 million was recorded in the fourth quarter of 2002 as a result of changes in estimates in restructuring charges originally recorded in prior years (See Note 3 to the Notes to Consolidated Financial Statements).
Goodwill and other intangible assets impairment
In the fourth quarter of 2002, based on our analysis of revised product directions, revenue forecasts and future cash flows, taking into account the estimated impact on product development and customer support resulting from the reductions in personnel, we determined that there was a permanent impairment of the long-lived assets related to our acquisitions. We re-evaluated the fair value of these long-lived assets and intangibles using primarily the estimated discounted cash flows method. We used the same methodology to evaluate the fair value of our long-lived assets and intangibles to allocate purchase price at the time of acquisition. As a result, we wrote off $5.6 million of goodwill and intangible assets, consisting of $4.9 million of goodwill and $0.7 million of other intangibles, through a charge to operations.
Amortization of goodwill and other intangible assets
On January 1, 2002, NetManage implemented SFAS No. 142 Goodwill and Other Intangible Assets that requires that goodwill no longer be amortized. In 2002, no goodwill and $3.1 million of other intangibles were amortized. In 2001, approximately $2.9 million of goodwill and $3.0 million of other intangibles were amortized. Amortization of other intangibles is recorded on a straight-line basis over an estimated useful life of five years.
Loss on investments, net
In the third quarter of 2002, we determined that our investment in easyBASE Ltd. and fusionOne, Inc. was permanently impaired, as a result of continued weakness in the software development industry and our analysis of data provided to us by both companies. In the past, we have invested in a number of companies that have developed technologies that we felt had related use with our products, and had significant opportunity in their own markets. In large part as a result of the current economy, we have determined that these investments in easyBASE and fusionOne were permanently impaired and wrote them down by $1.5 million and $0.3 million, respectively, to expected realizable values. In addition, we realized a loss of approximately $0.8 million on our investment in Kana Software, Inc. In the fourth quarter of 2002, as a result of our determination of further deterioration in their business outlook, we wrote off a bridge loan to easyBASE in the amount of $0.3 million that we believe will not be collectible. As a result, we recorded an aggregate loss on investments of approximately $2.8 million in 2002.
Interest income and other, net
The decrease in interest income and other, net for 2002 as compared to 2001, is primarily the result of the reduction in our cash accounts from $33.0 million to $24.0 million and the lower money market interest rates in 2002. As well, in 2001 we received approximately $1.4 million in interest income related to income tax refunds of approximately $9.3 million. No such tax refunds and interest were received in 2002.
Foreign currency transaction losses
We are exposed to foreign currency exchange rate risk inherent in our sales commitments, anticipated sales, anticipated purchases and assets and liabilities in currencies other than the U.S. dollar. We transact business in
Index to Financial Statements
approximately ten foreign currencies worldwide, of which the most significant to our operations are the euro, the Canadian dollar, the Israeli shekel, and the British pound. For most currencies, we are the net receiver of foreign currencies and therefore benefit from a weaker U.S. dollar and are adversely affected by a stronger U.S. dollar relative to those foreign currencies in which we transact significant amounts of business. In 2002, we recorded an increase in foreign currency transaction losses of $1.1 million as compared to 2001 resulting primarily from fluctuations in the Israeli Shekel.
Provision for income taxes
We recorded a provision for income taxes for the year-ended December 31, 2002 of approximately $1.1 million, which consisted primarily of foreign income taxes, net of state income tax benefits. Our effective tax rate for 2002 is less than 1%, due to our current consolidated loss position.
As of December 31, 2002, we had a gross deferred tax asset of approximately $76.6 million. Realization of the gross deferred tax asset is dependent on our generating sufficient future taxable income. Currently, we believe that it is likely the gross deferred tax asset may not be realized and, therefore, we have fully reserved the gross deferred tax asset.
Disclosures about market risk
Interest rate risk
Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We place our investments with high credit quality issuers and, by policy, limit our amount of credit exposure to any one issuer. As stated in our policy, we are averse to principal loss, and seek to preserve our invested funds by limiting default risk, liquidity risk, and territory risk.
We mitigate default and liquidity risks by investing only in safe and high credit quality securities, and by positioning our portfolio to respond appropriately to a significant reduction in a credit rating of any investment issuer or guarantor. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity. We mitigate territory risk by only allowing up to 25% of the portfolio to be placed outside of the United States.
The table below presents the carrying value, market value and related weighted average interest rates for our cash and interest-bearing investment portfolio as of December 31, 2003. All investments mature, by policy, in four years or less.
A hypothetical change of 10% in interest rates would not have a material impact on our financial position.
Foreign currency risk
We are exposed to foreign currency exchange rate risk inherent in our sales commitments, anticipated sales, anticipated purchases and assets and liabilities in currencies other than the U.S. dollar. We transact business in approximately ten foreign currencies worldwide, of which the most significant to our operations are the euro, the Canadian dollar, the Israeli shekel, and the British pound. For most currencies, we are the net receiver of foreign currencies and therefore benefit from a weaker U.S. dollar and are adversely affected by a stronger U.S. dollar
Index to Financial Statements
relative to those foreign currencies in which we transact significant amounts of business. The net results of the transaction gains or losses appear in the line entitled foreign currency transaction gain or loss in the Consolidated Statement of Operations. At the end of each period, the translation of the Consolidated Balance Sheet from local currency to the group currency appear in the Consolidated Statement of Comprehensive Loss under the foreign currency translation adjustments line.
The following table presents the potential impact on cash flow of changes in exchange rates as noted (in thousands):
(1) The offset entry for this change in exchange rates would be to Accumulated comprehensive loss in the Consolidated Balance Sheets.
(2) This assumes the change in exchange rates applies only to the relationship between the U.S. dollar and the local currency as of December 31, 2003 and that there is no change in rates between the various non U.S. dollar currencies. The offset entry for this change in exchange rates would be to Foreign currency transaction gain (loss) in the Consolidated Statements of Operations.
Liquidity and capital resources
Since our inception, our operations have been financed primarily through cash provided by operations and sales of capital stock. Our primary financing activities to date consist of our initial and secondary public stock offerings and private preferred stock issuances, which aggregated net proceeds to us of approximately $72.5 million. We do not have a bank line of credit. The domestic and international economic events over the past three years have negatively impacted our ability to generate sufficient cash to offset our cash outflows. We have taken a number of measures to reverse this trend through restructuring our organization, reducing our operating expenses through the closing of excess facilities, subleasing excess facility space, and carefully monitoring our discretionary expenses. Our business has been and will be dependent upon the spending of our customers in their respective IT organizations. No guarantees can be made as to when and how our products will be received in the future under these uncertain economic times.
During the year ended December 31, 2003, our aggregate cash and cash equivalents, short-term investments decreased from $24.1 million to $20.3 million. This decrease was due primarily to our net cash used in operating activities of $3.4 million, which is net of tax refunds of approximately $1.6 million; our repurchase of our common stock in the open market under the repurchase program described below; and equipment purchases. Our principal investing activities to date have been the purchase of short-term and long-term investments, business acquisitions, and equipment purchases. We do not have any specific commitments with regard to future capital expenditures. Net cash used in financing activities in 2002 reflects the issuance of shares under our employee stock purchase plan and stock option plans net of the repurchase of our common stock, from time to time, through open market purchases.
Index to Financial Statements At December 31, 2003, we had working capital of $7.8 million. We believe that our current cash balances and future operating cash flows will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months.
Our Board has authorized the repurchase from time to time of up to 2,142,857 shares of our common stock through open market purchases. During 2003, we repurchased 71,931 shares of our common stock for approximately $0.2 million on the open market at the average price of $2.44 per share. During 2002, we repurchased 616,401 shares of our common stock on the open market at an average purchase price of $3.83 per share for a total cost of approximately $2.4 million. During 2001, we repurchased 337,221 shares of our common stock on the open market at an average purchase price of $5.49 per share for a total cost of approximately $1.9 million. Cumulatively, as of December 31, 2003, we had repurchased 2,076,848 shares of our common stock at an average price of $10.02 per share for a total cost of approximately $20.8 million.
Contractual obligations
A table of our contractual obligations as of December 31, 2003 is as follows (in thousands):
Off-balance sheet arrangements
As of December 31, 2003, we did not engage in any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K promulgated by the Commission under the Securities Exchange Act of 1934, as amended.
Factors that may affect our future results and financial condition
Our business is subject to a number of risks and uncertainties. You should carefully consider the risks described below, in addition to the other information contained in this Report and in our other filings with the Securities and Exchange Commission, or SEC. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occur, our business, financial condition or results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose part or all of your investment.
Our operating results have fluctuated significantly in the past and may continue to do so in the future, which could cause our stock price to decline.
We have experienced, and expect to experience in future periods, significant fluctuations in operating results that may be caused by many factors including, among others:
• general economic conditions, in particular, the slowdown of purchases of information technology due to current economic conditions in North America and internationally;
• changes in the demand for our products;
• introduction or enhancements to our products and those of our competitors;
• technological changes in computer networking;
• competitive pricing pressures;
Index to Financial Statements
• market acceptance of new products;
• customer order deferrals in anticipation of new products and product enhancements;
• the size and timing of individual product orders;
• mix of international and domestic revenues;
• mix of distribution channels through which our products are sold;
• loss of, or failure to enter into, strategic alliances to develop or promote our products;
• quality control of our products;
• changes in our operating expenses;
• personnel changes;
• foreign currency exchange rates;
• seasonality; and
• adverse business conditions in specific industries.
In addition, our acquisition of complementary businesses, products or technologies has in the past caused and may continue to cause fluctuations in our operating results due to in-process research and development charges, the amortization of acquired intangible assets, and integration costs recorded in connection with acquisitions.
Since we generally ship software products within a short period after receipt of an order, we do not typically have a material backlog of unfilled orders, and our revenues in any one quarter are substantially dependent on orders booked in that quarter and particularly in the last month of that quarter. Our expenses are based in part on our expectations as to future revenues and to a large extent are fixed. Therefore, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Accordingly, any significant shortfall in demand for our products in relation to our expectations or any material delay of customer orders would have an almost immediate adverse impact on our operating results and on our ability to achieve profitability.
As a result, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Fluctuations in our operating results have caused, and may in the future cause us to perform below the expectations of public market analysts and investors. If our operating results fall below market expectations, the price of our common stock may fall.
We have not been profitable since 1995 and may never achieve profitability.
Notwithstanding the net profit reported for the fourth quarter of 2003, we had a net loss of approximately $2.7 million for the year ended December 31, 2003. We have not achieved profitability on an annual basis since 1995 and we may never obtain sufficient revenues to sustain profitability in any future period. In addition, if we are profitable, we cannot be certain that we can increase profitability, particularly to the extent that we face price competition. As a result, we will need to generate significant revenues to attain profitability. Increasing competition and the declining worldwide economy are likely to cause our prices to decline, which would harm our operating results. We expect our prices for our software products to decline over the next few years. We expect to face increased competition in markets where we sell our products, which will make it more difficult to increase or maintain our prices and profit margins. If anticipated increases in sales volume do not keep pace with anticipated pricing pressures, our revenues would decline and our business could be harmed. Despite our efforts to introduce enhancements to our products, we may not be successful in maintaining our pricing.
We rely significantly on third parties for sales of our products and our revenues could decline significantly with little or no notice.
We rely significantly on our independent distributors, systems integrators, and value-added resellers for certain elements of the marketing and distribution of our products. The agreements in place with these
Index to Financial Statements
organizations are generally non-exclusive, of limited duration, are terminable with little or no notice by either party and generally do not contain minimum purchase requirements. These distributors of our products are not within our control and generally represent competing product lines of other companies in addition to our products. There can be no assurance that these organizations will give a high priority to the marketing of our products, and they may give a higher priority to the products of our competitors.
Furthermore, our results of operations can also be materially adversely affected by changes in the inventory strategies of our resellers, which can occur rapidly and may not be related to end-user demand. As part of our continued strategy of selling through multiple distribution channels, we expect to continue using indirect distribution channels, particularly value-added resellers and system integrators, in addition to distributors and original equipment manufacturers. Indirect sales may grow as a percentage of both domestic and total net revenues during 2004 and beyond, as a result of acquisitions or increased market penetration. Any material increase in our indirect sales as a percentage of revenues may adversely affect our average selling prices and gross margins due to lower unit costs that are typically charged when selling through indirect channels. There can be no assurance that we will be able to attract or retain resellers and distributors who will be able to market our products effectively, will be qualified to provide timely and cost-effective customer support and service, or will continue to represent our products. If we are unable to recruit or retain important resellers or distributors or if they decrease their sales of our products, we may suffer a material adverse effect on our business, financial condition or results of operations.
We have undergone significant restructurings, which may have a material adverse effect on our operating results.
We undertook restructurings of our operations in August 2000, August 2002 and again in January 2003. These restructuring plans involved reductions in our worldwide workforce and the consolidation of certain of our sales, customer support, and research and development operations. We have also had to write-down assets as part of the restructuring effort that lowered our operating results. These restructuring plans may not be successful and may not improve future operating results. Completion of the restructuring plans may disrupt our operations and have a material adverse effect on our business, financial condition and results of operations. We may also be required to implement additional restructuring plans in the future.
We may not be able to successfully make acquisitions of or investments in other companies or technologies.
We have limited experience in acquiring or making investments in companies, technologies or services. We regularly evaluate product and technology acquisition opportunities and anticipate that we may make additional acquisitions in the future if we determine that an acquisition would further our corporate strategy. Acquisitions in our industry are particularly difficult to assess because of the rapidly changing technological standards in our industry. If we make any acquisitions, we will be required to assimilate the personnel, operations and products of the acquired business and train, retain and motivate key personnel from the acquired business. However, the key personnel of the acquired business may decide not to work for us. Moreover, if the operations of an acquired company or business do not meet our expectations, we may be required to restructure the acquired business, or write-off the value of some or all of the assets of the acquired business. No assurance can be given that any acquisition by us will or will not occur, that if an acquisition does occur, that it will not materially and adversely affect us, or that any such acquisition will be successful in enhancing our business.
We are dependent upon our key management for our future success, and few of our managers are obligated to stay with us.
Our success depends on the efforts and abilities of our senior management and certain other key personnel. Many of our key employees are employed on an at-will basis. If any of our key employees left or were unable to work and we were unable to find a suitable replacement, then our business, financial condition and results from operations could be materially harmed.
Index to Financial Statements We face significant competition and competition in our market is likely to increase and could harm our business.
The markets for our products are intensely competitive and characterized by rapidly changing technology, evolving industry standards, price erosion, changes in customers’ needs, and frequent new product introductions. We anticipate continued growth and competition in our industry and the entrance of new competitors into our markets, and accordingly, the markets for our products will remain intensely competitive. We expect that competition will increase in the near term and that our primary long-term competitors may not yet have entered the market. Several key factors contribute to the continued growth of our marketplaces including the proliferation of Microsoft Windows client server technology, and the continued implementation of web-based access to corporate mainframe and midrange computer systems. Our connectivity software products compete with major computer and communication systems vendors, including Microsoft, IBM, and Sun Microsystems, Inc., as well as smaller networking software companies such as Jacada Ltd., Seagull Holding HV, and Hummingbird Ltd. We also face competition from makers of terminal emulation software such as Attachmate Corporation, and WRQ, Inc.
Many of our current competitors have, and many of our future competitors may have, substantially greater financial, technical, sales, marketing and other resources, in addition to greater name recognition and a larger customer base than us. The markets for our products are characterized by significant price competition and we anticipate that we will face increasing pricing pressures from our competitors in the future. In addition, our current and future competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements than we can. Increased competition could result in price reductions, fewer customer orders, reduced gross profit margins and loss of market share, any of which could harm our business.
Furthermore, our competitors could seek to expand their product offerings by designing and selling products using technology that could render obsolete or adversely affect sales of our products. These developments may adversely affect sales of our products either by directly affecting customer-purchasing decisions or by causing potential customers to delay their purchases of our products. Several of our competitors have developed proprietary networking applications and certain of such vendors, including Novell, provide a TCP/IP protocol suite in their products at little or no additional cost. In particular, Microsoft has embedded a TCP/IP protocol suite in its Windows 98, Windows 2000, Windows ME, Windows NT, Windows XP, and Windows .NET operating systems. We have products, which are similar to connectivity products marketed by Microsoft. Microsoft is expected to increase development of such products, which could have a material adverse effect on our business, financial condition or results of operations.
If we fail to manage technological change, respond to consumer demands or evolving industry standards or if we fail to enhance our products’ interoperability with the products of our customers, demand for our products will decrease and our business will suffer.
From time to time many of our customers have delayed purchase decisions due to confusion in the marketplace relating to rapidly changing technology and product introductions. To maintain or improve our position in this industry, we must successfully develop, introduce, and market new products and product enhancements on a timely and cost-effective basis. We have experienced difficulty from time to time in developing and introducing new products and enhancing existing products, in a manner which satisfies customer requirements and changing market demands. Any failure by us to anticipate or respond adequately to changes in technology and customer preferences, or any significant delays in product development or introduction, could have a material adverse effect on our business, financial condition, and results of operations. The failure to develop products or product enhancements incorporating new functionality on a timely basis could cause customers to delay purchase of our current products or cause customers to purchase products from our competitors; either situation would adversely affect our business, financial condition, and results of operations. We may not be successful in developing new products or enhancing our existing products on a timely basis, and any new products or product enhancements developed by us may not achieve market acceptance. In addition, we incorporate software and other technologies owned by third parties and as a result, we are dependent upon such
Index to Financial Statements
third parties’ ability to enhance their current products, to develop new products that will meet changing customer needs on a timely and cost-effective basis, and to respond to emerging industry standards and other technological changes.
We depend upon technology licensed from third parties, and if we do not maintain these license arrangements, we will not be able to ship many of our products and our business will be seriously harmed.
Certain of our products incorporate software and other technologies developed and maintained by third parties. We license these technologies from third parties under agreements with a limited duration and we may not be able to maintain these license arrangements. If we fail to maintain our license arrangements or find suitable replacements, we would not be able to ship many of our products and our business would be materially harmed. For example, we have a license agreement with Dart Technologies, Inc. for Power TCP Telnet and Power TCP VT320 for five years, which we use in our OnWeb product line. There can be no assurance that we would be able to replace the functionality provided by the third-party technologies currently offered in conjunction with our products if those technologies become unavailable to us or obsolete or incompatible with future versions of our products or market standards.
We depend upon the compatibility of our products with applications operating on Microsoft Windows to sell our products.
Substantially all of our net revenues have been derived from the sales of products that provide internetworking applications for the Microsoft Windows environment and are marketed primarily to Windows users. As a result, sales of certain of our products would be negatively impacted by developments adverse to Microsoft’s Windows products. In addition, our strategy of developing products based on the Windows operating environment is substantially dependent on our ability to gain pre-release access to, and to develop expertise in, current and future Windows developments by Microsoft. If we are unable to gain such access our ability to develop new products compatible with future Windows release in a timely manner could be harmed.
The loss of any of our strategic relationships would make it more difficult to keep pace with evolving industry standards and to design products that appeal to the marketplace.
Our future success depends on our ability to maintain and enter into new strategic alliances and OEM relationships to develop necessary products or technologies, to expand our distribution channels or to jointly market or gain market awareness for our products. We currently rely on strategic relationships, such as those with Microsoft to provide us with state of the art technology, assist us in integrating our products with leading industry applications and help us make use of economies of scale in manufacturing and distribution. However, we do not have written agreements with many of our strategic partners and cannot ensure these relationships will continue for a significant period of time. Many of our agreements with these partners are informal and may be terminated by them at any time. There can be no assurance that we will be successful in maintaining current alliances or developing new alliances and relationships or that such alliances and relationships will achieve their intended purposes.
We may be subject to product returns, product liability claims and reduced sales because of defects in our products.
Software products as complex as those offered by us may contain undetected errors or failures when first introduced or as new versions are released. The likelihood of errors is higher when a new product is introduced or when new versions or enhancements are released. Errors may also arise as a result of defects in third-party products or components, which are incorporated, into our products. There can be no assurance that, despite testing by us and by current and potential customers, errors will not be found in new products or product enhancements after commencement of commercial shipments, which could result in loss of or delay in market acceptance. We may be required to devote significant financial resources and personnel to correct any defects.
Index to Financial Statements
Known or unknown errors or defects that affect the operation of our products could result in the following, any of which could have a material adverse effect on our business, financial condition, and results of operations:
• delay or loss or revenues;
• cancellation of a purchase order or contract due to defects;
• diversion of development resources;
• damage to our reputation;
• failure of our products to achieve market acceptance;
• increased service and warranty costs; and
• litigation costs.
Although some of our licenses with customers contain provisions designed to limit our exposure to potential product liability claims, these contractual limitations on liability may not be enforceable or may only limit, rather than eliminate potential liability. In addition, our product liability insurance may not be adequate to cover our losses in the event of a product liability claim resulting from defects in our products and may not be available to us in the future.
Our business depends upon licensing our intellectual property, and if we fail to protect our proprietary rights, our business could be harmed.
Our ability to compete depends substantially upon our internally developed proprietary technology. We rely primarily on a combination of copyright and trademark laws, trade secrets, confidentiality procedures, and contractual provisions to protect our proprietary rights. We seek to protect our software, documentation and other written materials under trade secret and copyright laws and contractual confidentiality agreements, which afford only limited protection, and, to a lesser extent, patent laws. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. Policing unauthorized use of our products and technology is difficult and, while we are unable to determine the extent to which piracy of our software products exists, software piracy can be expected to be a persistent problem. In selling our products, we rely primarily on “shrink-wrap” and “click-wrap” licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. If we are not successful in protecting our intellectual property, our business could be substantially harmed.
We rely upon trademarks, copyrights and trade secrets to protect our proprietary rights, which are only of limited value.
There can be no assurance that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology. In addition, the number of patents applied and granted for software inventions is increasing. Despite any precautions which we have taken:
• laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or deter others from developing similar technologies;
• other companies may claim common law trademark rights based upon state or foreign law which precede our federal registration of such marks; and
• current federal laws that prohibit software copying provide only limited protection from software “pirates,” and effective trademark, copyright and trade secret protection may be unavailable or limited in certain foreign countries.
Index to Financial Statements Our pending patent applications may never be issued, and even if issued, may provide us with little protection.
We regard the protection of patentable inventions as important to our business. However, it is possible that:
• our pending patent applications may not result in the issuance of patents;
• our patents may not be broad enough to protect our proprietary rights;
• any issued patent could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in those patents;
• current and future competitors may independently develop similar technology, duplicate our products or design around any of our patents; and
• effective patent protection, if any, may not be available in every country in which we do business.
If we are not successful in asserting our patent rights, our business could be substantially harmed. At the present time, we have six patents pending and we have been issued approximately 89 patents from the U.S. Patent Office.
We have received notices of claims that may result in litigation and we may become involved in costly and time-consuming litigation over proprietary rights.
Substantial litigation regarding intellectual property rights exists in our industry. We expect that software in our industry may be increasingly subject to third party infringement claims as the number of competitors grows and the functionality of products in different areas of the industry overlaps. Third parties may currently have, or may eventually be issued, patents that would be infringed by our products or technology. We cannot be certain that any of these third parties will not make a claim of infringement against us with respect to our products and technology. We have received, and may receive in the future, communications from third parties asserting that our products infringe, or may infringe, the proprietary rights of third parties seeking indemnification against such infringement or indicating that we may be interested in obtaining a license from such third parties. Any claims or actions asserted against us could result in the expenditure of significant financial resources and the diversion of management’s time and efforts. In addition, litigation in which we are accused of infringement may cause product shipment delays, require us to develop non-infringing technology or require us to enter into royalty or license agreements even before the issue of infringement has been decided on the merits. If any litigation were not to be resolved in our favor, we could become subject to substantial damage claims and be prohibited from using the technology at issue without a royalty or license agreement. These royalty or license agreements, if required, might not be available on acceptable terms, or at all, and could result in significant costs and harm our business. If a successful claim of infringement is made against us and we cannot develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed.
Our business is subject to risks from international operations such as legal uncertainty, tariffs, trade barriers and political and economic instability.
We derived approximately 28% of our net revenues from sales outside of North America (United States and Canada) during the year ended December 31, 2003. While we expect that international sales will continue to account for a significant portion of our net revenues, there can be no assurance that we will be able to maintain or increase international market demand for our products or that our distributors will be able to effectively meet that demand. Risks inherent in our international business activities generally include, among others:
• unexpected changes in regulatory requirements;
• legal uncertainty, particularly regarding intellectual property rights and protection;
• costs and risks of localizing products for foreign countries;
• longer accounts receivable payment cycles;
Index to Financial Statements
• language barriers in business discussions;
• cultural differences in the negotiation of contracts and conflict resolution;
• time zone differences;
• the limitations imposed by U.S. export laws (see Government Regulation and Legal Uncertainties below);
• changes in markets caused by a variety of political, social and economic factors;
• tariffs and other trade barriers;
• difficulties in managing international operations;
• currency exchange rate fluctuations;
• potentially adverse tax consequences;
• repatriation of earnings; and
• the burdens of complying with a wide variety of foreign laws.
Many of our customers are subject to many of the risks described above. These factors may have an adverse effect on our international sales and, consequently, on our business, financial condition or results of operations.
Terrorist attacks and threats or actual war could adversely affect our operating results and the price of our common stock.
The terrorist attacks in the United States, the United States response to these attacks, the current instability in Iraq, and the related decline in consumer confidence and continued economic weakness have had an adverse impact on our operations. Recent consumer reports indicate that consumer confidence has reached its lowest level since 1993. If consumer confidence continues to decline or does not recover, our revenues and results of operations may continue to be adversely impacted in 2004 and beyond. Any escalation in these events, or similar future events may disrupt our operations or those of our customers. These events have had and may continue to have an adverse impact on the United States and world economy in general and consumer confidence and spending in particular, which has and could continue to harm our sales. Any of these events could increase volatility in the United States and worldwide financial markets and economy, which could harm our stock price and may limit the capital resources available to us and our customers. This could have a significant impact on our operating results, revenues and costs and may result in increased volatility in the market price of our common stock and on the future price of our common stock.
It may be difficult to raise needed capital in the future, which could significantly harm our business.
We may require substantial additional capital to finance growth and fund ongoing operations in future years. Our capital requirements will depend on many factors including, among other things:
• our results of operations;
• acceptance of and demand for our products;
• the number and timing of any acquisitions and the cost of these acquisitions;
• the costs of developing new products;
• the costs associated with our refocusing on core products and technologies; and
• the extent to which we invest in new technology and research and development projects.
Although our current business plan does not foresee the need for further financing activities to fund our operations for the foreseeable future, due to risks and uncertainties in the marketplace as well as a potential of
Index to Financial Statements
pursuing further acquisitions, we may need to raise additional capital. If we issue additional stock to raise capital, your percentage ownership in us would be diluted. If we raise capital through debt; our debt servicing costs will increase. Additional financing may not be available when needed and, if such financing is available, it may not be available on terms favorable to us.
Because of their significant stock ownership, our officers and directors can exert significant control over our future direction.
As of March 15, 2004, our officers, directors and entities affiliated with them, in the aggregate, beneficially owned approximately 1.9 million shares, or 21% of our outstanding common stock. These stockholders, if acting together, would be able to exert significant influence on all matters requiring approval by our stockholders, including the election of directors, the approval of mergers or other business combination transactions or a sale of all or substantially all of our assets.
Certain provisions of our stock option plan, our stockholder rights plan and our certificate of incorporation and bylaws make changes of control difficult even if they would be beneficial to stockholders.
Our 1992 Stock Option Plan and our 1999 Nonstatutory Stock Option Plan provide that, in the event of a change of control of NetManage, all options outstanding under those plans would become fully vested and exercisable for at least 10 days prior to the consummation of such change of control transaction. These accelerations of vesting provisions would increase the cost to any potential acquirer and could have the effect of deterring or reducing the per share price paid to purchase NetManage.
In addition, our board of directors has the authority without any further vote or action on the part of the stockholders to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions of the preferred stock. This preferred stock, if it is ever issued, may have preference over and harm the rights of the holders of our common stock. Although the issuance of this preferred stock will provide us with flexibility in connection with possible acquisitions and other corporate purposes, the issuance of the preferred stock may make it more difficult for a third party to acquire a majority of our outstanding voting stock. We currently have no plans to issue preferred stock.
Our certificate of incorporation and bylaws include provisions that may have the effect of deterring an unsolicited offer to purchase our stock. In addition, we have implemented a stockholder rights plan that could deter or at least make it significantly more expensive for an unsolicited offer to purchase our stock. These provisions, coupled with the provisions of the Delaware General Corporation Law, may delay or impede a merger, tender offer or proxy contest involving us. Furthermore, our board of directors is divided into three classes, only one of which is elected each year. Directors are only capable of being removed by the affirmative vote of two thirds or greater of all classes of voting stock. These factors may further delay or prevent a change of control.
We face risks from the uncertainties of current and future governmental regulation.
We are not currently subject to direct regulation by any government agency, other than regulations applicable to businesses generally, and there are currently few laws or regulations directly applicable to access to or commerce on the Internet. However, due to the increasing popularity and use of the Internet, it is possible that various laws and regulations may be adopted with respect to the Internet, covering issues such as user privacy, pricing and characteristics and quality of products and services. The adoption of any such laws or regulations may decrease the growth of the Internet, which could in turn decrease the demand for our products, increase our cost of doing business or otherwise have an adverse effect on our business, financial condition or results of operations. Moreover, the applicability to the Internet of existing laws governing issues such as property ownership, libel and personal privacy is uncertain. Further, due to the encryption technology contained in certain of our products, such products are subject to U.S. export controls. There can be no assurance that such export controls, either in their current form or as may be subsequently enacted, will not limit our ability to distribute products outside of the United States or electronically. While we take precautions against unlawful exportation,
Index to Financial Statements
there can be no assurance that inadvertent violations will not occur, and the global nature of the Internet makes it virtually impossible to effectively control the distribution of our products. In addition, future federal or state legislation or regulation may further limit levels of encryption or authentication technology. Any such export restriction, new legislation or regulation or unlawful exportation could have a material adverse effect on our business, financial condition, or results of operations.
Recent accounting pronouncements
The FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”) in January 2003, and a revised interpretation of FIN 46 (“FIN 46-R”) in December 2003. FIN 46 requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. Since January 31, 2003, the Company has not invested in any entities it believes are variable interest entities for which the Company is the primary beneficiary. For all arrangements entered into after January 31, 2003, the Company is required to continue to apply FIN 46 through the end of the first quarter of fiscal 2004. The Company is required to adopt the provisions of FIN 46-R for those arrangements in the second quarter of fiscal 2004. For arrangements entered into prior to February 1, 2003, the Company is required to adopt the provisions of FIN 46-R in the second quarter of fiscal 2004. The Company does not expect the adoption of FIN 46-R to have an impact on the financial position, results of operations or cash flows of the Company.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company currently has no financial instruments which meet these requirements.
In April 2003 the FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts. The Statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clarifies when a derivative contains a financing component, amends the definition of an underlying derivative to conform it to language used in FASB Interpretation FIN No. 45, and amends certain other existing pronouncements. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. All provisions of the Statement, except those related to forward purchases or sales of “when-issued” securities, should be applied prospectively. The Company currently has no instruments that meet the definition of a derivative, and therefore, the adoption of this Statement had no impact on the Company’s financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees. FIN 45 also requires the recognition of a liability by a guarantor at the inception of certain guarantees that are entered into or modified after December 31, 2002. The Company has adopted the disclosure requirements of FIN 45 and the adoption did not have a material affect on the financial statements. (See Note 4 to the Notes to Consolidated Financial Statements.)
Item 7A
Item 7A - Quantitative and qualitative disclosures about market risk.
The information required by Item 7A is incorporated by reference from the section entitled Disclosures about market risk found above, under Item 7, Management’s discussion and analysis of financial condition and results of operations.
Index to Financial Statements
Item 8
Item 8 - Financial statements and supplementary data.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Financial Statements:
Independent Auditors’ Report
Consolidated Balance Sheets at December 31, 2003, and 2002
Consolidated Statements of Operations-Years ended
December 31, 2003, 2002, and 2001
Consolidated Statements of Comprehensive Loss-Years
ended December 31, 2003, 2002, and 2001
Consolidated Statements of Stockholders’ Equity-Years
ended December 31, 2003, 2002, and 2001
Consolidated Statements of Cash Flows-Years ended
December 31, 2003, 2002, and 2001
Index to Financial Statements
INDEPENDENT AUDITORS’ REPORT
To the Board of Directors and Stockholders of
NetManage, Inc.:
We have audited the accompanying consolidated balance sheets of NetManage, Inc. and subsidiaries (the “Company”) as of December 31, 2003 and 2002, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the consolidated financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of NetManage, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 2, in 2002 the Company changed its method of accounting for goodwill and other intangible assets to conform to Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”.
/s/ DELOITTE & TOUCHE LLP
San Jose, California
March 24, 2004
Index to Financial Statements
NETMANAGE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements
NETMANAGE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements
NETMANAGE, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements
NETMANAGE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements
NETMANAGE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Index to Financial Statements NETMANAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of operations and organization:
NetManage, Inc. (NetManage) develops and markets software and service solutions that allow its customers to access and leverage the investment they have in their host-based business applications, processes and data. NetManage’s business is primarily focused on providing a full spectrum of specific personal computer and network or application server-based software programs and software tools. These products are intended to allow NetManage customers to access and use their mission-critical line-of-business host applications and resources to publish information from existing host systems in a web presentation particularly to new users via the Internet and create new web-based applications that leverage a corporation’s existing business processes.
NetManage develops and markets its software solutions, under its Host Access Platform (HAP), to allow its customers to access and leverage applications, business processes and data on IBM corporate mainframe computers, and IBM midrange computers such as AS/400 or iSeries and on UNIX-based servers. The Company provides professional support, maintenance, and technical consultancy services to our customers in association with the products we develop and market. NetManage provides professional applications and management consultation to its customers in association with the server-based products it sells that allow customers to develop and deploy new web-based applications and to deliver existing host-based business processes in an industry standard component form to new application frameworks.
NetManage’s HAP-Access Services products enable end-user devices, including personal computers, to communicate with large centralized corporate computer systems and the applications that are hosted on them. These products are marketed and sold under the brand name of RUMBA. HAP-Presentation Services products allow devices running web browsers to communicate with large centralized corporate computer systems through either software downloaded into the client browser or through solutions that deliver connectivity for web browser users without the requirement for software on the user’s device other than the browser itself. HAP-Presentation Services solutions also allow single or multiple host applications to be completely re-presented with a web look and feel, and are marketed and sold under the brand name OnWeb. NetManage’s HAP-Integration Services products provide server-side solutions that allow the integration of single or multiple existing host-based business processes into reusable software components, such as Web Services, Microsoft .Net Assemblies or Enterprise Java Beans, that can be incorporated into new applications being built on the major application frameworks including .Net and J2EE. HAP-Integration Services products allow our customers to integrate existing legacy applications with new platform solutions and are marketed and sold under the OnWeb brand name.
2. Summary of significant accounting policies:
Principles of consolidation
The consolidated financial statements include the accounts of NetManage and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated.
Use of estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Foreign currency translation, foreign exchange contracts and comprehensive income
The functional currency of NetManage’s foreign subsidiaries is the local currency. Gains and losses resulting from the translation of the foreign subsidiaries’ financial statements are included in accumulated
Index to Financial Statements NETMANAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
comprehensive loss and reported as a separate component of stockholders’ equity. Gains and losses resulting from foreign currency transactions are included in the net loss.
NetManage currently does not enter into financial instruments for either trading or speculative purposes. There were no forward foreign exchange contracts used during the three year period ended December 31, 2003.
Comprehensive loss is comprised of net loss and other comprehensive earnings such as foreign currency translation gains or losses and unrealized gains or losses on marketable securities.
Cash and cash equivalents
NetManage considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Short-term investments
NetManage accounts for its investments under the provisions of the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under SFAS No. 115, short-term investments are classified as available-for-sale and are reported at fair value, with unrealized gains and losses, net of tax, reported in the Consolidated Statement of Comprehensive Loss. At December 31, 2003 and 2002, all short-term investments were classified as available-for-sale.
In December 2000 ServiceSoft, Inc., a private company in which NetManage owned a minority interest, was acquired by Broadbase, a publicly traded company. As a result NetManage received shares of Broadbase common stock in exchange for the minority interest NetManage held in the shares of common stock of ServiceSoft, Inc. and recognized a gain which was included in (loss)/gain on investments, of approximately $2.2 million on the original investment. The shares of Broadbase common stock owned by NetManage were classified as available-for-sale securities as of December 31, 2000. On June 29, 2001, Broadbase was acquired by KANA Software Inc., KANA, a publicly traded company, at which time NetManage recorded a $1.8 million loss on its investment.
Other investments
Other investments mainly consist of equity interests in private companies with less than 20% ownership interests. These investments are accounted for under the cost method.
On May 4, 2000 NetManage invested $1.5 million in 2,822 Series B Preferred shares of stock in easyBASE Ltd. which is approximately 12% of the total ownership of easyBASE Ltd. NetManage’s Chairman and Chief Executive Officer also has a personal investment of less than 1% in easyBASE Ltd. He is also a member of the board of directors of easyBASE Ltd.
In May, June, and December 1999 NetManage invested a total of $0.3 million in pcFirst, Inc. On April 28, 2001 pcFirst, Inc. was purchased by fusionOne, Inc., a development stage private company, and NetManage received 13,625 shares of common stock of fusionOne, Inc. NetManage’s investment represents less than 1% of the total ownership of fusionOne, Inc.
In the third quarter of 2002, NetManage determined that the investments in easyBASE Ltd. and fusionOne, Inc. were permanently impaired, as a result of continued weakness in the software development industry and
Index to Financial Statements NETMANAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
management’s analysis of data provided to NetManage by both companies. Also in the third quarter of 2002, NetManage determined that the investment in KANA was permanently impaired and wrote off $0.8 million of its investment. In the fourth quarter of 2002, NetManage determined that a $0.3 million bridge loan to easyBASE was not collectible and was written off.
Property and equipment
Property and equipment are recorded at cost. Improvements, renewals and extraordinary repairs that extend the lives of the asset are capitalized, other repairs and maintenance are expensed. Depreciation is computed using the straight-line method over the following estimated useful lives:
Classification
Life
Computer software and equipment
2 to 3 years
Furniture and fixtures
5 years
Leasehold improvements
Shorter of the lease term or the estimated useful life
Depreciation expense for 2003, 2002, and 2001 was $1.1 million, $1.8 million, and $3.4 million, respectively.
Property and equipment have been recorded at net book value as follows in the United States, Israel, and Other countries (in thousands):
Goodwill and other intangible assets, net
NetManage reviews long-lived assets and certain identifiable intangibles to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. NetManage evaluates possible impairment of long-lived assets using estimates of undiscounted future cash flows. Impairment loss to be recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Management evaluates the fair value of long-lived assets and intangibles using primarily the estimated discounted future cash flows method. Management uses other alternative valuation techniques whenever the estimated discounted future cash flows method is not applicable. Effective January 1, 2002, NetManage adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144). SFAS No. 144 removes goodwill from its scope and retains the requirements of SFAS No. 121 to (a) recognize an impairment loss only if the carrying amount of the long-lived asset is not recoverable from its undiscounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and the fair value of the asset. There was no effect from the adoption of SFAS No. 144. In the fourth quarter of 2002, NetManage recorded a $0.7 million charge to fully impair the developed technology acquired in connection with the purchase of Aqueduct Software, Inc.
Effective January 1, 2002, NetManage adopted SFAS No. 142, Goodwill and Other Intangibles. Under SFAS No. 142, goodwill is no longer subject to amortization. Rather, SFAS No. 142 requires that intangible
Index to Financial Statements NETMANAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
assets deemed to have an indefinite useful life be reviewed for impairment upon adoption of SFAS No. 142 and at least annually thereafter. NetManage typically performs its annual impairment review during the fourth quarter of each year. Under SFAS No. 142, goodwill impairment may exist if the net book value of a reporting unit exceeds its estimated fair value. NetManage determines an impairment loss using the discounted future cash flows method. Upon the adoption of SFAS No. 142 on January 1, 2002, NetManage ceased amortization of assembled workforce and reclassified the net carrying amount of $0.2 million to goodwill.
In connection with its annual impairment review, in the fourth quarter of 2002 NetManage determined that the net carrying amount of goodwill for the Host Integration reporting unit was impaired and recorded a $4.9 million impairment loss. In addition, goodwill was reduced by $0.7 million in 2002 as a result of the utilization of pre-acquisition tax attributes of Wall Data (see Note 7). There were no impairment charges in fiscal 2003.
The following table provides pro forma results for the years ended December 31, 2003, 2002 and 2001 as if the non-amortization provisions of SFAS No. 142, had been applied at the beginning of 2001 (in thousands, except per share amounts):
The following table provides a summary of the carrying amounts of other intangible assets that will continue to be amortized (in thousands):
Amortization expense for the year ending December 31, 2004 is expected to be $1.6 million at which time the carrying amount of other intangible assets will be fully amortized.
Index to Financial Statements NETMANAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Accrued liabilities
Accrued liabilities at December 31, 2003 and 2002 consisted of the following (in thousands):
Additional restructuring reserves of $0.3 million and $1.0 million are included in long-term liabilities at December 31, 2003 and 2002, respectively.
Effective January 1, 2003, NetManage adopted the provisions of SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 requires that the liability for cost associated with an exit or disposal activity be recognized when the liability is incurred. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. The provisions of SFAS No. 146 apply to restructuring activity initiated after January 2003.
NetManage accounts for restructuring charges recorded prior to January 1, 2003 under the provisions of the FASB’s Emerging Issues Task Force (EITF) No. 94-3 Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) and Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) No. 100 regarding the accounting for and disclosure of certain expenses commonly reported in connection with exit activities and business combinations.
Software development costs
Software development costs are accounted for in accordance with SFAS No. 86, Accounting for Computer Software to be Sold, Leased or Otherwise Marketed, under which capitalization of software development costs begins upon the establishment of technological feasibility of the product, which management defines as the development of a working model and further defines as the development of a beta version of the software. The establishment of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, anticipated future gross product revenue, estimated economic life and changes in technology. Such costs are reported at the lower of cost or net realizable value. Amortization of purchased software is generally computed on a straight-line basis over one to five years or, if less, the estimated remaining economic life of the underlying products. To date, software development costs that were eligible for capitalization have not been significant. Additionally, all other software development costs have been expensed as incurred.
Concentrations of credit risk
Financial instruments, which potentially subject NetManage to concentrations of credit risk, consist principally of cash investments and trade receivables. NetManage has a cash investment policy that limits the amount of credit exposure to any one issuer and restricts placement of these investments to issuers evaluated as less than creditworthy. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising NetManage’s customer base and their dispersion across many different industries and geographies. There were no customers that amounted for more than 10% of consolidated revenues in 2003, 2002, or 2001.
Index to Financial Statements NETMANAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Net loss per share
On August 28, 2002, NetManage stockholders approved a one-for-seven reverse stock split of its common stock for stockholders of record on July 15, 2002. All share and per share information in the accompanying financial statements have been adjusted to retroactively give effect to the reverse stock split.
Basic net loss per share data has been computed using the weighted average number of shares of common stock outstanding during the periods. Diluted net loss per share data has been computed using the weighted average number of shares of common stock and potentially dilutive common shares. Potentially dilutive common shares include dilutive shares issuable upon the exercise of outstanding common stock options computed using the treasury stock method. For the years ended December 31, 2003, 2002, and 2001, the number of shares used in the computation of diluted earnings per share were the same as those used for the computation of basic earnings per share. Potentially dilutive securities of 34,506, 6,857, and 0 shares were not included in the computation of diluted earnings per common share because to do so would have been antidilutive for the years ended December 31, 2003, 2002, and 2001, respectively.
Revenue recognition
NetManage derives revenue from primarily two sources: (1) product revenue, which includes software license and royalty revenue, and (2) services and support revenue, which includes software license maintenance and consulting. NetManage licenses its software products on a term basis and on a perpetual basis. Its term based arrangements are primarily for a period of 12 months. NetManage applies the provisions of the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition, and related amendments and interpretations to all transactions involving the sale of software products and to hardware transactions where the software is not incidental.
NetManage recognizes revenue from the sale of software licenses to end users and resellers when persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed and determinable and collection of the resulting receivable is reasonably assured. Delivery occurs when product is delivered to a common carrier or when a soft key has been transmitted to our customer.
Product is sold, without the right of return, except for distributor inventory rotation of old or excess product. Certain of its sales are made to domestic distributors under agreements allowing rights of return and price protection on unsold merchandise. Accordingly, the Company defers recognition of such sales until the distributor sells the merchandise. NetManage recognizes sales to international distributors upon shipment, provided all other revenue recognition criteria have been met. NetManage gives rebates to customers on a limited basis. These rebates are presented in its Consolidated Statement of Operations as a reduction of revenue.
At the time of the transaction, the Company assesses whether the fee associated with our revenue transactions is fixed and determinable and whether or not collection is reasonably assured. NetManage assesses whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after our normal payment terms, the Company accounts for the fee as not being fixed and determinable. In these cases, it recognizes revenue as the fees become due.
NetManage assesses collectability based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. We do not request collateral from our customers. If it determines that collection of a fee is not reasonably assured, the Company recognizes revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.
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For all sales, except those completed over the Internet, NetManage uses either a binding purchase order or signed license agreement as evidence of an arrangement. For sales over the Internet, it uses a credit card authorization as evidence of an arrangement. Sales through the Company’s distributors are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction-by-transaction basis.
For arrangements with multiple elements (for example, undelivered maintenance and support), the Company allocates revenue to each component of the arrangement using the residual value method based on vendor-specific objective evidence (VSOE) of the fair value of the undelivered elements. This means that it defers revenue from the arrangement fee equivalent to the fair value of the undelivered elements. Fair values for the ongoing maintenance and support obligations are generally based upon separate sales of renewals to other customers or upon renewal rates quoted in the contracts. Fair value of services, such as training or consulting, is based upon separate sales by us of these services to other customers. However, if an arrangement includes an acceptance provision, acceptance occurs upon the earlier of receipt of a written customer acceptance or expiration of the acceptance period.
Service revenues are derived from providing our customers with software updates for existing software products, user documentation and technical support, under annual service agreements. These revenues are recognized ratably over the terms of such agreements. If such services are included in the initial licensing fee, the value of the services determined based on VSOE of fair value is unbundled and recognized ratably over the related service period. Service revenues derived from consulting and training are deferred and recognized when the services are performed and the collectability is deemed probable. To date, consulting revenue has not been significant.
Advertising and sales promotion costs
Advertising and sales promotion costs are expensed as incurred. Advertising costs consist primarily of magazine advertisements, agency fees and other direct production costs. Advertising and sales promotion costs totaled approximately $0.8 million, $1.8 million, and $1.5 million for the years ended December 31, 2003, 2002, and 2001, respectively.
Income taxes
NetManage accounts for income taxes under the liability method. Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. NetManage is required to adjust its deferred tax liabilities in the period when tax rates or the provisions of the income tax laws change. Valuation allowances are established when necessary to reduce deferred tax assets to amounts that more likely than not are expected to be realized.
Stock compensation
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock Based Compensation-Transition and Disclosure-an Amendment of FASB Statement No.123, which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has adopted the amended annual and interim disclosure requirements of SFAS No. 123.
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SFAS No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the fair value of the award which is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Company’s stock option plans have no intrinsic value at the grant date. Accordingly, under APB Opinion No. 25, no compensation cost is recognized. The Company has elected to continue with the method of accounting prescribed in APB Opinion No. 25 and, as a result, must provide pro forma disclosures of net loss and loss per share and other disclosures as if the fair value based method of accounting had been applied. Had compensation cost for the Company’s outstanding stock options been determined based on the fair value at the grant dates for awards under those plans consistent with the method prescribed by SFAS No. 123, the Company’s net loss and loss per share would have been adjusted to the pro forma amounts indicated below (in thousands except per share data):
The fair value of each option granted is estimated on the date of grant using the Black-Scholes model with the following assumptions used for grants during the applicable periods:
Stock option exchange offer
On May 16, 2003 the Company announced a voluntary stock option exchange program for certain of its employees. The offer to exchange options, or Offer, was open to eligible option holders, excluding non-employee members of the board of directors and non-exempt employees, holding options to purchase shares of the Company’s common stock with an exercise price per share of $1.50 or greater. In accordance with the terms of the Offer, participating employees tendered their eligible options in exchange for replacement options. Under the terms of the Offer, replacement options will vest and become exercisable for the balance of the option shares in accordance with the same vesting schedule that was in effect for the cancelled options, but measured from the grant date of the replacement options. In addition, no vesting credit will be provided for the period between the date the original options were tendered and the date the replacement options are granted.
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On June 13, 2003, employees tendered options to purchase an aggregate of 542,150 shares in connection with the Offer. These options were cancelled under the Company’s 1992 Stock Option Plan as amended, and the 1999 Non-statutory Stock Option Plan following their exchange.
The Company granted 519,328 replacement options on December 16, 2003 at an exercise price of $4.78 per share representing the fair market value of the Company’s common stock on the date of grant. The fair market value of the Company’s common stock is equal to the last reported sale price of its common stock on the Nasdaq National Market on December 16, 2003.
The exchange program has been accounted for in accordance with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation-an Interpretation of APB Opinion No. 25 and results in no compensation expense.
Reclassifications
Certain reclassifications have been made to prior year amounts to conform to current year presentation.
Recent accounting pronouncements
The FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”) in January 2003, and a revised interpretation of FIN 46 (“FIN 46-R”) in December 2003. FIN 46 requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. Since January 31, 2003, the Company has not invested in any entities it believes are variable interest entities for which the Company is the primary beneficiary. For all arrangements entered into after January 31, 2003, the Company is required to continue to apply FIN 46 through the end of the first quarter of fiscal 2004. The Company is required to adopt the provisions of FIN 46-R for those arrangements in the second quarter of fiscal 2004. For arrangements entered into prior to February 1, 2003, the Company is required to adopt the provisions of FIN 46-R in the second quarter of fiscal 2004. The Company does not expect the adoption of FIN 46-R to have an impact on the financial position, results of operations or cash flows of the Company.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise effective at the beginning of the first interim period beginning after June 15, 2003. The Company currently has no financial instruments which meet these requirements.
In April 2003 the FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts. The Statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clarifies when a derivative contains a financing component, amends the definition of an underlying derivative to conform it to language used in FASB Interpretation FIN No. 45, and amends certain other existing pronouncements. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. All provisions of the Statement, except those related to forward purchases or sales of “when-issued” securities, should be applied prospectively. The Company currently has no instruments
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that meet the definition of a derivative, and therefore, the adoption of this Statement will have no impact on the Company’s financial position or results of operations.
In November 2002, the FASB issued FIN 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which addresses the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees. FIN 45 also requires the recognition of a liability by a guarantor at the inception of certain guarantees that are entered into or modified after December 31, 2002. The Company has adopted the disclosure requirements of FIN 45 and the adoption did not have a material affect on the financial statements.
3. Restructuring charges:
On January 30, 2003 NetManage announced a restructuring of its operations in response to the sluggish North America and European economies. It was necessary to refocus our operations and reduce our operating expenses to bring them in line with our revised anticipated revenue levels. The Company implemented a reduction in its workforce of more than 30% and recorded a $3.2 million restructuring charge related to expenses for employee terminations and expenses related to facilities no longer needed for company operations as required by SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, during 2003. As of December 31, 2003, restructuring costs totaling $3.2 million required $2.7 million in cash expenditures, leaving a remaining restructuring liability of $0.5 million, which is included in accrued liabilities.
The distribution of the reduction in workforce was as follows (number of employees):
The restructuring charge of $3.2 million includes approximately $2.6 million for employee severances and related expenses, plus approximately $0.6 million in facility expenses related to leased facilities in Germany and Canada (in thousands).
On August 8, 2002, NetManage announced a restructuring of its operations designed to re-align its core business functions and reduce operating expenses. As part of the restructuring, NetManage reduced its workforce by approximately 26% and recorded a $4.6 million charge to operating expenses in the third quarter of 2002. The restructuring charge included approximately $2.6 million of expenses related to facilities no longer needed for company operations and $2.0 million of employee and other-related expenses for employee terminations. Approximately $0.2 million of this restructuring activity relates to write-off of excess equipment, furniture,
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software and leasehold improvements and is included in the approximately $2.6 million related to facilities. In 2003, based on a review of current operations, the decision was made to revise the original restructuring plan by retaining certain personnel in European locations who had been identified for termination and certain related offices that had been identified for closure. This decision resulted in an approximately $0.9 million reduction in employee costs and approximately $0.4 million reduction in facility costs. We recorded an additional $0.1 million in employee related severance costs for Latin America and Europe offset by a reduction of approximately $0.1 million in facility related expenses. As of December 31, 2003, NetManage had incurred costs totaling $2.5 million related to the restructuring, which required approximately $2.3 million in cash expenditures. The remaining reserve related to this restructuring is approximately $0.8 million, and is included in accrued liabilities as of December 31, 2003 and all restructuring activities have been completed.
The following table lists the components of the August 2002 restructuring charge for the year ended December 31, 2003 (in thousands):
On August 3, 2000, NetManage announced a restructuring of its operations designed to re-focus its core business functions and reduce operating expenses. In connection with the restructuring, NetManage reduced its workforce by approximately 20% from the second quarter of 2000, consisting of sales, marketing and general employees, and made provisions for reductions in office space, related overhead expenses and the write down of certain assets. The total amount of the restructuring charge was $5.6 million. The reserve has been fully utilized as of December 31, 2003 and all restructuring activities have been completed.
The following table lists the components of the August 2000 restructuring charge for the years ended December 31, 2003, 2002 and 2001 (in thousands):
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In the fourth quarter of 1999, following the acquisitions of Wall Data and Simware, NetManage initiated a plan to restructure its worldwide operations in connection with the integration of operations of the two acquired companies. In connection with this plan, NetManage recorded a $3.8 million charge to operating expenses in 1999. The remaining reserve related to this restructuring is approximately $0.1 million, and is included in accrued liabilities as of December 31, 2003.
The following table lists the components of the NetManage restructuring charge from 2001 for the years ended December 31, 2003, 2002, and 2001 (in thousands):
In August 1998, following the acquisition of FTP Software, or FTP, we initiated a plan to restructure our worldwide operations as a result of business conditions and in connection with the integration of the operations of FTP. In connection with this plan, we recorded a $7.0 million charge to operating expenses in 1998. The remaining reserve related to this restructuring is approximately $0.3 million, and is included in accrued liabilities as of December 31, 2003.
The following table lists the change in the FTP restructuring reserve for the years ended December 31, 2003, 2002 and 2001 (in thousands):
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4. Commitments and contingencies:
Legal proceedings
On November 22, 1999, Kenneth Fisher filed a complaint alleging violations of the False Claims Act, 31 U.S.C. § 3729 et seq., against the Company and its affiliates Network Software Associates, Inc., or NSA, and NetSoft Inc., or NetSoft, in the United States District Court of the District of Columbia. Mr. Fisher purported to file the action on behalf of himself and the United States federal government. NetManage acquired NSA and NetSoft in 1997. The United States government declined to pursue the action on its own behalf and, therefore, the action was pursued by Kenneth Fisher, as relator, on behalf of himself, and the government. NetManage, and its affiliates, first learned of the action when the Company was served with the amended complaint in May 2001. On September 5, 2001, Mr. Fisher agreed to voluntarily dismiss the Company from this action, without prejudice, in exchange for an agreement to suspend applicable statutes of limitation as to Mr. Fisher’s claims.
On January 31, 2002, on an order of the court granting in part and denying in part the defendant’s motion to dismiss the May 2001 amended complaint, Mr. Fisher filed a Second Amended Complaint, or Second Complaint, in the United States District Court of the District of Columbia against NSA and NetSoft among numerous other defendants. On May 13, 2002, on an order of the court following defendants’ successful motion to strike the Second Complaint, Mr. Fisher filed a Third Amended Complaint, or complaint, in the United States District Court of the District of Columbia against NSA and NetSoft among numerous other defendants. Mr. Fisher is asserting the claims in the present complaint solely in his capacity as Relator on behalf of the United States. The complaint alleges that NSA, NetSoft and the other defendants made false claims to the government to obtain government contracts set aside for entities owned and controlled by disadvantaged persons admitted to the Section 8(a) Minority Small Business Development Program. Specifically, the complaint alleges that from 1993 to 1997, NSA, NetSoft, and the other defendants presented false or fraudulent claims for payment or approval to the government in violation of 31 U.S.C. § 3729 (a)(1), and used false records or statements to get claims paid or approved by the government in violation of 31 U.S.C. § 3729 (a) (2). In addition, the complaint alleges that NSA, NetSoft and the other defendants conspired to defraud the government by working to fraudulently continue NSA’s certification as a Section 8 (a) entity for alleged use by NSA’s Federal Systems Division and by getting fraudulent claims allowed and paid by virtue of the alleged fraudulent Section 8(a) status, in violation of 31 U.S.C. § 3729 (a) (3). NetManage did not acquire NSA until July 1997 and had no involvement with the events alleged by Mr. Fisher. According to the earlier amended complaint (although not alleged in the current complaint), Mr. Fisher’s theory was that the liabilities of NSA and NetSoft, including alleged liability in this suit, passed to NetManage. On May 31, 2002, NSA and NetSoft and the other defendants answered the complaint. The Company and its affiliates, dispute Mr. Fisher’s allegations and discovery is presently continuing in this matter. The Company has insufficient information at this time to estimate the possible loss, if any, which might result from this lawsuit.
In addition, the Company may be contingently liable with respect to certain asserted and unasserted claims that arise during the normal course of business. Management believes the impact, if any, resulting from these matters would not have a material impact on the Company’s financial statements.
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Leases
Facilities and equipment are leased under non-cancelable operating leases expiring on various dates through the year 2011. As of December 31, 2003, future minimum rental and lease payments under operating leases are as follows (in thousands):
Rent expense was approximately $3.0 million, $4.0 million and $4.9 million for the years ended December 31, 2003, 2002, and 2001 respectively, net of sublease payments.
NetManage Ltd., has entered into a lease arrangement with the owner of the building in Haifa, Israel where our offices are located. The lease agreement requires NetManage, Inc. to guarantee three promissory notes totaling approximately $ 0.1 million in lieu of providing a security deposit. The lease for the building expires in February 2005.
Other
As an element of its standard commercial terms, NetManage includes an indemnification clause in its software licensing agreements that indemnifies the licensee against liability and damages (including legal defense costs) arising from any claims of patent, copyright, trademark, or trade secret infringement by its software. NetManage’s indemnification limitation is the cost to defend any third party claim brought against its customers and to the maximum a refund of the purchase price. NetManage licenses software on a perpetual basis.
5. Stockholders’ equity:
On August 28, 2002, NetManage’s stockholders approved a one-for-seven reverse stock split of its common stock for shareholders of record at the close of business on July 15, 2002. All shares and per share information in the accompanying consolidated financial statements have been adjusted to retroactively give effect to the reverse stock split.
Common stock
As of December 31, 2003, NetManage reserved the following shares of authorized but unissued common stock:
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Stock repurchase plan
Previously, NetManage’s Board of Directors authorized the repurchase of up to 2,142,857 shares of the Company’s common stock from time to time for possible reissue and general corporate purposes. During 2003, 2002, and 2001, NetManage repurchased 71,931, 616,401, and 337,221 shares of NetManage common stock, respectively, on the open market at an average purchase price of $2.44, $3.83, and $5.49 per share, respectively, for a total cost of $0.2 million, $2.4 million, and $1.9 million, respectively.
6. Stock option, stock purchase plans, and employee benefit plan:
Employee stock option plans
In October 1999, the Board of Directors adopted the 1999 Non-Statutory Stock Option Plan, or the 1999 Plan. The Board of Directors authorized and reserved for the issuance of 571,429 shares of NetManage common stock. The 1999 Plan provides for the grant of non-qualified stock options for employees. Options may not be granted to officers and directors, except as an essential inducement to an officer entering into an employment agreement regarding his or her initial service with NetManage. The 1999 Plan does not allow for issuance to NetManage’s directors. The exercise price of the stock options, issued under the 1999 Plan, is established by the 1999 Plan Administrator, which is a committee of the Board of Directors. Options granted under the 1999 Plan become exercisable at a rate of 25% of the shares subject to the option at the end of the first year and 1/48 of the shares subject to the option at the end of each calendar month thereafter. The maximum term of a stock option under the 1999 Plan is 10 years.
During 1992, NetManage established the 1992 Employee Stock Option Plan, or the 1992 Plan. As of December 31, 2003, NetManage stockholders had authorized a total of 2,332,899 shares for issuance under the 1992 Plan including 261,470, 214,286 and 142,857 shares authorized for issuance in 2003, 2002, and 2001, respectively. The 1992 Plan provides for the grant of incentive stock options to employees and officers and non-statutory stock options to employees, officers, directors and consultants. The exercise price of incentive stock options may not be less than 100% of the fair market value of the common stock on the date of grant (110% of such fair market value in the case of a grant to a holder of more than 10% of the voting power of NetManage’s outstanding capital stock (a 10% stockholder)); the exercise price of non-statutory options may not be less than 85% of such fair market value. Under the 1992 Plan stock options generally vest over a period of four to five years. The maximum term of a stock option under the 1992 Plan is 10 years (five years in the case of an incentive option granted to a 10% stockholder).
Non-employee directors’ stock option plan
In July 1993, NetManage adopted the 1993 Directors’ Stock Option Plan, or Directors’ Plan, and reserved 114,286 shares of common stock for issuance thereunder. As of December 31, 2003, NetManage stockholders had authorized a total of 200,000 shares for issuance under the Directors’ Plan. Under the Directors’ Plan, options may be granted only to non-employee directors at an exercise price of 100% of the fair market value of the stock on the date of grant. Options granted under the Directors’ Plan become exercisable at a rate of 25% of the shares subject to the option at the end of the first year and 1/48 of the shares subject to the option at the end of each calendar month thereafter. The maximum term of a stock option under the Directors’ Plan is 10 years.
Employee stock purchase plan
In July 1993, NetManage adopted the Employee Stock Purchase Plan, or the Purchase Plan. As of December 31, 2003, NetManage’s stockholders authorized 1,072,873 shares of common stock for issuance under the
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Purchase Plan including 87,156, 214,286 and 285,714 shares authorized for issuance in 2003, 2002, and 2001, respectively. Under the Purchase Plan, NetManage employees, subject to certain restrictions, may purchase shares of common stock at a price per share that is equal to 85% of the lower of the fair market value of the common stock on the commencement date of each offering period or the relevant purchase date. For the years ended December 31, 2003, 2002, and 2001, 87,283, 169,394, and 153,244 shares, respectively, were issued under the Purchase Plan at prices ranging from $0.72 to $1.15, $0.89 to $3.99, and $3.93 to $5.00 per share, respectively.
Stock-based compensation
Option activity, including the acquired options, under NetManage’s stock option plans was as follows:
The following table summarizes NetManage’s outstanding options as of December 31, 2003:
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The weighted average fair values of options granted during 2003, 2002, and 2001 were $3.09, $3.20, and $4.32 per share, respectively.
Employee benefit plan
NetManage has an Employee 401(k) Savings Plan, or 401(k) Plan, established in 1992 to provide retirement and incidental benefits for its employees. As allowed under Section 401(k) of the Internal Revenue Code, the 401(k) Plan provides tax-deferred salary deductions for eligible employees. Employees may contribute from 1% to 25% of their eligible pre-tax compensation up to the amount allowable under current income tax regulations. Under the plan NetManage is not required to make contributions and has not made any contributions since inception.
7. Income taxes
The provision (benefit) for income taxes is based upon loss before income taxes as follows (in thousands):
The components of the provision (benefit) for income taxes, net of valuation allowances, are as follows (in thousands):
The provision (benefit) for income taxes differs from the amounts that would result by applying the applicable statutory federal income tax rate to income before taxes, as follows (in thousands):
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The components of the net deferred income tax asset are as follows (in thousands):
The pretax income (loss) from foreign operations, which is comprised of Canadian, European, Asian, and Latin American operations, was $(3.0) million, $(4.7) million, and $5.5 million, in 2003, 2002, and 2001, respectively. Undistributed earnings of NetManage’s foreign subsidiaries are considered to be indefinitely reinvested and, accordingly, no provision for federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of a dividend or otherwise, NetManage would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. It is not practical to estimate the income tax liability that might be incurred on the remittance of such earnings.
The income tax benefit of $1.3 million for the year ended December 31, 2003 resulted primarily from German tax refunds of $1.4 million, UK tax refunds of $0.1 million, France tax refunds of $0.1 million, net of international tax expense of $0.3 million. The $0.3 million international provision included a $0.1 million expense relating to a purchase accounting adjustment from Canadian pre-acquisition tax credits. The income tax provision of $1.1 million for the year ended December 31, 2002 resulted primarily from a $0.7 million purchase accounting adjustment relating to Canadian pre-acquisition tax assets, international tax expense of $0.5 million, net of U.S. state tax and other benefits of $0.1 million. The income tax provision of $0.7 million for the year ended December 31, 2001 resulted primarily from a $2.6 million purchase accounting adjustment relating to Canadian pre-acquisition tax assets, international tax expense of $0.7 million, U.S. state tax expense and other expense of $0.1 million, net of a $2.7 million benefit for release of international accruals from prior years.
Currently, management believes it is more likely than not that the net deferred tax asset will not be realized and, accordingly, has recorded a valuation allowance for the entire balance. This is due to the history of net operating losses that NetManage has and expects to incur. The amount of the deferred tax asset considered realizable, however, may change if actual future taxable income differs from estimated amounts.
At December 31, 2003, NetManage had gross net operating loss carryforwards of approximately $118.9 million and $145.0 million for federal income tax purposes and state income tax purposes, respectively, expiring at various dates through 2023 and federal tax credit carryforwards of approximately $1.1 million that expire in various years through 2011. At December 31, 2003, NetManage had foreign net operating loss carryforwards of approximately $47.4 million available to offset future taxable income in several foreign jurisdictions. In accordance with certain provisions of the Internal Revenue Code, as amended, a change in ownership of greater
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than 50% of a company within a three year period results in an annual limitation on its ability to utilize its net operating loss carryforward from tax periods prior to the ownership change. Such a change in ownership occurred with respect to NetManage’s past acquisition of certain companies, including Wall Data. Accordingly, NetManage’s net operating losses and credits are subject to these limitations.
Included in the above net operating loss carryforwards are $62.5 million, $18.4 million, and $5.3 million of federal, state and foreign net operating losses, respectively, related to acquisitions accounted for under the purchase method of accounting. There are also $0.8 million and $0.1 million in federal and foreign tax credit carryforwards, respectively, from these acquisitions. The benefit of such losses and tax credits, if and when realized, will be credited first to reduce to zero any goodwill related to the respective acquisition, second to reduce to zero other non-current intangible assets related to the respective acquisition, and third to reduce income tax expense. At December 31, 2003, the net carrying amount of goodwill and other non-current intangible assets against which such pre-acquisition tax attributes could be applied is $3.4 million. During 2003, 2002, and 2001, NetManage utilized pre-acquisition net operating losses and tax credits of Simware in Canada to reduce current tax liabilities for those years on Canadian taxable income to zero. The benefit from the release of valuation allowance attributable to these tax attributes, which approximated $0.1 million, $0.7 million, and $2.6 million in 2003, 2002, and 2001, respectively, has been recorded as a reduction of goodwill.
During the years ended December 31, 2003, 2002, and 2001, NetManage recognized benefits of $0.2 million, $0.4 million, and $0.3 million, respectively from the utilization of Canadian post-acquisition net operating loss carryforwards for which NetManage had previously established a full valuation allowance. Because of the full valuation allowance against the deferred tax assets, the benefit from the utilization of these tax attributes has not been previously recognized.
NetManage’s subsidiary in Haifa, Israel (NetManage, Ltd.) has a ten-year tax holiday, which commenced January 1, 1995. During the first two years of the tax holiday, the subsidiary was exempt from taxation on income generated during that period. During the remaining eight years in which income is generated by the subsidiary, that generated income will be taxed at a reduced income tax rate of 10%. In December 2001, NetManage, Ltd. came to an agreement with the tax authorities in Israel concerning the gain on the sale of shares in NetVision in 1997. A $0.1 million tax liability resulted from this transaction and tax reserves previously recorded of approximately $1.9 million, for this matter, were reversed.
8. Segment information
NetManage has concluded that it operates, based on products and services, in two segments: Host Access and Host Integration. NetManage’s chief operating decision-maker evaluates these segments at the sales and bookings level.
NetManage’s Host Access segment provides the technology to make the connection between personal computers and large corporate computers possible. These products are designed to leverage the strengths and popularity of the Internet, as well as corporate private networks, and offer features to improve network manageability. The Host Integration segment provides the technology to allow customers to leverage the investment they have in existing host-based systems, applications and business processes for new web-based presentations, applications, and solutions. This segment includes NetManage product branded as OnWeb. These segments have similar economic characteristics and are similar with respect to the nature of the products, the nature of the production processes, the type of customer that the products are sold to and the methods used to
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distribute the products. Net revenues for the Host Access and Host Integration segments were as follows for the years ended December 31, 2003, 2002, and 2001 (in thousands):
The following table presents a summary of operations by geographic area (in thousands):
North America consists of the United States and Canada, whose operations have not been separated as it would be impracticable to do so. Revenues are attributed to individual countries primarily based on customer “ship to” and “invoice to” addresses.
There were no customers that accounted for more than 10% of net revenues for the years ended December 31, 2003, 2002, or 2001.
9. Related party transactions
On May 28, 2003, the Company entered into an independent contractor services agreement with Dr. Shelley Harrison, a director of the Company, pursuant to which Dr. Harrison will receive compensation in consideration for consultancy and advisory services he is providing the Company over a two-year period. The terms of the agreement require the Company to pay Dr. Harrison a fixed fee of $0.1 million per year, and a one time grant to Dr. Harrison of an option to purchase 146,800 shares of the Company’s common stock, at an exercise price of $1.92 per share (which represents the quoted market price of the stock at the date of grant). The option vests on a monthly basis over the two-year term of the agreement. The option expires five years from the date of issuance. The fair value of the option was determined using the Black-Scholes option pricing model with the following assumptions: stock price $2.95-$5.27; no dividends; risk free interest rate of 2.00%-2.41%; volatility of 63%-90%; and a contractual life of five years. The fair value of the option is subject to change over the vesting period of the option based on changes in the underlying assumptions (variable award accounting). Through
Index to Financial Statements NETMANAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
December 31, 2003 the Company had recorded approximately $0.2 million in compensation expense under this agreement, based on an aggregate option fair value of $0.5 million. In connection with his entering into the agreement, Dr. Harrison resigned from the Company’s Audit Committee effective May 28, 2003. In 2003, the Company recorded total aggregate cash and non-cash compensation of $0.3 million under General and Administrative expense in the Consolidated Statements of Operations.
10. Subsequent event
In January 2004, the Board of Directors authorized a change in the Company’s authorized capital. The Board of Director’s authorized a reduction in the number of authorized common shares available for issuance from 125,000,000 to 36,000,000 and a reduction in the number of authorized preferred shares available for issuance from 5,000,000 to 1,000,000. This proposal will be put to a stockholder vote at the next annual meeting of stockholders scheduled to be held on May 26, 2004.
Index to Financial Statements Quarterly financial data (unaudited)
We have experienced, and expect to experience in future periods, significant fluctuations in operating results that may be caused by many factors, including, among others, those described above within “Factors that may affect our future results and financial condition” of Item 7, Management’s discussion and analysis of financial condition and results of operations. Our future revenues and results of operations could be subject to significant volatility and may also be unpredictable due to shipment patterns typical of the software industry. A significant percentage of our net revenues are generally recognized in the third month of each quarter and tend to occur in the latter half of that month. We believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance.
The following table sets forth unaudited consolidated quarterly financial information for 2003 and 2002. This unaudited information has been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, includes all normal and reoccurring adjustments necessary for the fair presentation of the information for the periods presented.
2003 Quarter Ended (Unaudited) (in thousands, except per share amounts)
(1) Net revenues have been revised to reflect a reclassification from cost of goods to net revenues relating to shipping costs.
2002 Quarter Ended (Unaudited) (in thousands, except per share amounts)
(1) Net revenues have been revised to reflect a reclassification from cost of goods to net revenues relating to shipping costs.
Item 9
Item 9 - Changes in and disagreements with accountants on accounting and financial disclosure.
None
Item 9A.
Item 9A.-Controls and Procedures
Based on their evaluation as of the end of the period covered by this report, NetManage’s Chief Executive Officer and Chief Financial Officer have concluded that NetManage’s disclosure controls and procedures, as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, are effective. There have been no significant changes in internal controls over financial reporting identified in connection with the evaluation referred to above that occurred during NetManage’s fourth fiscal quarter of 2003 that has materially affected, or is reasonably likely to materially affect, NetManage’s internal control over financial reporting.
Index to Financial Statements
PART III
Item 10
Item 10 - Directors and executive officers of the registrant.
Our definitive Proxy Statement will be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for our Annual Meeting of Stockholders, to be held on May 26, 2004. Certain information required by this item is incorporated by reference from the information contained in the Proxy Statement under the captions “Election of Directors” and “Security Ownership of Certain Beneficial Owners and Management-Compliance with the Reporting Requirements of Section 16(a).”
Reference is made to the information regarding executive officers appearing in Part I of this Annual Report on Form 10-K, which information is hereby incorporated by reference.
Item 11
Item 11 - Executive compensation.
The information required by this item is incorporated herein by reference from the information contained in the Proxy Statement under the caption “Executive Compensation,” except for the information appearing under the captions “ Ten Year Option Repricing,”, “ Report of the Board of Directors on Repricing of Options”, “ Report of the Compensation Committee of the Board of Directors on Executive Compensation”, and “Performance Measurement Comparison.”
Item 12
Item 12 - Security ownership of certain beneficial owners and management and related stockholder matters.
The information required by this item is incorporated herein by reference from the information contained in our Proxy Statement under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Information for Plans or Individual Arrangements with Employees and Non-Employees”.
Item 13
Item 13 - Certain relationships and related transactions.
The information required by this item is incorporated herein by reference from the information contained in our Proxy Statement under the caption “Certain Transactions.”
Item 14
Item 14 - Principal accountant fees and services.
The information required by this item is incorporated herein by reference from the information contained in the Proxy Statement under the caption “Fees paid to Deloitte &Touche during 2003”.
Index to Financial Statements
PART IV
Item 15
Item 15 - Exhibits, financial statement schedules and reports on Form 8-K.
a. The following documents are filed as part of this Report on Form 10-K:
1. Consolidated financial statements:
See Index to Consolidated Financial Statements at Item 8 on page 39 of this Report.
2. Financial statement schedule:
See Index to Consolidated Financial Statements at Item 8 on page 39 of this Report.
Exhibits:
Index to Financial Statements
(1)
Incorporated by reference to the Exhibits filed with the Registrant’s Registration Statement on Form S-1 (No. 33-66460) dated July 24, 1993, as amended, which became effective September 20, 1993.
(2)
Incorporated by reference to the Exhibits filed with the Registrant’s Registration Statement on Form S-4 (No. 333-59101) dated July 17, 1998 (the Form S-4).
(3)
Incorporated by reference to the Exhibits filed with the Registrant’s Registration Statement on Form S-1 (No. 33-74364) dated January 24, 1994, as amended, which became effective February 10, 1994.
(4)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 10-Q for the quarter ended September 30, 1994.
(5)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 10-Q for the quarter ended March 31, 1995.
(6)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 10-K for the year ended December 31, 1995.
Index to Financial Statements
(7)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 8-K dated July 29, 1997.
(8)
Incorporated by reference to Annex A to the Joint Proxy Statement/Prospectus included in the Form S-4.
(9)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 8-K dated December 23, 1999.
(10)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 8-K dated January 12, 2000.
(11)
Incorporated by reference to the Exhibits filed with Wall Data Incorporated Form 10-K dated March 30, 1995.
(12)
Incorporated by reference to the exhibits filed with the Registrants Form 10-K dated March 30, 2000.
(13)
Incorporated by reference to the Exhibits filed with the Registrant’s Form S-8 Registration Statement filed on April 9, 2003.
(14)
This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference in any filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.
*
Employee Benefit Plan
**
Filed herein
(b) Reports on Form 8-K
On October 27, 2003, the Registrant filed a Current Report on Form 8-K, announcing its third quarter fiscal 2003 financial results for the three months ended September 30, 2003.
(c) Exhibits
The exhibits required by this Item are listed under Item 15(a).
(d) Financial Statement Schedules
The financial statement schedule required by this Item is listed under Item 15(a).
Index to Financial Statements NETMANAGE, INC.
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
(1) Consists primarily of write-offs of approximately five customer accounts in 2001.
(2) Includes the write-offs of the accounts of two domestic customers aggregating $630,000.
Index to Financial Statements
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized on the 25th day of March 2004.
NETMANAGE, INC.
By:
/s/ ZVI ALON
Zvi Alon
Chairman of the Board, President
and Chief Executive Officer
(On behalf of the Registrant)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Index to Financial Statements EXHIBIT INDEX
Index to Financial Statements
(1)
Incorporated by reference to the Exhibits filed with the Registrant’s Registration Statement on Form S-1 (No. 33-66460) dated July 24, 1993, as amended, which became effective September 20, 1993.
(2)
Incorporated by reference to the Exhibits filed with the Registrant’s Registration Statement on Form S-4 (No. 333-59101) dated July 17, 1998 (the Form S-4).
(3)
Incorporated by reference to the Exhibits filed with the Registrant’s Registration Statement on Form S-1 (No. 33-74364) dated January 24, 1994, as amended, which became effective February 10, 1994.
(4)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 10-Q for the quarter ended September 30, 1994.
(5)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 10-Q for the quarter ended March 31, 1995.
(6)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 10-K for the year ended December 31, 1995.
(7)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 8-K dated July 29, 1997.
(8)
Incorporated by reference to Annex A to the Joint Proxy Statement/Prospectus included in the Form S-4.
(9)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 8-K dated December 23, 1999.
(10)
Incorporated by reference to the Exhibits filed with the Registrant’s Form 8-K dated January 12, 2000.
(11)
Incorporated by reference to the Exhibits filed with Wall Data Incorporated Form 10-K dated March 30, 1995.
(12)
Incorporated by reference to the exhibits filed with the Registrants Form 10-K dated March 30, 2000.
(13)
Incorporated by reference to the Exhibits filed with the Registrant’s Form S-8 Registration Statement filed on April 9, 2003.
(14)
This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference in any filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.
*
Employee Benefit Plan
**
Filed herein