SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996
------------------
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO _______
COMMISSION FILE NUMBER 0-22466
FTP SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2906463
(State or other jurisdiction of (I.R.S.Employer Identification No.)
incorporation or organization)
100 BRICKSTONE SQUARE, FIFTH FLOOR
ANDOVER, MASSACHUSETTS 01810
(Address of principal executive offices) (Zip Code)
(508) 685-4000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, par value $.01 per share 33,619,096
- -------------------------------------- -------------------------------
Class Outstanding at November 8, 1996
FTP SOFTWARE, INC.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at September 30, 1996
and December 31, 1995 (unaudited) 3
Consolidated Statements of Operations for the three and nine
months ended September 30, 1996 and 1995 (unaudited) 4
Consolidated Statements of Cash Flows for the nine
months ended September 30, 1996 and 1995 (unaudited) 5
Notes to Interim Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
Signature 26
2
FTP SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 14,210 $ 30,237
Short-term investments 24,108 36,211
Accounts receivable, net of allowance
for doubtful accounts of $1,800 for
1996 and $1,600 for 1995 12,882 30,787
Inventories 1,438 1,063
Prepaid expenses and other current assets 4,983 3,185
Refundable income taxes 15,332 11,686
Net assets of discontinued operations 6,295 1,333
-------- --------
Total current assets 79,248 114,502
Property and equipment, net 20,327 18,355
Purchased software, net 6,309 3,653
Investments 55,459 52,751
Other assets 1,106 368
-------- --------
Total assets $162,449 $189,629
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses 11,218 9,614
Accrued employee compensation and benefits 3,529 4,484
Current portion of long-term obligations 188 811
Deferred revenue 9,004 9,091
-------- --------
Total current liabilities 23,939 24,000
Long-term obligations 73 821
-------- --------
Total liabilities 24,012 24,821
-------- --------
Stockholders' equity:
Preferred stock, $0.01 par value;
authorized 5,000,000 shares; none
issued and outstanding -- --
Common stock, $0.01 par value;
authorized 100,000,000 shares; issued
and outstanding 33,571,007 and 26,506,729
in 1996 and 1995, respectively 336 265
Additional paid-in capital 136,017 92,607
Retained earnings 1,330 72,130
Equity adjustments 754 (194)
-------- --------
Total stockholders' equity 162,449 164,808
Total liabilities and -------- --------
stockholders' equity $162,449 $189,629
======== ========
The accompanying notes are an integral part of these financial statements.
3
FTP SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1996 1995 1996 1995
-------- ------- -------- -------
Revenue:
Product revenue $ 18,158 $30,983 $ 62,837 $89,899
Service revenue 4,116 3,480 12,051 9,306
-------- ------- -------- -------
Total revenue 22,274 34,463 74,888 99,205
-------- ------- -------- -------
Cost of revenue:
Product cost 1,903 1,657 4,704 5,129
Service cost 2,509 2,195 7,384 6,943
-------- ------- -------- -------
Total cost of revenue 4,412 3,852 12,088 12,072
-------- ------- -------- -------
Gross margin 17,862 30,611 62,800 87,133
-------- ------- -------- -------
Operating expenses:
Sales and marketing 10,836 9,520 33,007 24,706
Product development 44,558 6,374 57,238 15,444
General and administrative 5,310 3,032 14,479 8,785
-------- ------- -------- -------
Total operating expenses 60,704 18,926 104,724 48,935
-------- ------- -------- -------
Income (loss) from continuing
operations (42,842) 11,685 (41,924) 38,198
Investment income 1,265 1,418 3,450 3,714
-------- ------- -------- -------
Income (loss) from continuing
operations before provision
(benefit) for income taxes (41,577) 13,103 (38,474) 41,912
Provision (benefit) for income taxes 1,550 4,815 (1,473) 15,496
-------- ------- -------- -------
Net income (loss) from continuing
operations (43,127) 8,288 (37,001) 26,416
Discontinued operations:
Operating losses, net of income
tax benefit of $0, $2,050,
$2,480 and $2,610, respectively (1,324) (3,529) (29,039) (4,493)
Provision for dispositions (4,760) -- (4,760) --
-------- ------- -------- -------
Net income (loss) $(49,211) $ 4,759 $(70,800) $21,923
======== ======= ======== =======
Net income (loss) per share:
Continuing operations $(1.35) $ .30 $(1.29) $.93
Discontinued operations (.19) (.13) (1.18) (.16)
-------- ------- -------- -------
$(1.54) $.17 $(2.47) $.77
======== ======= ======= =======
Weighted average common and
common equivalent shares
outstanding 32,013 28,053 28,645 28,297
======== ======= ======= =======
The accompanying notes are an integral part of these financial statements.
4
FTP SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS, UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
1996 1995
------------ ----------
Cash flows from operating activities:
Net income (loss) from continuing operations $(37,001) $ 26,416
Adjustments to reconcile net income (loss) from continuing
operations to net cash provided by continuing operations
Depreciation and amortization 6,329 4,154
Provision for doubtful accounts 200 200
Acquired in-process technology 37,852 --
Tax benefit of stock option activity -- 9,883
Changes in operating assets and liabilities net of effects
from acquisitions and divestitures:
Accounts receivable 20,388 (12,321)
Inventories (311) (614)
Prepaid expenses and other current assets (785) (490)
Refundable income taxes (5,557) (1,338)
Other assets (650) (169)
Accounts payable and accrued expenses (1,312) 1,545
Accrued employee compensation and benefits (2,460) 1,388
Deferred revenue (314) 2,040
------------ ----------
Net cash provided by continuing operations 16,379 30,694
Net cash used for discontinued operations (5,952) (3,487)
------------ ----------
Net cash provided by operating activities 10,427 27,207
------------ ----------
Cash flows from investing activities:
Capital expenditures (6,203) (6,939)
Maturities of investments 16,511 4,737
Acquisitions, net of cash acquired (3,776) --
Other investing activities, net 21 --
------------ ----------
Net cash provided by (used for) continuing operations 6,553 (2,202)
Net cash used for discontinued operations (32,809) (2,365)
------------ ----------
Net cash used for investing activities (26,256) (4,567)
------------ ----------
Cash flows from financing activities:
Proceeds from issuance of common stock 1,402 6,268
Principal payments on long-term obligations (1,582) --
------------ ----------
Net cash (used for) provided by financing activities (180) 6,268
------------ ----------
Effect of exchange rate changes on cash (18) --
------------ ----------
Net (decrease) increase in cash and cash equivalents (16,027) 28,908
Cash and cash equivalents, beginning of period 30,237 10,896
------------ ----------
Cash and cash equivalents, end of period $ 14,210 $ 39,804
============ ==========
The accompanying notes are an integral part of these financial statements.
5
FTP SOFTWARE, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. INTERIM FINANCIAL DATA
The accompanying unaudited consolidated financial statements have been
prepared by FTP Software, Inc. ("FTP" or the "Company") in accordance with
generally accepted accounting principles. In the opinion of management, the
accompanying unaudited consolidated financial statements contain all
adjustments, consisting only of those of a normal recurring nature, necessary
for a fair presentation of the Company's financial position, results of
operations and cash flows at the dates and for the periods indicated. While the
Company believes that the disclosures presented are adequate to make the
information not misleading, these financial statements should be read in
conjunction with the audited consolidated financial statements and notes related
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1995.
The results of the three- and nine-month periods ended September 30, 1996
are not necessarily indicative of the results to be expected for the full fiscal
year. The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
2. ACQUISITIONS
During 1996, the Company acquired the following collaborative software
businesses: in March 1996, the Company acquired substantially all of the assets
of HyperDesk Corporation, including its GroupWorks/R/ product, for a net cash
purchase price of approximately $6.3 million; and in April 1996, the Company
acquired all of the outstanding stock of Campbell Services, Inc., the developer
of OnTime/R/, for a net cash purchase price of approximately $15.0 million
through the merger of a subsidiary of FTP into Campbell Services. In February
1996, the Company acquired the Mariner/TM/Internet software product line of
Networking Computing Devices, Inc. for a net cash purchase price of
approximately $7.4 million. All of these acquisitions were accounted for as
purchases and are now reflected in discontinued operations. See note 3.
On July 22, 1996, the Company acquired Firefox Communications Inc.
("Firefox"), a supplier of server-centric departmental and LAN-based IP
(Internet protocol) solutions and services, for a net purchase price of
approximately $61.0 million, through the merger of a wholly-owned subsidiary of
the Company into Firefox (the "Firefox Merger"). Pursuant to the Firefox
Merger, all of the outstanding shares of the common stock of Firefox were
converted into a total of approximately 6.4 million shares of the Company's
common stock ("Common Stock") valued at approximately $40.6 million and
approximately $9.1 million in cash. In addition, outstanding employee stock
options to purchase Firefox common stock were
6
converted into options to purchase 359,216 shares of Common Stock valued at
approximately $1.5 million. The Company also incurred acquisition-related costs
of approximately $3.7 million and liabilities treated as assumed totaling
approximately $6.1 million which are included in the net purchase price. The
transaction was accounted for as a purchase. Based upon a valuation of the
assets acquired, approximately $2.6 million was allocated to completed
technology, which is included in purchased software and is being amortized over
its estimated useful life of three years; approximately $37.9 million was
allocated to in-process technology and charged to product development expense in
the three-month period ended September 30, 1996; and approximately $20.5 million
was allocated to the remaining assets of Firefox, primarily short-term
investments and accounts receivable. Results of operations include activity from
Firefox since the date of the acquisition.
The unaudited pro forma consolidated results of continuing operations would
have been as follows if the Firefox Merger had occurred on January 1, 1995 (in
thousands, except per share amounts):
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1996 1995 1996 1995
---------- -------- --------- ---------
Revenue $22,496 $40,147 $83,193 $114,919
Net income (loss) (6,254) 8,801 (2,466) 27,432
Net income (loss) per share $ (.20) $ .25 $ (.09) $ .80
These unaudited pro forma results are presented for informational purposes
only and include certain adjustments such as additional amortization expense as
a result of purchased software. They do not include the approximately $37.9
million charge for acquired in-process technology and do not purport to be
indicative of the Company's actual results of operations had the Firefox Merger
occurred on January 1, 1995, nor are they indicative of the Company's results of
operations for any future period. Anticipated efficiencies from the
consolidation of the Company and Firefox are not fully determinable and
therefore have been excluded from the amounts included in the pro forma summary
above.
The Company allocates the purchase price of acquired technologies to
completed technology and in-process technology based upon their respective fair
values. Completed technology that has reached technological feasibility is
valued using a risk adjusted cash flow model under which future cash flows are
discounted, taking into account risks related to existing and future markets and
assessments of the life expectancy of completed technology. In-process
technology that has not reached technological feasibility and that has no
alternative future use is valued by using the same method. Expected future cash
flows associated with in-process technology are discounted considering risks and
uncertainties related to the viability of and to potential changes in the future
target markets and to the completion of the products expected to be ultimately
marketed by the Company. Amounts charged to product development expense for in-
process technology are either not fully deductible in the same period or are
non-deductible for tax purposes.
7
3. DISCONTINUED OPERATIONS AND RECLASSIFICATIONS
During September 1996, the Company announced its vision for the Virtual IP
("VIP") Network. The Company also announced a formal plan to spin off, through
the sale to third parties, within the next year, its collaborative lines of
business and discontinue selected product lines which were not specifically
related to the Company's continuing network connectivity business. These
operations are treated as discontinued operations in the accompanying financial
statements. As a result, the Company recorded a $4.8 million charge to write
down the related assets to estimated net realizable values.
The consolidated financial statements have been reclassified to report
separately in all periods presented the net assets and operating results of the
discontinued operations. Prior year operating results have been restated to
reflect continuing operations. Net assets of discontinued operations consist
primarily of purchased software and fixed assets less accounts payable and
accrued expenses. Summary operating results for the discontinued operations are
as follows:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
1996 1995 1996 1995
--------- --------- -------- ---------
Revenue $1,937 $2,653 $ 6,458 $3,308
Gross margin 1,118 1,811 2,431 2,207
Operating loss 1,324 5,579 31,519 7,103
Net loss 6,084 3,529 33,799 4,493
In addition, certain prior year amounts have been reclassified to conform
with the current year's presentation.
4. STOCK OPTION REPRICING
During the third quarter of 1996, the Company offered its employees (other
than executive officers) the opportunity to exchange each option to purchase
Common Stock granted during 1994, 1995 and 1996 for a new option covering 50% of
the number of shares of Common Stock covered by the original option, with a new
exercise price fixed at the date of exchange. During the option exchange offer
period, options to purchase 2,130,352 shares of Common Stock at exercise prices
ranging from $9.50 to $31.75 per share were exchanged for options to purchase
1,065,175 shares of Common Stock at exercise prices ranging from $7.25 to $9.063
per share.
5. LEGAL PROCEEDINGS
On March 14, 1996, a class action lawsuit was filed in the United States
District Court for the District of Massachusetts, naming FTP, certain of its
officers and two former officers as defendants. The lawsuit captioned Lawrence
--------
M. Greebel v. FTP Software, Inc. et al., Civil Action No. 96-10544, alleges that
- --------------------------------------
the defendants publicly issued false and misleading statements and omitted to
disclose material facts necessary to make such statements not false and
misleading, which the plaintiffs contend caused an artificial inflation in the
price of FTP's common stock. Specifically, the original complaint alleged that
the defendants knowingly concealed adverse facts and made false or misleading
forward and non-forward looking statements concerning the operating results and
financial condition of FTP, the effects of the
8
Company's July 1995 corporate restructuring and changing competitive factors in
FTP's industry. The lawsuit, which is purportedly brought on behalf of a class
of purchasers of FTP's common stock during the period from July 14, 1995 to
January 3, 1996, alleges violations of Section 10(b) and Section 20(a) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Rule 10b-5
thereunder and seeks relief in the form of unspecified compensatory damages,
costs and expenses and such other relief as the court deems proper and just.
Plaintiffs filed an amended complaint on August 12, 1996 adding allegations
concerning what plaintiffs claim were wrongful sales and accounting practices by
FTP during the class period, but asserting the same causes of action as the
original complaint. Plaintiffs filed a second amended complaint on September 12,
1996 which is identical in all respects to the first amended complaint except
that it adds additional plaintiffs and reflects the court's order concerning the
appointment of lead plaintiffs. On October 11, 1996, FTP filed a motion to
dismiss the second amended complaint on the grounds that the plaintiffs had not
met the pleading requirements of the Private Securities Reform Act of 1995. The
motion is scheduled to be heard by the court on January 7, 1997. FTP has
reviewed the allegations in the lawsuit, believes them to be without merit, and
intends to defend itself and its officers vigorously. In order to support an
adequate defense, FTP may be required to expend substantial sums for legal and
expert fees and costs. The cost of defending the litigation and the outcome of
the litigation are uncertain and cannot be estimated. If the lawsuit were
determined adversely to FTP, FTP could be required to pay a substantial
judgment, which could have a material adverse effect on the Company's business,
financial condition and results of operations.
On February 23, 1996, a class action lawsuit, captioned Richard Zeid and
----------------
Siom Misrahi et al. v. John Kimberley, Frank M. Richardson, Mark A. Rowlinson
- -----------------------------------------------------------------------------
and Firefox Communications, Inc., Case No. C96 20136, was filed in the United
- --------------------------------
States District Court for the Northern District of California, San Francisco
Division (transferred to the San Jose Division) naming Firefox and certain of
its current and former officers and former directors as defendants. The
original complaint alleged that the defendants misrepresented or failed to
disclose material facts about Firefox's operations and financial results, which
the plaintiffs contended resulted in an artificial inflation of the price of
Firefox's common stock. The suit was purportedly brought on behalf of a class
of purchasers of Firefox's common stock during the period from August 3, 1995 to
January 2, 1996. The complaint alleged claims for violations of Sections 10(b)
and 20(a) of the Exchange Act and Rule 10b-5 thereunder and sought relief in the
form of unspecified compensatory damages, pre- and post-judgment interest,
attorneys and expert witness fees and other extraordinary, equitable and/or
injunctive relief as permitted by law, equity and the federal statutory
provisions under which the suit was brought. On June 5, 1996, the District
Court entered an order dismissing plaintiffs' complaint. Certain of plaintiffs'
claims that alleged that Firefox was responsible for false and misleading
analysts reports, Firefox statements and financial statements were dismissed
with leave to amend. In addition, certain of plaintiffs' claims that warnings
and disclosures in Firefox's Form 10-Qs were false and misleading were dismissed
with prejudice.
On July 19, 1996, plaintiffs filed an amended complaint. The amended
complaint alleges that defendants misrepresented or failed to disclose material
facts about Firefox's operations and financial results which the plaintiffs
contend resulted in an artificial inflation of the price of Firefox's common
stock. The amended complaint is purportedly brought on behalf of a class of
purchasers of Firefox's common stock during the period from July 20, 1995 to
January 2, 1996. The amended complaint also alleges claims for violations of
Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 thereunder and seeks
relief in the form of
9
unspecified compensatory damages, pre- and post-judgment interest, attorneys and
expert witness fees and such extraordinary, equitable and/or injunctive relief
as if permitted by law, equity and the federal statutory provisions under which
the suit was brought. Specifically, the amended complaint alleges that
defendants knew allegedly material adverse non-public information about
Firefox's financial results and business conditions which allegedly was not
disclosed, that they improperly directed that certain sales and revenues be
recognized and failed to keep adequate reserves and participated in drafting,
reviewing and/or approving allegedly misleading statements, releases, analysts
reports and other public representations, including disclaimers and warnings of
and about Firefox. The amended complaint also alleges that John A. Kimberley, an
officer and director of Firefox, and Frank Richardson, a former officer and
director of Firefox, are liable as "controlling persons" of Firefox. On
September 6, 1996, Firefox filed a motion to dismiss the amended complaint on
the grounds that the plaintiffs had not met the pleading requirements of the
Private Securities Reform Act of 1995. The motion is scheduled to be heard by
the court on December 3, 1996.
Firefox has reviewed the allegations in the lawsuit, believes them to be
without merit and intends to defend itself and its officers and directors
vigorously. In order to support an adequate defense, Firefox may be required to
expend substantial sums for legal and expert fees and costs. The cost of
defending the litigation and the outcome of the litigation are uncertain and
cannot be estimated. If the lawsuit were determined adversely to Firefox,
Firefox could be required to pay a substantial judgment, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
6. INCOME TAXES
Due to the uncertainty as to when the deferred tax assets may be realized,
as of September 30, 1996 the Company has recorded a valuation allowance for all
tax assets in excess of amounts available to be recovered pursuant to tax loss
carrybacks.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW; RECENT DEVELOPMENTS
The following discussion and analysis provides information that management
of FTP Software, Inc. ("FTP" or the "Company") believes is relevant to an
assessment and understanding of FTP's consolidated results of operations and
financial condition for the three- and nine-month periods ended September 30,
1996. This discussion should be read in conjunction with FTP's unaudited
consolidated financial statements and the notes related thereto included
elsewhere herein.
FORWARD-LOOKING STATEMENTS IN THIS SECTION AND ELSEWHERE IN THIS REPORT ARE
MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION
REFORM ACT OF 1995. ALL FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND
UNCERTAINTIES, AND ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED
IN THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN FOR A VARIETY OF REASONS.
THESE REASONS INCLUDE, BUT ARE NOT LIMITED TO, COMPETITION, TECHNOLOGICAL AND
OTHER MARKET CHANGES, INCREASED DEMANDS ON MANAGEMENT AS A RESULT OF RECENT
ACQUISITIONS, CHANGES IN DISTRIBUTOR TERMS OR PERFORMANCE, AND OTHER RISKS
OUTLINED BELOW AND IN APPENDIX A, "CAUTIONARY FACTORS RELEVANT TO FORWARD-
LOOKING STATEMENTS," TO THIS REPORT.
In late September 1996, the Company unveiled its vision for the
Virtual IP ("VIP") Network, a set of user-defined, standards-based software
solutions to deploy, manage and secure IP (Internet protocol) infrastructures.
The VIP Network is intended to enable companies to securely extend their
networks beyond traditional boundaries, intranets and the Internet to build
virtual workgroups or enable electronic commerce. The Company believes that the
VIP Network concept is an effective means both of combining FTP's client-based
networking software products and agent technology with the server-based
connectivity software products developed by Firefox Communications Inc.
("Firefox"), which was acquired by the Company in July 1996, and of addressing
opportunities in the continually changing networking software market. In
September 1996, the Company shipped its first two products for the VIP Network,
VIP OnNet32(R) v2.0 and the VIP Internet Gateway for NetWare, the Company's
first product incorporating Firefox's technology. VIP OnNet32 v2.0 is a robust
32-bit TCP/IP connectivity suite that provides end-users with a suite of
applications designed to reach and share information on corporate intranets and
the Internet and across legacy systems. The VIP Internet Gateway for NetWare
allows network managers to troubleshoot, manage and analyze users' access to a
company's intranet and Internet resources.
As part of its ongoing business, FTP continues to design, develop, market
and support networking and other software products that enable personal computer
users to find, access and use heterogeneous hardware, information and
applications resources across local area, enterprise-wide and global networks.
The Company's principal networking products, OnNet(R) and PC/TCP(R), which are
based upon the industry standard Transmission Control Protocol/Internet Protocol
("TCP/IP") data communications protocol suite, enable remote access, file and
resource sharing and other applications across a variety of operating systems,
computing platforms and network environments. To date, substantially all of
FTP's revenue has been attributable to sales of its OnNet and PC/TCP product
lines.
11
Firefox, the Company's principal subsidiary, develops, markets and
supports server-based networking connectivity and communications software.
Firefox's products provide connectivity for local area networks ("LANs") running
Novell NetWare and allow work groups to access local and remote computing
resources, including the Internet, across different networking protocols and
client operating systems. Firefox's products are centrally configured on the
server and integrated with the network operating system ("NOS"), thereby taking
advantage of the management and security features already implemented in the NOS
and enhancing control, administration and security of the LAN. The Company
acquired Firefox on July 22, 1996 through the merger of a subsidiary of FTP into
Firefox, which continues to operate as a wholly-owned subsidiary of FTP.
Pursuant to the merger, all of the outstanding common stock of Firefox was
converted into a total of approximately 6.4 million shares of FTP's common stock
("Common Stock") and approximately $9.1 million in cash, and outstanding
employee options to purchase shares of the common stock of Firefox were
converted into options to purchase 359,216 shares of Common Stock.
In May 1996, as a result of significant changes in the networking
software industry and the increasingly rapid evolution of the Internet market
and in connection with its determination to effect certain cost-cutting
measures, FTP decided to reorganize its operations to better position itself to
address customer needs and to take advantage of the market potential for
intranet product suites incorporating both TCP/IP and Internet products. Such
cost-cutting measures included a reduction of approximately 10% in the number of
FTP's full-time employees, effected May 1, 1996.
In late 1995, FTP determined to explore then-existing opportunities in
the collaborative software market. As a result, in March 1996, FTP acquired
substantially all of the assets of HyperDesk Corporation, including its
GroupWorks product, for a net cash purchase price of approximately $6.3 million,
and in April 1996, FTP acquired Campbell Services, Inc., the developer of
OnTime, for a net cash purchase price of approximately $15.0 million. FTP also
acquired the Mariner Internet software product line of Network Computing
Devices, Inc. in February 1996 for a net cash purchase price of approximately
$7.4 million. As part of the announcement of its new strategic vision in
September 1996 and as a result of its determination to focus on the client-
server, agent, security and directory services products necessary to implement
that strategy, the Company announced a formal plan to spin off, through the sale
to third parties, its collaborative lines of business and to discontinue other
selected product lines, including those described above and the assets acquired
in early 1995 from Keyword Office Technologies Ltd. described under "Liquidity
and Capital Resources" below. Accordingly, these operations are treated as
discontinued operations in the accompanying financial statements, and the
Company has recorded a $4.8 million charge in the three- and nine-month periods
ended September 30, 1996 to write down the related assets to estimated net
realizable values.
Looking forward, FTP intends to continue to make substantial investments in
its business (including through internal and joint third party development
activities, royalty agreements and acquisitions) over the foreseeable future,
through the use of FTP's internal cash resources, the issuance of shares of its
common stock or other securities, or a combination thereof. There can be no
assurance, however, that the capital resources necessary in order to fund such
investments will be available or that, if available, such resources will be on
terms acceptable to FTP.
12
RESULTS OF CONTINUING OPERATIONS
TOTAL REVENUE. Total revenue consists of product revenue and service
revenue. Product revenue includes revenue from product sales and royalties from
certain OEM customers. Service revenue includes revenue from maintenance,
consulting and training contracts and is recognized ratably over the length of
the contract periods.
Total revenue decreased from approximately $34.5 million for the three-
month period ended September 30, 1995 to approximately $22.3 million for the
same period of 1996. Product revenue decreased from approximately $31.0 million
for the three-month period ended September 30, 1995 to approximately $18.2
million for the same period of 1996. As a percentage of total revenue, product
revenue decreased from approximately 90% for the three-month period ended
September 30, 1995 to approximately 82% for the same period in 1996. Service
revenue increased from approximately $3.5 million for the three-month period
ended September 30, 1995 to approximately $4.1 million for the same period of
1996. As a percentage of total revenue, service revenue increased from
approximately 10% for the three-month period ended September 30, 1995 to
approximately 18% for the same period of 1996.
The Company's total revenue decreased from approximately $99.2 million
for the nine-month period ended September 30, 1995 to approximately $74.9
million for the same period of 1996. Product revenue decreased from
approximately $89.9 million (approximately 91% of total revenue) for the nine-
month period ended September 30, 1995 to approximately $62.8 million
(approximately 84% of total revenue) for the same period of 1996. Service
revenue increased from approximately $9.3 million (approximately 9% of total
revenue) for the nine-month period ended September 30, 1995 to approximately
$12.1 million (approximately 16% of total revenue) for the same period of 1996.
Product revenue decreased during the current year periods primarily as
a result of (i) an increase in the number of competitors and competing products
offered in the TCP/IP market, and (ii) longer product sales cycles, lower
average unit sales prices for FTP's products and, in the third quarter of 1996,
a decrease in unit sales, all of which FTP believes were attributable not only
to such increased competition but also to an increase in lower-priced or no-cost
products introduced by certain of FTP's competitors in the third and fourth
quarters of 1995 and a decrease in customer demand for DOS-based products. In
addition, the Company believes that a delay in the expected release date of
OnNet32 v2.0 resulted in the deferral of purchasing decisions by certain
customers, and that such deferral also contributed to the decrease in revenues
in the current quarter; however, the Company is unable to predict whether the
release of such product in September 1996 will result in an increase in product
revenue in subsequent periods. The dollar increases in service revenue from
the three- and nine-month periods ended September 30, 1995 to the same periods
in 1996 were primarily attributable to increased growth in FTP's installed
product base from which such revenues are obtained.
International sales consist of export sales, primarily to customers in
Europe, Asia Pacific and Canada. International sales of approximately $15.5
million and $9.5 million accounted for approximately 45% and 43% of the
Company's total revenue for the three-month periods ended September 30, 1995 and
1996, respectively. International sales of approximately $44.9 million and
$33.2 million accounted for approximately 45% and 44% of the Company's total
revenue for the nine-month periods ended September 30, 1995 and 1996,
respectively. The decreases from the three-month period ended September 30,
1995 to the same period of
13
1996 and the nine-month period ended September 30, 1995 to the same
period of 1996 were primarily due to increased competition, longer sale cycles,
lower average unit sales prices and, in the third quarter of 1996, a decrease in
unit sales as described in the preceding paragraph.
Historically, FTP has priced, invoiced and collected international
sales primarily in United States dollars. Accordingly, currency fluctuations
have not had a material effect on FTP's income from operations. However,
Firefox prices, invoices and collects a substantial portion of its sales in
foreign currencies, primarily British pounds sterling, and FTP anticipates that
it will transact a greater number of sales in local currencies as its
distribution channels are combined with those of Firefox. Accordingly, the
Company anticipates that currency fluctuations may have an increased effect on
its results of operations and financial condition in the future.
As indicated above, FTP is facing increasing competition in the TCP/IP
market which has resulted in longer sales cycles and a decrease in average unit
sales prices for FTP's products. The slow-down in FTP's sales is also due, in
part, to technological changes in the market such as the decline in the use of
DOS-based computing systems, to the embedding of competing products into new
PCs, and to slower sales rates similar in effect to those experienced and
announced by hardware and other software manufacturers. Looking forward, FTP
anticipates that these trends will continue, and believes that the Company's
future is substantially dependent on the successful implementation of its new
corporate strategy described above under "Overview; Recent Developments." This
in turn will be dependent on the ability of the Company (i) to successfully
market the VIP Network concept, (ii) to enter into strategic alliances that will
enable the Company to both expand its distribution channels and develop
additional products to fully implement the VIP Network concept (through both the
incorporation of the Company's technologies in the products of third parties and
the incorporation of the technologies of third parties, possibly including
security and directory services technologies, in certain planned VIP Network
products) and (iii) to successfully develop and timely release the additional
VIP Network products necessary to fully implement the VIP Network concept. If
the Company is unsuccessful in any such regard, the Company believes that the
continuation of the trends described above will continue to have a material
adverse effect on the Company's business, results of operations and financial
condition. In addition, due to the encryption technology contained or expected
to be contained in certain of the Company's current and planned VIP Network
products, such products are and will be subject to U.S. export controls, and
there can be no assurance that such export controls will not limit the Company's
ability to distribute such products outside the United States or that
international customers will accept the products that the Company is allowed to
export under such controls, which could have a material adverse effect on the
Company's business, results of operations and financial condition. Even if the
Company is successful in implementing its new corporate strategy, there can be
no assurance that it will result in a material improvement in the Company's
business, results of operations or financial condition.
The Company believes that certain other factors have also contributed
to the decline in the Company's financial results in the current year.
Management of FTP believes that the rapid expansion of its sales and marketing
force from 220 persons at December 31, 1994 to 329 persons at December 31, 1995
to 375 persons at May 2, 1996, and the opening and expansion of several new
offices outside of the United States during 1995 and early 1996, resulted in
certain inefficiencies in its sales and marketing organizations. During the
fall of 1996, the Company hired a number of experienced management personnel to
reorganize the Company's sales and marketing organizations and eliminate such
inefficiencies. However, if the Company
14
is unsuccessful in eliminating such inefficiencies, it will not be
able to take full advantage of the expansion of its sales and marketing
organizations, which may have a material adverse effect on its results of
operations. In addition, the acquisitions completed by the Company during 1996,
particularly the acquisition of Firefox, required the attention and dedication
of management and other resources, which caused a disruption of the business
activities of the Company and, in the case of the Firefox acquisition, Firefox,
as well as a loss of momentum in the business of Firefox. Finally, the Company
has experienced a loss of additional personnel since the May 1996 reorganization
described above under "Overview; Recent Developments" which the Company believes
is attributable to increased competition for qualified personnel in the
industry, the decline in the Company's financial results and the trading prices
of its Common Stock during 1996 and, to a lesser extent, the integration of
Firefox. FTP's ability to maintain or increase revenue will also be dependent
upon its ability to effectively respond to these factors.
See Appendix A for additional discussion of the factors described above and
other factors which may affect FTP's business, financial condition and results
of operations.
GROSS MARGIN. Product gross margin as a percentage of product revenue
decreased from approximately 95% for the three-month period ended September 30,
1995 to approximately 90% for the three-month period ended September 30, 1996,
and from approximately 94% for the nine-month period ended September 30, 1995 to
approximately 93% for the nine-month period ended September 30, 1996. The
product gross margin percentage decreases from 1995 to 1996 reflect increases in
costs, primarily those associated with the amortization of technologies licensed
or purchased in 1995 and 1996, on lower revenues during the current year
periods. Amortization expenses were approximately $0.9 million and $1.7 million
for the three- and nine-month periods ended September 30, 1996, respectively,
compared to approximately $0.5 million and $1.7 million, respectively, for the
same periods in 1995. As noted above under "-- Total Revenue," FTP believes
that average unit sales prices for and unit sales of its products may continue
to decrease as the markets for those products continue to become more
competitive, reducing gross margin on those products.
Service gross margin as a percentage of service revenue was approximately
37% and 39% for the three-month periods ended September 30, 1995 and 1996,
respectively, and approximately 25% and 39% for the nine-month periods ended
September 30, 1995 and 1996, respectively. These increases are primarily
attributable to a higher rate of increase in FTP's installed product base from
which such revenues are obtained compared to the rate of increase in the cost of
providing such services.
The gross margins reported above are not necessarily indicative of
gross margin for future periods, which may vary significantly depending on,
among other things, product mix, price competition, technological change, cost
changes and changes in product distribution channels.
SALES AND MARKETING. Sales and marketing expenses increased from
approximately $9.5 million for the three-month period ended September 30, 1995
to approximately $10.8 million for the same period in 1996. Such expenses as a
percentage of total revenue were approximately 28% and 49% for the three-month
periods ended September 30, 1995 and 1996, respectively. Sales and marketing
expenses increased from approximately $24.7 million for the nine-month period
ended September 30, 1995 to approximately $33.0 million for the same period in
1996. Such expenses as a percentage of total revenue were approximately 25% and
15
44% for the nine-month periods ended September 30, 1995 and 1996, respectively.
The $1.3 million increase for the three-month period ended September 30, 1996
and the $8.3 million increase for the nine-month period ended September 30, 1996
were primarily the results of efforts to increase sales through the opening and
expansion of several international and domestic offices beginning in the first
quarter of 1995 (including the opening and expansion of offices in Europe in
1995 and the opening of offices in Japan and Singapore in late 1995 to early
1996), increasing the number of sales and marketing employees during the period
from January 1, 1995 through April 1996, increasing the levels of advertising,
trade show and international marketing activities, and higher sales and
marketing expenses incurred in the third quarter of 1996 relating to the
integration of Firefox. The percentage increases over these periods were due to
both the dollar increases in such expenses described above and the dollar
decreases in revenue over such periods described under "-- Total Revenue" above.
FTP expects to continue to incur significant expenses during the remainder
of 1996 relating to the implementation of its new corporate strategy, continued
domestic and international sales and marketing activities, the integration of
FTP's and Firefox's distribution channels and the reorganization of certain of
FTP's international offices. As a result of these factors, sales and marketing
expenses are expected to continue to increase both in dollars and as a
percentage of revenue in 1996.
PRODUCT DEVELOPMENT. Product development expenses increased from
approximately $6.4 million for the three-month period ended September 30, 1995
to approximately $44.6 million for the same period in 1996, representing
approximately 18% and 200% of total revenue for each period, respectively.
Product development expenses increased from approximately $15.4 million for the
nine-month period ended September 30, 1995 to approximately $57.2 million for
the same period in 1996, representing approximately 16% and 76% of total revenue
for each period, respectively.
The increase in product development expenses of approximately $38.2
million and $41.8 million for the three- and nine-month periods ended September
30, 1996, respectively, are primarily attributable to a charge of approximately
$37.9 million (approximately 170% and 51% of total revenue for the current year
three- and nine-month periods, respectively) for acquired in-process technology
related to the acquisition of Firefox. An increase in compensation expenses
related to an increase in personnel, as well as an increase in the use of
outside contractors in connection with new product releases, in the current year
three- and nine-month periods compared to the prior year periods also
contributed to the increase in product development expense.
Excluding the approximately $37.9 million charge for acquired in-process
technology in the current year three-month period, product development expenses
as a percentage of total revenue increased from approximately 18% for the three-
month period ended September 30, 1995 to approximately 30% for the same period
in 1996, and from approximately 16% for the nine-month period ended September
30, 1995 to approximately 26% for the same period in 1996. Such percentage
increases are primarily attributable to the decreases in total revenue and the
increases in personnel-related expenses and the use of outside contractors
described above in the current year periods compared to the prior year periods.
16
FTP expects product development expenses to continue to increase in
the remainder of 1996 as the Company continues to develop products to support
the VIP Network strategy described above and as a result of the Firefox
acquisition.
The Company allocates the purchase price of acquired technologies to
completed technology and in-process technology based upon their respective fair
values. Completed technology that has reached technological feasibility is
valued using a risk adjusted cash flow model under which future cash flows are
discounted, taking into account risks related to existing and future markets and
assessments of the life expectancy of the completed technology. In-process
technology that has not reached technological feasibility and that has no
alternative future use is valued using the same method. Expected future cash
flows associated with in-process technology are discounted considering risks and
uncertainties related to the viability of and to the potential changes in future
target markets and to the completion of the products expected to ultimately be
marketed by the Company. Amounts charged to product development expense for in-
process technology are either not fully deductible in the same period or are
non-deductible for tax purposes.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
increased from approximately $3.0 million for the three-month period ended
September 30, 1995 to approximately $5.3 million for the same period in 1996,
representing approximately 9% and 24% of total revenue for such periods,
respectively. General and administrative expenses increased from approximately
$8.8 million for the nine-month period ended September 30, 1995 to approximately
$14.5 million for the same period in 1996, representing approximately 9% and 19%
of total revenue for such periods, respectively. The dollar increases over such
periods were primarily due to expenses relating to an increase in personnel
(including the hiring of certain senior executive officers) compared to the same
periods of 1995, costs incurred in connection with the defense of the legal
proceedings described under "Liquidity and Capital Resources" below and
increases in miscellaneous administrative costs. The percentage increases over
such periods were also due to such factors as well as to the decreases in
revenue over such periods described above under "-- Total Revenue."
INCOME (LOSS) FROM CONTINUING OPERATIONS. The Company had income from
continuing operations of approximately $11.7 million for the three-month period
ended September 30, 1995 compared to a loss from continuing operations of
approximately $(42.8) million for the same period in 1996, representing
approximately 34% and (192%) of total revenue for such periods, respectively.
The Company had income from continuing operations of approximately $38.2 million
for the nine-month period ended September 30, 1995 compared to a loss from
continuing operations of approximately $(41.9) million in the same period in
1996, representing approximately 39% and (56%) of total revenue for such
periods, respectively. These decreases were primarily due to the decreases in
total revenue described above under "-- Total Revenue," the charge for the
acquisition of in-process technology described above under "-- Product
Development," and the increases in other expenses described above.
Excluding the approximately $37.9 million charge for acquired in-process
technology in the three-month period ended September 30, 1996, loss from
continuing operations for the three- and nine-month periods ended September 30,
1996 was approximately $5.0 million (approximately (22%) of total revenue) and
approximately $4.1 million (approximately (5%) of total revenue), respectively.
17
INVESTMENT INCOME. Investment income decreased from approximately
$1.4 million for the three-month period ended September 30, 1995 to
approximately $1.3 million for the same period in 1996, and from approximately
$3.7 million for nine-month period ended September 30, 1995 to approximately
$3.5 million for the same period in 1996. The decreases from 1995 to 1996 were
primarily attributable a reduction in the Company's investment portfolio
resulting from the investment of cash in the 1996 acquisitions described above
under "Overview; Recent Developments." The Company places net cash provided by
operating activities into high grade municipal bonds, U.S. government
treasury obligations, high grade corporate obligations and equity investments.
PROVISION FOR INCOME TAXES. The provision for income taxes was
approximately $4.8 million for the three-month period ended September 30, 1995
compared to approximately $1.6 million for the same period in 1996. The
effective tax rate decreased from approximately 37% for the three-month period
ended September 30, 1995 to approximately 4% for the same period in 1996. The
provision for income taxes was approximately $15.5 million for the nine-month
period ended September 30, 1995 compared to a benefit of approximately $1.5
million for the same period in 1996. The effective tax rate decreased from
approximately 37% for the nine-month period ended September 30, 1995 to
approximately 4% for the same period in 1996. Due to the uncertainty as to when
the deferred tax assets may be realized, the Company has recorded a valuation
allowance for all tax assets in excess of amounts available to be recovered
pursuant to tax loss carrybacks for the three- and nine-month periods ended
September 30, 1996.
DISCONTINUED OPERATIONS. As described above under "Overview; Recent
Developments," in September 1996 the Company announced a formal plan to spin
off, through the sale to third parties, its collaborative lines of business and
to discontinue other selected product lines. Accordingly, these operations are
treated as discontinued operations in the accompanying financial statements, and
the Company has recorded a $4.8 million charge in the three- and nine-month
periods ended September 30, 1996 to write down the related assets to estimated
net realizable values. As described in note 3 to the accompanying financial
statements, such financial statements have been reclassified to report
separately in all periods presented the net assets and operating results of the
discontinued operations, and prior year operating results have been restated to
reflect continuing operations. Net assets of discontinued operations consist
primarily of purchased software and fixed assets less accounts payable and
accrued expenses.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1996, FTP had an aggregate of approximately $93.8
million in cash and cash equivalents, short-term investments and long-term
investments. Of this amount, approximately $14.2 million was invested primarily
in highly liquid investments with original maturities of three months or less,
approximately $24.1 million was invested in short-term investments consisting of
U.S. government obligations and commercial paper with maturities of less than
one year and approximately $55.5 million was invested in U.S. government
obligations, commercial paper and municipal obligations with maturities of
greater than one year and in equity investments.
Accounts receivable, net, totaled approximately $30.8 million at
December 31, 1995 and approximately $12.9 million at September 30, 1996. The
decrease in accounts receivable from
18
December 31, 1995 to September 30, 1996 is primarily attributable to a decrease
in revenue in the first nine months of 1996 and to the payment in early 1996 of
a substantial portion of the accounts receivable outstanding at December 31,
1995.
In March 1995, FTP acquired substantially all of the assets of Keyword
Office Technologies Ltd. for a net cash purchase price of approximately $2.4
million. As noted above under "Overview; Recent Developments," in February 1996,
FTP acquired the Mariner product line of Network Computing Devices, Inc. for a
net cash purchase price of approximately $7.4 million; in March 1996, FTP
acquired substantially all of the assets of HyperDesk Corporation for a net cash
purchase price of approximately $6.3 million; and in April 1996, FTP acquired
all of the outstanding stock of Campbell Services by merger for a net cash
purchase price of approximately $15.0 million. In July 1996, FTP acquired
Firefox by merger pursuant to which all of the outstanding common stock of
Firefox was converted into a total of approximately 6.4 million shares of Common
Stock and approximately $9.1 million in cash. In connection with the Firefox
acquisition, the Company incurred approximately $3.7 million of acquisition-
related expenses (consisting primarily of investment advisory fees and legal and
accounting expenses).
FTP made capital expenditures of approximately $6.9 million and $6.2
million in the nine-month periods ended September 30, 1995 and 1996,
respectively. Capital expenditures are primarily the result of the purchase of
equipment, primarily relating to information systems.
To date, inflation has not had a material impact on the Company's
financial results.
Looking forward, FTP believes that its available cash, cash equivalents and
short-term investments and expected cash flow from operations will be sufficient
to fund FTP's operations at least through 1997. As noted above under "Overview;
Recent Developments," FTP intends to make substantial investments in the
products necessary to implement its new strategic vision. There can be no
assurance, however, that the capital resources necessary to continue to fund
such investments will be available or that, if available, such resources will be
on terms acceptable to FTP.
On March 14, 1996, a class action lawsuit was filed in the United
States District Court for the District of Massachusetts, naming FTP, certain of
its officers and two former officers as defendants. The lawsuit captioned
Lawrence M. Greebel v. FTP Software, Inc. et al., Civil Action No. 96-10544,
- -----------------------------------------------
alleges that the defendants publicly issued false and misleading statements and
omitted to disclose material facts necessary to make such statements not false
and misleading, which the plaintiffs contend caused an artificial inflation in
the price of FTP's common stock. Specifically, the original complaint alleged
that the defendants knowingly concealed adverse facts and made false or
misleading forward and non-forward looking statements concerning the operating
results and financial condition of FTP, the effects of the Company's July 1995
corporate restructuring and changing competitive factors in FTP's industry. The
lawsuit, which is purportedly brought on behalf of a class of purchasers of
FTP's common stock during the period from July 14, 1995 to January 3, 1996,
alleges violations of Section 10(b) and Section 20(a) of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"), and Rule 10b-5 thereunder and
seeks relief in the form of unspecified compensatory damages, costs and expenses
and such other relief as the court deems proper and just. Plaintiffs filed an
amended complaint on August 12, 1996 adding allegations concerning what
plaintiffs claim were wrongful sales and accounting practices by FTP during the
class period, but asserting the same causes of action as the original complaint.
Plaintiffs
19
filed a second amended complaint on September 12, 1996 which is identical in all
respects to the first amended complaint except that it adds additional
plaintiffs and reflects the court's order concerning the appointment of lead
plaintiffs. On October 11, 1996, FTP filed a motion to dismiss the second
amended complaint on the grounds that the plaintiffs had not met the pleading
requirements of the Private Securities Reform Act of 1995. The motion is
scheduled to be heard by the court on January 7, 1997. FTP has reviewed the
allegations in the lawsuit, believes them to be without merit, and intends to
defend itself and its officers vigorously. In order to support an adequate
defense, FTP may be required to expend substantial sums for legal and expert
fees and costs. The cost of defending the litigation and the outcome of the
litigation are uncertain and cannot be estimated. If the lawsuit were determined
adversely to FTP, FTP could be required to pay a substantial judgment, which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
On February 23, 1996, a class action lawsuit captioned Richard Zeid
-------------
and Siom Misrah et al. v. John Kimberley, Frank M. Richardson, Mark A. Rowlinson
- --------------------------------------------------------------------------------
and Firefox Communications, Inc., Case No. C96 20136, was filed in the United
- ---------------------------------
States District Court for the Northern District of California, San Francisco
Division, (transferred to the San Jose Division) naming Firefox and certain of
its current and former officers and former directors as defendants. On June 5,
1996, the District Court entered an order dismissing the complaint in its
entirety, with leave to amend. The original complaint alleged that the
defendants misrepresented or failed to disclose material facts about Firefox's
operations and financial results, which the plaintiffs contend resulted in an
artificial inflation in the price of Firefox's common stock. The suit was
purportedly brought on behalf of a class of purchasers of Firefox's common stock
during the period from August 3, 1995 to January 2, 1996. The complaint alleged
claims for violations of Sections 10(b) and 20(a) of the Exchange Act and Rule
10b-5 thereunder and sought relief in the form of unspecified compensatory
damages, pre- and post-judgment interest, attorneys' and expert witness fees and
such extraordinary, equitable and/or injunctive relief as permitted by law,
equity and the federal statutory provisions under which the suit was brought.
On June 5, 1996, the District Court entered an order dismissing plaintiffs'
complaint. Certain of plaintiffs' claims that alleged that Firefox was
responsible for false and misleading analysts reports, Firefox statements and
financial statements were dismissed with leave to amend. In addition, certain
of plaintiffs' claims that warnings and disclosures in Firefox's Form 10-Qs were
false and misleading were dismissed with prejudice.
On July 19, 1996, plaintiffs filed an amended complaint. The amended
complaint alleges that defendants misrepresented or failed to disclose material
facts about Firefox's operations and financial results which the plaintiffs
contend resulted in an artificial inflation of the price of Firefox's common
stock. The amended complaint is purportedly brought on behalf of a class of
purchasers of Firefox's common stock during the period from July 20, 1995 to
January 2, 1996. The amended complaint also alleges claims for violations of
Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 thereunder and seeks
relief in the form of unspecified compensatory damages, pre- and post-judgment
interest, attorneys and expert witness fees and such extraordinary, equitable
and/or injunctive relief as is permitted by law, equity and the federal
statutory provisions under which the suit was brought. Specifically, the
amended complaint alleges that defendants knew allegedly material adverse non-
public information about Firefox's financial results and business conditions
which allegedly was not disclosed, that they improperly directed that certain
sales and revenues be recognized and failed to keep adequate reserves and
participated in drafting, reviewing and/or approving allegedly misleading
statements, releases, analysts reports and other public representations,
20
including disclaimers and warnings of and about Firefox. The amended complaint
also alleges that John A. Kimberley, an officer and director of Firefox, and
Frank Richardson, a former officer and director of Firefox, are liable as
"controlling persons" of Firefox. On September 6, 1996, Firefox filed a motion
to dismiss the amended complaint on the grounds that the plaintiffs had not met
the pleading requirements of the Private Securities Reform Act of 1995. The
motion is scheduled to be heard by the court on December 3, 1996.
Firefox has reviewed the allegations in the lawsuit, believes them to
be without merit, and intends to defend itself and its officers and directors
vigorously. In order to support an adequate defense, Firefox may be required to
expend substantial sums for legal and expert fees and costs. The cost of
defending the litigation and the outcome of the litigation are uncertain and
cannot be estimated. If the lawsuit were determined adversely to Firefox,
Firefox could be required to pay a substantial judgment, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
21
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
For a description of certain legal proceedings involving FTP and a
description of certain legal proceedings involving Firefox, see "Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Part I of this Report.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On July 22, 1996, the Company held a special meeting of stockholders for
the purpose of considering a proposal to approve the issuance of the shares of
Common Stock issuable pursuant to the Agreement and Plan of Merger dated as of
May 21, 1996 among the Company, Firefox Acquisition Corp. and Firefox. The
affirmative vote of the holders of a majority of the 16,372,278 outstanding
shares of Common Stock entitled to vote and present at the meeting in person or
by proxy was required to approve such proposal, in accordance with the rules of
the National Association of Securities Dealers, Inc. (the "NASD"). Of such
shares, 9,789,312 were voted in favor of such proposal, 4,246,568 were voted
against such proposal, 99,770 abstained and 2,236,628 were not voted.
On August 22, 1996, the Company held a special meeting in lieu of 1996
annual meeting of stockholders for the purposes of: (i) electing Vinton G. Cerf,
Glenn C. Hazard and Louise A. Mathews as Class III Directors, to serve until the
1999 annual meeting of stockholders of the Company or until the qualification
and election of their successors; (ii) considering a proposal to approve an
amendment to the Company's Restated Articles of Organization, as amended, to
increase the number of authorized shares of Common Stock from 50 million to 100
million; and (iii) considering a proposal to approve the FTP Software, Inc. 1996
Executive Equity Incentive Plan. The results of the votes were as follows:
1. Election of Class III Directors:
Nominee For Against Withheld Broker Non-Votes
- ------------- ---------- ------- --------- ----------------
Dr. Cerf 27,422,785 0 1,437,941 0
Mr. Hazard 27,419,271 0 1,441,455 0
Ms. Mathews 27,421,835 0 1,438,891 0
The following persons continued as directors following the meeting: Class I
Directors -- David D. Clark and F. David Fowler; Class II Directors -- John H.
Keller, John A. Kimberley and David H. Zirkle.
2. Proposal to increase the number of authorized shares of Common Stock:
For Against Abstained Broker Non-Votes
- ------------ --------- --------- ----------------
26,407,170 2,247,933 134,697 70,926
22
The affirmative vote of the holders of a majority of the shares of Common Stock
outstanding as of the July 25, 1996 record date for the meeting (33,418,987
shares) was required to approve this proposal, in accordance with Massachusetts
law.
3. Proposal to approve the 1996 Executive Equity Incentive Plan:
For Against Abstained Broker Non-Votes
- ------------ --------- --------- ----------------
25,769,036 2,843,318 177,446 70,926
The affirmative vote of the holders of a majority of the outstanding shares of
Common Stock entitled to vote and present at the meeting in person or by proxy
(28,860,726 shares) was required to approve this proposal, in accordance with
the rules of the NASD.
ITEM 5. OTHER INFORMATION.
Pursuant to an Amendment to Rights Agreement dated as of November 7, 1996
between the Company and State Street Bank and Trust Company, as Rights Agent,
the Company amended the Rights Agreement dated as of December 1, 1995 between
such parties to permit Kopp Investment Advisors, Inc. (but not any of its
transferees), subject to certain conditions, to own up to 6,722,400 shares of
the Company's Common Stock (slightly under 20% of the number of outstanding
shares of Common Stock) without triggering the exercisability of the Junior
Preferred Stock purchase rights established by the Rights Agreement.
On November 11, 1996, the Company announced that Glenn C. Hazard, President
of the Company, has also been elected as Chief Executive Officer of the Company.
David H. Zirkle, who had served as Chief Executive Officer of the Company since
January 1993, will continue to serve as Chairman of the Company until his
retirement, anticipated to occur in April 1997. Mr. Hazard joined the Company
as President and Chief Operating Officer in April 1996.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
A. EXHIBITS
EXHIBIT NO. TITLE
- ----------- -----
3.1 Restated Articles of Organization of the Company(1)
3.2 Certificate of Designation, Preferences and Rights of Junior
Preferred Stock of the Company(1)
3.3 Articles of Amendment to Restated Articles of Organization of
the Company*
3.4 Amended and Restated Bylaws of the Company(1)
4.1 Specimen common stock certificate(1)
4.2 Rights Agreement dated as of December 1, 1995 between the
Company and State Street Bank and Trust Company, as Rights Agent
(including form of Rights Certificate)(1)
23
EXHIBIT NO. TITLE
- ----------- -----
4.3 Amendment to Rights Agreement dated as of November 7, 1996 between
the Company and State Street Bank and Trust Company, as Rights
Agent*
10.1 Indenture of Lease between the Company and North Andover Mills
Realty dated November 19, 1991(1)
10.2 Amendment No. 1 to Indenture of Lease between the Company and North
Andover Mills Realty dated as of September 1, 1992(1)
10.3 Amendment No. 2 to Indenture of Lease between the Company and North
Andover Mills Realty dated as of January 6, 1993(1)
10.4 Amendment No. 3 to Indenture of Lease between the Company and North
Andover Mills Realty dated as of June 18, 1993(1)
10.5 Amendment No. 4 to Indenture of Lease between the Company and North
Andover Mills Realty dated as of September 30, 1993(1)
10.6 Amendment No. 5 to Indenture of Lease between the Company and North
Andover Mills Realty Limited Partnership dated August 12, 1995(1)
10.7 Employment Agreement between the Company and David H. Zirkle dated
as of July 26, 1996*
10.8 Employment Agreement between the Company and David H. Zirkle dated
as of March 1, 1993(1)
10.9 Amendment No. 1 to Employment Agreement between the Company and
David H. Zirkle dated as of June 14, 1993(1)
10.10 Amendment No. 2 to Employment Agreement between the Company and
David H. Zirkle dated as of August 15, 1994(1)
10.11 Amendment No. 3 to Employment Agreement between the Company and
David H. Zirkle dated as of February 28, 1995(1)
10.12 Employment Agreement between the Company and Glenn C. Hazard dated
as of July 29, 1996*
10.13 Employment Agreement between the Company and Susan L. Bostrom dated
as of July 23, 1996*
10.14 Employment Agreement between the Company and Douglas F. Flood dated
as of July 23, 1996*
10.15 Employment Agreement between the Company and John H. Keller dated
as of July 23, 1996*
10.16 Employment Agreement between the Company and John A. Kimberley
dated as of the "Effective Date" of the Firefox Merger*
10.17 Employment Agreement between the Company and Peter R. Simkin dated
as of the "Effective Date" of the Firefox Merger, together with
Amendment No. 1 thereto dated August 24, 1996*
24
EXHIBIT NO. TITLE
- ----------- -----
10.18 Employment Agreement between the Company and John J. Warnock, Jr.,
dated as of July 31, 1996*
10.19 FTP Software, Inc. Stock Option Plan(1)
10.20 Composite FTP Software, Inc. 1993 Non-Employee Directors' Stock
Option Plan incorporating Amendment No. 1 effective as of June 2,
1995 and Amendment No. 2 effective as of August 22, 1996*
10.21 FTP Software, Inc. 1996 Executive Equity Incentive Plan*
10.22 FTP Software, Inc. 1993 Executive Bonus Plan(1)
10.23 FTP Software, Inc. 1994 Executive Compensation Plan(1)
10.24 FTP Software, Inc. 1995 Executive Compensation Plan(1)
10.25 FTP Software, Inc. 1995 V-P Sales Plan(1)
10.26 Indenture of Lease between the Company and Andover Mills Realty
Limited Partnership dated as of October 1, 1993(1)
10.27 Amendment No. 1 to Indenture of Lease between the Company and
Andover Mills Realty Limited Partnership dated as of February 10,
1994(1)
10.28 Amendment No. 2 to Indenture of Lease between the Company and
Andover Mills Realty Limited Partnership dated as of June 7,
1995(1)
10.29 Amended and Restated Agreement and Plan of Merger by and among the
Company, Firefox Acquisition Corp. and Firefox Communications Inc.
dated as of May 21, 1996(2)
11 Weighted Shares Used in Computation of Earnings Per Share*
27 Financial Data Schedule*
99 Cautionary Statements Relevant to Forward-Looking Statements(3)
_____________________
*Filed herewith
(1) Included with, and incorporated herein by reference to, the Company's
Registration Statement on Form S-4 (No. 333-06917) filed with the
Securities and Exchange Commission (the "Commission") on June 26, 1996.
(2) Included as Appendix A to, and incorporated herein by reference to, the
Company's Joint Proxy Statement/Prospectus for its Special Meeting of
Stockholders filed with the Commission on July 1, 1996.
(3) Included as Appendix A to, and incorporated herein by reference to, the
Company's Quarterly Report on Form 10-Q for the quarter ended September 30,
1996.
25
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FTP SOFTWARE, INC.
Date: November 14, 1996 By:/s/ John J. Warnock, Jr.
------------------------
John J. Warnock, Jr.
Senior Vice President, Chief Financial Officer
and Treasurer
(Principal Financial and Accounting Officer)
26
APPENDIX A
CAUTIONARY FACTORS RELEVANT TO FORWARD-LOOKING STATEMENTS
FROM TIME TO TIME MANAGEMENT OF FTP SOFTWARE, INC. ("FTP" OR THE "COMPANY")
HAS MADE, AND MAY IN THE FUTURE MAKE, FORWARD-LOOKING STATEMENTS, BASED ON
MANAGEMENT'S THEN-CURRENT EXPECTATIONS, INCLUDING STATEMENTS MADE IN SECURITIES
AND EXCHANGE COMMISSION FILINGS, IN PRESS RELEASES AND ORAL STATEMENTS. THESE
FORWARD-LOOKING STATEMENTS ARE MADE PURSUANT TO THE SAFE HARBOR PROVISIONS OF
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. ALL FORWARD-LOOKING
STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, AND ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE SET FORTH IN THE FORWARD-LOOKING STATEMENTS FOR A VARIETY
OF REASONS. THESE REASONS INCLUDE, BUT ARE NOT LIMITED TO, COMPETITION,
TECHNOLOGICAL AND OTHER MARKET CHANGES, INCREASED DEMANDS ON MANAGEMENT AS A
RESULT OF RECENT ACQUISITIONS, AND OTHER FACTORS OUTLINED BELOW AND IN "ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" OF THE COMPANY'S REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER
30, 1996 (THE "FORM 10-Q") TO WHICH THIS APPENDIX IS ATTACHED.
As used herein, the term the "Company" is generally deemed to refer to FTP
and its subsidiaries, including Firefox Communications Inc. ("Firefox"), which
the Company acquired on July 22, 1996 through a merger of a subsidiary of the
Company with Firefox.
Competition. As described in Item 2 of the Form 10-Q, in September 1996 the
Company announced its vision for the Virtual IP ("VIP") Network, a set of user-
defined, standards-based software solutions to deploy, manage and secure IP
(Internet protocol) infrastructures. The Company believes that none of its
competitors presently has a set of software solutions designed to provide the
features intended to be provided by the VIP Network. However, the Company
believes that the major U.S. computer and communications systems vendors,
including International Business Machines Corporation ("IBM"), Microsoft
Corporation ("Microsoft"), Novell, Inc. ("Novell") and Sun Microsystems, Inc.
("Sun"), could design and implement their own versions of the VIP Network. Such
vendors have substantially greater financial, technical, sales, marketing and
other resources than the Company, as well as greater name recognition and a
larger customer base, and the implementation by such vendors of similar products
could have a material adverse effect on the Company's business, results of
operations and financial condition.
The networking software industry is highly competitive, and is
characterized by evolving industry standards, frequent introduction of new
products and product enhancements, and continuous improvement in product
reliability, compatibility, memory use and performance. The Company's
networking software products compete with major computer and communications
systems vendors, again including IBM, Microsoft, Novell and Sun, as well as
smaller networking software companies, such as NetManage, Inc. ("NetManage").
Some of the Company's competitors have substantially greater financial,
technical, sales, marketing and other resources than the Company, as well as
greater name recognition and a larger customer base. In addition, the Company's
core product lines are based upon the Transmission Control Protocol/Internet
Protocol ("TCP/IP"), an open non-proprietary data communications protocol suite.
Several of the Company's competitors have developed proprietary networking
applications and certain of such vendors, including Microsoft, provide a TCP/IP
protocol suite in
A-1
their products at little or no additional cost. The introduction of such
protocol suites has lengthened the sales cycles of, and has resulted in a
decrease in average unit sales prices for and, in the third quarter of 1996, a
decrease in unit sales of, certain of the Company's products and may continue to
have this effect, which has materially adversely affected the Company's results
of operations in the first three quarters of 1996 and may continue to have this
effect in the remainder of 1996 and beyond. The Company anticipates that other
companies may also enter the market with their own implementations of TCP/IP.
The Company is also facing competition from makers of terminal emulation
software, such as Attachmate Corporation ("Attachmate") and Wall Data, Inc.
("Wall Data"). In addition, existing competitors could devote additional
resources to the development of TCP/IP or expand their existing TCP/IP product
lines. Increased competition from existing or new products could adversely
affect demand for the Company's products and has led, and could continue to
lead, to increased price competition, longer sales cycles and other concessions,
adversely affecting the Company's gross margins and operating results.
The market for Internet-based software and services is new, intensely
competitive, rapidly evolving and subject to rapid technological change. The
Company expects competition in this market to persist, intensify and increase in
the future. Some of the Company's current and potential competitors have longer
operating histories, greater name recognition, larger installed customer bases
and significantly greater financial, technical and marketing resources than does
the Company. Such competition has had a material adverse effect on the
Company's business, operating results and financial condition in 1996. The
Company's current and potential competitors include Microsoft, browser software
vendors including Netscape Communications Corporation ("Netscape"), Web server
software and service vendors, PC and UNIX software vendors and other vendors,
including Apple Computer, Inc., Sun, Hewlett-Packard Co. ("Hewlett-Packard"),
IBM, Digital Equipment Corp. ("Digital"), The Santa Cruz Operation, Inc. and
Silicon Graphics, Inc. Certain operating system companies, such as Microsoft,
have incorporated Web client functionality into their software products and
offer this functionality at little or no additional cost to customers. If client
products incorporated into operating systems by such operating system vendors
gain market acceptance, these organizations may be better positioned than the
Company to sell server and applications software products. In addition, software
companies which have server products in other product categories may choose in
the future to enhance the functionality of existing products or develop new
competitive products. Further, the Company's current products are designed
around certain standards, and industry acceptance of competing standards could
decrease the demand for the Company's products. For example, Microsoft and IBM
are each proposing an alternative security standard, and widespread adoption of
either standard could have a material adverse effect on the Company's business,
financial condition and results of operations.
There can be no assurance that the Company will be able to compete
successfully against current or future competitors. Competitive pressures faced
by the Company have materially adversely affected its business, financial
condition and results of operations in the first three quarters of 1996 and may
continue to have such an effect during the remainder of 1996 and beyond.
Because NOV*IX and other Firefox products have been developed for LANs
running Novell's NetWare LAN operating system, sales of such products (and, as a
result, the business, financial condition and results of operations of the
Company) could be materially adversely affected by market developments adverse
to Novell or NetWare.
A-2
Rapid Technological and Other Market Changes and Dependence on New
Products. The market for agent and networking software products is subject to
rapid changes in technology and customer preferences, such as the recent decline
in the use of DOS-based computing systems and the embedding of competing
products into new PCs. The Company's growth and future financial performance
will depend upon its ability to successfully market its new strategic VIP
Network concept and to develop and introduce new products and enhancements of
existing products that accommodate the latest technological advances and
customer requirements, and also on its ability to increase unit volume sales of
its connectivity products and to generate significant product revenues from its
new VIP Network products and products currently under development. Any failure
to increase revenues from connectivity products or to generate significant
revenues from such other products could have a material adverse effect on the
Company's business, financial condition and results of operations. There can be
no assurance that the VIP Network, new products or product enhancements will be
developed or marketed successfully by the Company on a timely basis or at all,
that the VIP Network and any new product or product enhancements will achieve
market acceptance, that other software vendors will not develop and market
products which are superior to the Company's products or that such other
products will not achieve greater market acceptance. In addition, the ability
of the Company to develop and market the VIP Network and new products and
product enhancements is dependent upon its ability to enter into certain
strategic alliances as described below under "Strategic Alliances" and to retain
qualified employees. Any failure by the Company to anticipate or respond
adequately to changes in technology and customer preferences, to develop and
introduce new products or product enhancements in a timely fashion, or to retain
qualified employees, could have a material adverse effect on its business,
financial condition and results of operations.
Because certain of the Company's products incorporate software and other
technologies developed and maintained by third parties, the Company is to a
certain extent dependent upon such third parties' ability to enhance their
current products, to develop new products on a timely and cost-effective basis
that will meet changing customer needs, and to respond to emerging industry
standards and other technological changes. There can be no assurance that the
Company would be able to replace the functionality provided by the third party
technologies currently offered in conjunction with the Company's products if
such technologies become unavailable to the Company or obsolete or incompatible
with future versions of the Company's products or market standards. The absence
of or any significant delay in the replacement of that functionality could have
a material adverse effect on the Company's business, financial condition or
results of operations.
Software products as complex as those offered by the Company may contain
undetected errors or failures when first introduced or as new versions are
released. There can be no assurance that, despite testing by the Company and
current and potential customers, errors will not be found in new products and
product enhancements after commencement of commercial shipments, resulting in
loss of or delay in market acceptance. Such loss or delay could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Declining Average Selling Prices. Until 1995, the market for the Company's
products was not characterized by significant price competition; however, as
noted above, the Company is facing increasing pricing pressures from
competitors. These pressures are likely to continue
A-3
to increase, have led to a decrease in average unit sales prices for certain of
the Company's products, could continue to have this effect on average unit sales
prices for the Company's products, and have had and could continue to have a
material adverse effect on the Company's results of operations and financial
condition.
Reliance on Strategic Alliances. In addition to internal development, the
Company expects to implement its VIP Network strategy described under Item 2
of the Form 10-Q in part through strategic alliances with industry partners
that have developed products and technologies that are complementary to those of
the Company (both for the purpose of incorporating the Company's technologies in
the products of third parties and the incorporation of the technologies of third
parties, possibly including security and directory services technologies, in
certain planned Company products) as well as strategic alliances with industry
partners that have developed complementary distribution channels. This strategy
is an important component of the Company's ability to achieve its goal of
providing to its customers, through the VIP Network, a set of user-defined,
standards-based software solutions to deploy, manage and secure IP
infrastructures, enabling companies to securely extend their networks beyond
traditional boundaries, intranets and the Internet to build virtual workgroups
or enable electronic commerce. While the Company is searching for strategic
alliance opportunities, there can be no assurance that it will be successful in
identifying or developing such alliances or that such alliances will achieve
their intended purposes.
While the Company does not presently intend to acquire additional
businesses or companies, the Company continues to evaluate potential
acquisitions and may pursue acquisition candidates if it determines that an
acquisition would further its corporate strategy as described above.
Acquisitions involve a number of special risks and factors, including, among
other things, the diversion of management's attention, the assimilation of the
operations and personnel of the acquired company or business, the incorporation
of acquired products into existing product lines, adverse short-term effects on
reported operating results, the amortization of acquired intangible assets, the
loss of key employees of the acquired company or business and the difficulty of
presenting a unified corporate image. No assurance can be given that any
acquisition by the Company will or will not occur, that if an acquisition does
occur that it will not materially and adversely affect the Company or that any
such acquisition will be successful in enhancing its business. If the
operations of an acquired company or business do not meet expectations, the
Company may be required to restructure the acquired business or write off the
value of some or all of the assets of the acquired business.
Changes in Personnel. The Company experienced rapid growth during 1995 and
early 1996, from approximately 474 employees at January 1, 1995 to approximately
880 employees at April 30, 1996, which placed a significant demand on the
Company's management and other resources. Included in such increase were key
members of management as well as approximately 150 employees hired in connection
with business acquisitions. In early May 1996, in connection with a
reorganization of the Company's operations, the Company decided to effect
certain cost-cutting measures, including a reduction of approximately 10% in the
number of the Company's full-time employees. Since the May reorganization, the
number of the Company's employees has decreased further, which the Company
believes is primarily attributable to increased competition for qualified
personnel in the market, to the decline in the Company's operating results and
the trading prices of its Common Stock during 1996 and, to a lesser extent, the
integration of Firefox. In connection with the Firefox acquisition, the number
A-4
of the Company's employees increased by approximately 124 persons. At September
30, 1996, the Company employed approximately 700 persons in its continuing
operations.
Additionally, management of FTP believes that the rapid expansion of its
sales and marketing force during the same period, from approximately 220 persons
at December 31, 1994 to approximately 330 persons at December 31, 1995 to
approximately 375 persons at May 2, 1996, and the opening and expansion of
several new offices outside of the United States during 1995 and early 1996,
resulted in certain inefficiencies in its sales and marketing organizations.
During the fall of 1996, the Company hired a number of experienced management
personnel to reorganize the Company's sales and marketing organizations and
eliminate such inefficiencies. However, if the Company is unsuccessful in
eliminating such inefficiencies, it will not be able to take full advantage of
the expansion of its sales and marketing organizations, which may have a
material adverse effect on its results of operations.
Competition for qualified personnel in the software industry is intense and
there can be no assurance that the Company will be able to retain a sufficient
number of qualified employees. The success of the Company will depend to a
significant degree upon its ability to retain qualified personnel and the
continued contributions of its key management, marketing, product development
and operational personnel. It may become increasingly difficult for the Company
to hire, train and assimilate new employees. If the Company is unable to
recruit or retain key technical, sales and other personnel, the Company's
business, financial condition and results of operations could be materially
adversely affected.
Integration of Firefox. The successful combination of companies in the
rapidly changing high technology industry requires coordination of sales and
marketing and research and development efforts and may be more difficult to
accomplish than in some other industries. While the Company believes that the
integration of Firefox is substantially complete, the Company and Firefox are in
the process of integrating their distribution channels. Firefox has relied
significantly on its independent distributors, systems integrators and value-
added resellers for certain elements of the marketing and distribution of its
products. There can be no assurance that any of Firefox's current distributors,
systems integrators or value-added resellers will be retained. Any changes in
distribution channels may adversely affect sales of the Firefox product line and
consequently may adversely affect the Company's business, financial condition
and results of operations, at least in the near term.
Potential Fluctuations in Operating Results. The Company's operating
results have in the past and may in the future fluctuate from period to period
as a result of a variety of factors, including, among other things: the
purchasing patterns of its customers; the lengthening of sales cycles; the mix
of products sold; customer order deferrals in anticipation of new products or
product enhancements; market acceptance and timing of the introductions of new
products and product enhancements by the Company and its competitors; variations
in sales by product and distribution channel; changes in resellers' inventory
practices; the exercise of stock rotation or inventory price protection
practices by distributors; the accuracy of resellers' forecasts of customer
demands; fluctuations in domestic and foreign economic conditions; competitive
pricing pressures; and the Company's sales compensation programs, which are
based on both quarterly and annual sales levels. In addition, substantially all
of the Company's product revenue and profit in each quarter result from orders
received in that quarter, and an increasingly large portion of orders are
received during the last month of such quarter. If revenue does not meet
expectations in any given quarter, operating results may be materially
A-5
adversely affected. There can be no assurance that the Company will not
experience significant fluctuations in operating results in the future.
Quarterly sales and operating results generally depend on the volume and timing
of and ability to fulfill orders received within the quarter, which are
difficult to forecast. The Company may be unable to adjust spending in a timely
manner to compensate for any unexpected revenue shortfall. Accordingly, any
significant shortfall of demand for the Company's products and services in
relation to the Company's expectations would have an immediate adverse impact on
the Company's business, financial condition and results of operations. To the
extent that expenses precede or are not subsequently followed by increased
revenue, the Company's business, financial condition and results of operations
will be materially adversely affected. Based on the foregoing, the Company
believes that period to period comparisons of results of operations are not
necessarily meaningful and should not be relied upon as an indicator of future
performance.
International Sales. Sales outside the United States accounted for
approximately 44% and 46% of the Company's total revenues in 1994 and 1995,
respectively. Sales in the United Kingdom accounted for approximately 40% and
39% of Firefox's net revenues in 1994 and 1995, respectively. The Company
expects that sales outside the United States will continue to account for a
substantial portion of revenue for the foreseeable future. Growth in
international sales is expected to be a significant factor in the future success
of the Company. The Company's international sales have decreased in 1996,
primarily as a result of increased competition, longer sales cycles, lower
average unit sales prices and, in the third quarter of 1996, decreased unit
sales as described above. There can be no assurance that the Company will be
able to increase international sales of its products or that its international
distribution channels will be able to service and support its products
adequately.
Due to the encryption technology contained or to be contained in certain of
the Company's current and planned VIP Network products, such products are and
will be subject to U.S. export controls, and there can be no assurance that such
export controls will not limit the Company's ability to distribute such products
outside the United States or that international customers will accept the
products that the Company is allowed to export under such controls, which could
have a material adverse effect on the Company's business, results of operations
and financial condition. See "Government Regulation and Legal Uncertainties"
below.
There are certain general risks inherent in conducting international
business, including exposure to currency exchange rate fluctuations, changes in
markets caused by various political, social and economic factors, unexpected
changes in regulatory requirements, tariffs and other trade barriers, costs and
risks of localizing products for foreign countries, longer payment terms,
potentially adverse tax consequences, repatriation of earnings, the burdens of
complying with a wide variety of foreign laws and the difficulties of managing
international operations. In addition, revenue of the Company earned in various
countries where the Company does business may be subject to taxation by more
than one jurisdiction, thereby adversely affecting the Company's earnings.
There can be no assurance that such factors will not have a material adverse
effect on the revenue from the Company's future international sales and,
consequently, the Company's business, financial condition and results of
operations.
An increase in the value of the U.S. dollar relative to foreign currencies
would make the Company's products more expensive and therefore potentially less
competitive in those markets. While the Company has historically priced,
invoiced and collected international sales primarily in United States dollars,
Firefox prices, invoices and collects a substantial portion of its
A-6
sales in foreign currencies, primarily British pounds sterling, and FTP
anticipates that it will transact a greater number of sales in local currencies
as its distribution channels are combined with those of Firefox. Accordingly,
the Company anticipates that fluctuations in currency exchange rates could in
the future have an adverse effect on its results of operations and financial
condition.
Because substantially all of the Company's international sales are
indirect, any material increase in the Company's international sales as a
percentage of total revenue may have an adverse effect on its gross margins due
to the lower per unit revenue realized by the Company on sales through indirect
channels.
Proprietary Rights. The Company considers its implementations of the
TCP/IP protocol, its OnNet(R) Kernel software and PC/TCP(R) Kernel software, to
be proprietary and relies primarily on a combination of copyrights, trademarks,
trade secret law and contracts to protect such proprietary implementations.
However, the basic TCP/IP protocols are non-proprietary and other parties have
developed their own versions. See "Competition" above.
The Company generally enters into confidentiality and/or license agreements
with its consultants, distributors, customers and potential customers and limits
access to and distribution of its source code and other proprietary information.
Although the Company currently has no issued patents, the number of patents
granted on software inventions is increasing. Consequently, there is a growing
risk of third parties asserting patent claims against the Company. In the
future, the Company may receive communications from third parties asserting that
the Company's products infringe, or may infringe, the patents or other
proprietary rights of such third parties, or seeking indemnification against
such infringement, or asserting that the Company must obtain a license from such
third parties. Such communications, and any resulting litigation, could result
in substantial costs and diversion of resources and could have a material
adverse effect on the Company's business, financial condition and results of
operations. If any claims or actions were to be asserted against the Company and
the Company were required to seek a license of a third party's intellectual
property, there can be no assurance that the Company would be able to acquire
such a license on reasonable terms or at all, and no prediction can be made
about the effect that such license might have on the Company's business,
financial condition or results of operations. Should litigation with respect to
any such claim commence, such litigation could be extremely expensive and time
consuming and could materially adversely affect the Company's business,
financial condition and results of operations regardless of the outcome of the
litigation.
Marketing and Distribution Risks. As part of its sales and marketing
strategies, the Company intends to continue to exert significant sales and
marketing efforts. There can be no assurance that these efforts will be
successful. For example, there can be no assurance that the Company will be
able to attract or retain qualified direct sales personnel, that such efforts
will result in increased sales of the Company's products, or that such efforts
will enable the Company to compete successfully against the larger and better
funded sales and marketing organizations of some of its competitors.
The Company relies significantly on its independent distributors, systems
integrators and value-added resellers for certain elements of the marketing and
distribution of its products. The agreements in place with these organizations
are generally non-exclusive. These organizations are not within the control of
the Company, may represent other product lines in
A-7
addition to those of the Company and are not obligated to purchase products from
the Company. There can be no assurance that such organizations will give a high
priority to the marketing of the Company's products, and such organizations may
give a higher priority to other products, which may include the products of the
Company's competitors. Actions of this nature by such organizations could result
in a lower sales effort applied to the Company's products and a consequent
reduction in the Company's operating results. The Company's results of
operations can also be materially adversely affected by changes in the inventory
strategies of its resellers, which can occur rapidly and in many cases may not
be related to end-user demand.
The Company may grant its distributors limited rights to exchange unsold
products for other products and provide inventory price protection in the event
of price reductions by the Company. While the Company provides allowances for
projected returns and price protection in certain instances, there can be no
assurance that allowances will be sufficient to offset product returns and price
protection in the future. Substantial returns of products or a decrease in the
price of the Company's products could have a material adverse effect on the
Company's business, financial condition and results of operations.
Government Regulation and Legal Uncertainties. The Company is not currently
subject to direct regulation by any government agency, other than regulations
applicable to business generally, and (with the exception of regulations
controlling the export and import of encryption technology referred to below)
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. For example, the
relatively new Communications Decency Act prohibits distribution of obscene,
lascivious or indecent communications on the Internet. The adoption of any such
laws or regulations may decrease the growth of the Internet, which could in turn
decrease the demand for certain of the Company's products and increase the
Company's cost of doing business or otherwise have an adverse effect on the
Company's 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. Due to the encryption
technology contained in certain of the Company's 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 the Company's ability to distribute products outside of the United
States or electronically or that international customers will accept the
products that the Company is allowed to export within the limits of those
controls. While the Company takes precautions against unlawful exportation, the
global nature of the Internet makes it virtually impossible to effectively
control the distribution of the Company's products. In addition, federal or
state legislation or regulation may further limit levels of encryption or
authentication technology. Any such export restrictions, new legislation or
regulation or unlawful exportation could have a material adverse effect on the
Company's business, financial condition and results of operations.
Legal Proceedings Against FTP and Firefox. See Item 2 of the Form 10-Q for
a description of certain legal proceedings against FTP and Firefox which could
materially adversely affect such companies' future business, operations and
financial condition.
A-8
EXHIBIT INDEX
EXHIBIT NO. TITLE
----------- -----
3.1 Restated Articles of Organization of the Company(1)
3.2 Certificate of Designation, Preferences and Rights of
Junior Preferred Stock of the Company(1)
3.3 Articles of Amendment to Restated Articles of Organization of the
Company*
3.4 Amended and Restated Bylaws of the Company(1)
4.1 Specimen common stock certificate(1)
4.2 Rights Agreement dated as of December 1, 1995 between the
Company and State Street Bank and Trust Company, as Rights Agent
(including form of Rights Certificate)(1)
4.3 Amendment to Rights Agreement dated as of November 7, 1996
between the Company and State Street Bank and Trust Company, as
Rights Agent*
10.1 Indenture of Lease between the Company and North Andover Mills
Realty dated November 19, 1991(1)
10.2 Amendment No. 1 to Indenture of Lease between the Company and North
Andover Mills Realty dated as of September 1, 1992(1)
10.3 Amendment No. 2 to Indenture of Lease between the Company and North
Andover Mills Realty dated as of January 6, 1993(1)
10.4 Amendment No. 3 to Indenture of Lease between the Company and North
Andover Mills Realty dated as of June 18, 1993(1)
10.5 Amendment No. 4 to Indenture of Lease between the Company and North
Andover Mills Realty dated as of September 30, 1993(1)
10.6 Amendment No. 5 to Indenture of Lease between the Company and North
Andover Mills Realty Limited Partnership dated August 12, 1995(1)
10.7 Employment Agreement between the Company and David H. Zirkle dated as
of July 26, 1996*
10.8 Employment Agreement between the Company and David H. Zirkle dated as
of March 1, 1993(1)
10.9 Amendment No. 1 to Employment Agreement between the Company and David
H. Zirkle dated as of June 14, 1993(1)
10.10 Amendment No. 2 to Employment Agreement between the Company and
David H. Zirkle dated as of August 15, 1994(1)
10.11 Amendment No. 3 to Employment Agreement between the Company and
David H. Zirkle dated as of February 28, 1995(1)
EXHIBIT NO. TITLE
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10.12 Employment Agreement between the Company and Glenn C. Hazard dated
as of July 29, 1996*
10.13 Employment Agreement between the Company and Susan L. Bostrom
dated as of July 23, 1996*
10.14 Employment Agreement between the Company and Douglas F. Flood
dated as of July 23, 1996*
10.15 Employment Agreement between the Company and John H. Keller dated
as of July 23, 1996*
10.16 Employment Agreement between the Company and John A. Kimberley
dated as of the "Effective Date" of the Firefox Merger*
10.17 Employment Agreement between the Company and Peter R. Simkin dated
as of the "Effective Date" of the Firefox Merger, together with
Amendment No. 1 thereto dated August 24, 1996*
10.18 Employment Agreement between the Company and John J. Warnock, Jr.,
dated as of July 31, 1996*
10.19 FTP Software, Inc. Stock Option Plan(1)
10.20 Composite FTP Software, Inc. 1993 Non-Employee Directors' Stock
Option Plan incorporating Amendment No. 1 effective as of June 2,
1996 and Amendment No. 2 effective as of August 22, 1996*
10.21 FTP Software, Inc. 1996 Executive Equity Incentive Plan*
10.22 FTP Software, Inc. 1993 Executive Bonus Plan(1)
10.23 FTP Software, Inc. 1994 Executive Compensation Plan(1)
10.24 FTP Software, Inc. 1995 Executive Compensation Plan(1)
10.25 FTP Software, Inc. 1995 V-P Sales Plan(1)
10.26 Indenture of Lease between the Company and Andover Mills Realty
Limited Partnership dated as of October 1, 1993(1)
10.27 Amendment No. 1 to Indenture of Lease between the Company and
Andover Mills Realty Limited Partnership dated as of February 10,
1994(1)
10.28 Amendment No. 2 to Indenture of Lease between the Company and
Andover Mills Realty Limited Partnership dated as of June 7, 1995(1)
10.29 Amended and Restated Agreement and Plan of Merger by and among the
Company, Firefox Acquisition Corp. and Firefox Communications Inc.
dated as of May 21, 1996(2)
11 Weighted Shares Used in Computation of Earnings Per Share*
EXHIBIT NO. TITLE
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27 Financial Data Schedule*
99 Cautionary Statements Relevant to Forward-Looking Statements(3)
_____________________
*Filed herewith
(1) Included with, and incorporated herein by reference to, the Company's
Registration Statement on Form S-4 (No. 333-06917) filed with the
Securities and Exchange Commission (the "Commission") on June 26, 1996.
(2) Included as Appendix A to, and incorporated herein by reference to, the
Company's Joint Proxy Statement/Prospectus for its Special Meeting of
Stockholders filed with the Commission on July 1, 1996.
(3) Included as Appendix A to, and incorporated herein by reference to, the
Company's Quarterly Report on Form 10-Q for the quarter ended September
30, 1996.