<PAGE>
FORTE
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------
FORM 10-Q
(Mark One)
/X/ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended JUNE 30, 1999
/ / 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: 0-27838
--------------------
FORTE SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3131872
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1800 Harrison Street
Oakland, California 94612
(510) 869-3400
(Address, including zip code, of Registrant's
principal executive offices and 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, $0.01 par value 20,544,074
(Class of common stock) (Shares outstanding at August 3, 1999)
<PAGE>
FORTE SOFTWARE, INC.
FORM 10-Q QUARTERLY REPORT
QUARTER ENDED JUNE 30, 1999
Table of Contents
PART I FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheet
At June 30, 1999 and March 31, 1999 3
Condensed Consolidated Statement of Operations
For the Three Months Ended June 30, 1999 and 1998 4
Condensed Consolidated Statement of Cash Flow
For the Three Months Ended June 30, 1999 and 1998 5
Notes to Condensed 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 29
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
</TABLE>
2
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PART 1.
ITEM 1. FINANCIAL STATEMENTS
FORTE SOFTWARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS; UNAUDITED)
<TABLE>
<CAPTION>
-------------------------------------
June 30, March 31,
1999 1999
------------------ -----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 14,568 $ 11,789
Short-term investments 8,828 14,880
Accounts receivable, net 27,823 23,231
Prepaid expenses and other current assets 4,266 3,115
------------------ -----------------
Total current assets 55,485 53,015
Equipment and leasehold improvements, net 3,990 4,707
Other assets 1,500 1,500
------------------ -----------------
Total assets $ 60,975 $ 59,222
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,018 $ 1,959
Accrued expenses and other liabilities 9,203 8,989
Deferred revenue 12,111 10,337
------------------ -----------------
Total current liabilities 23,332 21,285
Deferred revenue 33 66
Commitments
Stockholders' equity:
Common stock 204 203
Additional paid-in capital 69,320 68,621
Accumulated deficit (31,508) (31,021)
Foreign currency translation adjustments (406) 68
------------------ -----------------
Total stockholders' equity 37,610 37,871
------------------ -----------------
Total liabilities and stockholders' equity $ 60,975 $ 59,222
================== =================
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
3
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FORTE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA; UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
June 30,
----------------------------------
1999 1998
---------------- -----------------
<S> <C> <C>
Revenue:
License fees $12,296 $ 8,331
Maintenance and services 9,857 9,825
---------------- -----------------
Total revenue 22,153 18,156
---------------- -----------------
Cost of revenue:
Cost of license fees 328 234
Cost of maintenance and services 5,486 4,934
---------------- -----------------
Total cost of revenue 5,814 5,168
Gross profit 16,339 12,988
Operating expenses:
Sales and marketing 11,061 10,029
Product development and engineering 4,192 4,145
General and administrative 1,663 1,417
---------------- -----------------
Total operating expenses 16,916 15,591
---------------- -----------------
Operating loss (577) (2,603)
Interest income, net 235 385
---------------- -----------------
Loss before income taxes (342) (2,218)
Provision for income taxes 145 128
---------------- -----------------
Net loss $ (487) $ (2,346)
================ =================
Net loss per share---basic $ (0.02) $ (0.12)
================ =================
Net loss per share---diluted $ (0.02) $ (0.12)
================ =================
Shares used in per share calculation
Basic 20,342 19,686
================ =================
Diluted 20,342 19,686
================ =================
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
4
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FORTE SOFTWARE, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOW
(IN THOUSANDS; UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended June 30,
-----------------------------------------
1999 1998
--------------- -----------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (487) $ (2,346)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 1,021 1,035
Changes in operating assets and liabilities:
Accounts receivable (4,731) 3,064
Prepaid expenses and other assets (851) (428)
Accounts payable (81) (377)
Accrued expenses and other liabilities 288 (1,767)
Deferred revenue 1,601 (1,689)
--------------- -----------------
Net cash used in operating activities (3,240) (2,508)
--------------- -----------------
INVESTING ACTIVITIES
Purchases of equipment and leasehold improvements (304) (207)
Purchases of short-term investments - (6,836)
Maturities of short-term investments 5,997 13,390
Loan to officer (300) -
--------------- -----------------
Net cash provided by investing activities 5,393 6,347
--------------- -----------------
FINANCING ACTIVITIES
Reduction in capital lease obligations (74) (299)
Proceeds from issuance of common stock 700 1,081
--------------- -----------------
Net cash provided by financing activities 626 782
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Increase in cash and cash equivalents 2,779 4,621
Cash and cash equivalents at beginning of period 11,789 13,358
--------------- -----------------
Cash and cash equivalents at end of period $ 14,568 $ 17,979
=============== =================
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
5
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FORTE SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The unaudited condensed consolidated financial statements included
herein reflect all adjustments, consisting only of normal recurring accruals,
which in the opinion of management are necessary to fairly present the Company's
consolidated financial position, results of operations, and cash flow for the
periods presented. These condensed consolidated financial statements should be
read in conjunction with the Company's audited consolidated financial statements
as included in the Company's Annual Report on Form 10-K for the year ended March
31, 1999. Certain information and footnote disclosures normally included in
audited financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to the Securities
and Exchange Commission rules and regulations. The condensed consolidated
statement of operations for the three month period ended June 30, 1999 is not
necessarily indicative of the results that may be expected for entire fiscal
year ending March 31, 2000. The March 31, 1999 condensed consolidated balance
sheet was derived from audited consolidated financial statements, but does not
include all disclosures required by generally accepted accounting principles.
NOTE 2. NET LOSS PER SHARE
Basic net loss per share is computed using the weighted average number
of shares outstanding during the period. Diluted net loss per share is computed
using the weighted average number of common shares plus the dilutive effect of
outstanding stock options using the "treasury stock" method. The following table
shows the computation of basic and diluted net loss per share.
<TABLE>
<CAPTION>
Three Months Ended
June 30,
1999 1998
---------------- ---------------
(in thousands, except per
share data)
<S> <C> <C>
Net loss $ (487) $ (2,346)
---------------- ---------------
Shares used in computing basic net
loss per share 20,342 19,686
Effect of diluted securities (If
their inclusion would not be
antidilutive) - -
---------------- ---------------
Shares used in computing diluted net
loss per share 20,342 19,686
================ ===============
Basic $ (0.02) $ (0.12)
================ ===============
Diluted $ (0.02) $ (0.12)
================ ===============
</TABLE>
6
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FORTE SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 3. SHORT-TERM INVESTMENTS
As of June 30, 1999, all short-term investments were classified as
available-for-sale securities pursuant to the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." Available-for-sale securities are stated at
estimated fair market value. Differences between the estimated fair market value
and cost were not material.
The following is a summary of the Company's investments and a
reconciliation of the Company's investments to the condensed consolidated
balance sheet at June 30, 1999 (in thousands).
<TABLE>
<CAPTION>
Estimated
Fair
Value
---------------
<S> <C>
Commercial Paper $ 6,373
Treasury Notes 557
Medium Term Notes 5,859
Market Auction Preferreds 2,305
Corporate Notes 2,412
Money Market Funds 17
---------------
Total investments $17,523
===============
<CAPTION>
Estimated
Fair
Value
---------------
<S> <C>
Cash equivalents $ 8,695
Short-term investments 8,828
---------------
Total investments 17,523
Cash 5,873
---------------
Total cash, cash equivalents and
short-term investments $23,396
===============
</TABLE>
7
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FORTE SOFTWARE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS CONTINUED
(UNAUDITED)
NOTE 4. LOAN TO OFFICER
In April 1999, an additional $0.3 million was loaned to one of the
Company's executive officers against an existing promissory note to bring the
total amount due the Company at June 30, 1999 to $1.0 million, including accrued
interest. This full-recourse promissory note is collateralized at 140 percent of
the loan value in shares of the Company's common stock owned by this individual,
and is due and payable to the Company in August 2000. Amounts outstanding accrue
interest at an interest rate of seven and one-half percent per annum. Notes
receivable and related interest are classified in other assets in the Company's
condensed consolidated balance sheet.
NOTE 5. REVENUE RECOGNITION
Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as
amended by Statement of Position 98-4, was issued in October 1997 and addresses
software revenue recognition matters. The SOP supersedes SOP 91-1 and is
effective for transactions entered into for fiscal years beginning after
December 15, 1997. The Company adopted this SOP in its first quarter of fiscal
year 1999 and restatement of prior financial statements was prohibited. Based
upon its reading and interpretation of SOP 97-2, the Company believes its
current revenue recognition policies and practices are materially consistent
with the SOP.
In December 1998, SOP 98-9, "Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions," was issued. SOP 98-9 amends
paragraphs 11 and 12 of SOP 97-2 to require recognition of revenue using the
"residual method" when (1) there is evidence of "vendor specific objective
evidence" ("VSOE") of fair value for all undelivered elements in a
multiple-element arrangement that is not accounted for using long-term contract
accounting, (2) VSOE of fair value does not exist for one or more of the
delivered elements in the arrangement and (3) all revenue recognition criteria
in SOP 97-2 other than the requirement for VSOE of the fair value of each
delivered element of the arrangement are satisfied. Under the residual method,
(1) the fair market value is applied to all the undelivered items based on their
previously determined VSOE of fair values and is deferred until earned based on
other sections of SOP 97-2, and (2) the difference between the total contract
value and the amount deferred for the undelivered elements is recognized as
revenue related to the delivered elements. The provisions of SOP 98-9 are being
applied to all transactions in the Company's current fiscal year ending March
31, 2000.
8
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NOTE 6. COMPREHENSIVE INCOME (LOSS)
Effective April 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income," ("SFAS 130").
SFAS 130 requires certain revenues, expenses, gains or losses that, prior to
adoption, were reported separately in stockholders' equity and excluded from net
income (loss) to be included in other comprehensive income (loss). The Company's
components of comprehensive income (loss) consist of net income (loss), foreign
currency translation adjustments and unrealized gains and losses on short-term
investments. The Company has evaluated the impact on the consolidated financial
statements and has determined the impact to be immaterial to total revenue for
the quarters ended June 30, 1999 and June 30, 1998, respectively.
NOTE 7. SEGMENT AND GEOGRAPHICAL INFORMATION
The Company has adopted SFAS 131 effective March 31, 1999. The new
rules established revised standards for public companies relating to the
reporting of financial information about operating segments.
SEGMENT INFORMATION
The Company has identified two reportable operating segments based upon
the provisions of SFAS 131, license fees and services. License fees are derived
from sales of the Company's software products. Service fees include consulting,
training and support.
The Company's Chief Operating Decision Maker ("CODM"), who is the
President and Chief Executive Officer, evaluates performance based on segment
revenue. The accounting policies of the reportable segments are the same as
those described in the summary of significant accounting policies. Operating
costs and expenses, interest income, interest expense and other, net and the
provision for income taxes are not broken out by segment. The Company does not
account for or report to the CODM its assets or capital expenditures by
segments.
Based upon the above, the Company's statement of operations discloses
the available financial information of its reportable segments in accordance
with SFAS 131 for the quarters ended June 30, 1999 and 1998, respectively.
GEOGRAPHICAL INFORMATION
The Company markets its products and services internationally through
foreign subsidiaries in Europe, Australia and Canada, and other distributors and
resellers located in the United States, Canada, Asia, Europe, South America,
South Africa and Israel. Export sales through distributors, resellers and the
domestic direct sales organization totaled $586,000 and $2,630,000 for the
quarters ended June 30, 1999 and 1998, respectively. Sales through the Company's
foreign subsidiaries totaled $6,190,000 and $6,890,000 for the quarters ended
June 30, 1999 and 1998, respectively.
9
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The following table indicates revenue by region for the quarters ended June 30,
1999 and 1998:
<TABLE>
<CAPTION>
JUNE 30,
1999 1998
---- ----
<S> <C> <C>
Total Revenue
United States....................................... $15,377,000 $8,636,000
International....................................... 6,776,000 9,520,000
---------------- ----------------
Total............................................... $22,153,000 $18,156,000
================ ================
</TABLE>
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS
WHICH REFLECT THE COMPANY'S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND
FINANCIAL PERFORMANCE. IN THIS REPORT, THE WORDS "ANTICIPATE," "BELIEVES,"
"EXPECTS," "INTENDS," "FUTURE," AND OTHER SIMILAR EXPRESSIONS IDENTIFY
FORWARD-LOOKING STATEMENTS. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO
CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE DISCUSSED IN "BUSINESS RISKS"
BELOW AND IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS," THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY
FROM HISTORICAL RESULTS OR THOSE ANTICIPATED.
The following table sets forth certain unaudited condensed consolidated
statement of operations data as a percentage of total revenue for the three
months ended June 30, 1999 and 1998, respectively.
<TABLE>
<CAPTION>
Three months ended June 30,
1999 1998
---------------- -----------------
<S> <C> <C>
Revenue:
License fees 55.5% 45.9%
Maintenance and services 44.5 54.1
---------------- -----------------
Total revenue 100.0 100.0
================ =================
Cost of revenue:
Cost of license fees 1.5 1.3
Cost of maintenance and services 24.8 27.2
---------------- -----------------
Total cost of revenue 26.3 28.5
---------------- -----------------
Gross profit 73.7 71.5
Operating expenses:
Sales and marketing 49.9 55.2
Product development and engineering 18.9 22.8
General and administrative 7.5 7.8
---------------- -----------------
Total operating expenses 76.3 85.8
---------------- -----------------
Operating loss (2.6) (14.3)
Interest income, net 1.1 2.1
---------------- -----------------
Loss before income taxes (1.5) (12.2)
Provision for income taxes 0.7 0.7
---------------- -----------------
Net loss (2.2)% (12.9)%
================ =================
</TABLE>
11
<PAGE>
REVENUE
The Company's total revenue consists of license fees for its Forte
Application Environment and related products, as well as associated maintenance
and services revenue. The Company licenses software under non-cancelable license
agreements and provides services including maintenance, training and consulting.
License fees revenue is recognized when a non-cancelable license agreement has
been signed, the product has been shipped, the fees are fixed and determinable,
and collectibility is reasonably assured. License fees revenue from distributors
is generally recognized as sales to end users are reported, the product is
shipped and collectibility is reasonably assured. Fees for services are charged
separately from the license of the Company's software products. Maintenance
revenue consists of fees for ongoing support and product updates and is
recognized ratably over the term of the contract, which is typically twelve
months. Revenue from training is recognized upon completion of the related
training class. Consulting revenue is recognized as the services are performed.
Allowances for credit risks and for estimated future sales returns are provided
for upon product shipment. Returns to date have not been material. Actual credit
losses and returns may differ from the Company's estimates and such differences
could be material to the consolidated financial statements.
The Company's license agreements typically require the payment of a
nonrefundable, one-time license fee for a license of perpetual term. Customers
make separate payments for annual maintenance and other services. The Company
can terminate the license agreement only upon a material breach by the other
party, provided that the breach is not cured within a specified cure period.
The Company's total revenue increased 22 percent to $22.2 million for
the quarter ended June 30, 1999 from $18.2 million for the same prior year
quarter. International revenue decreased by 29 percent to $6.8 million for the
quarter ended June 30, 1999, as compared to $9.5 million for the same quarter in
the prior year. The international revenue decrease was primarily due to softness
of software license revenue in Europe and additionally due to lower revenue
generated in Canada. Further, international revenue contributed 31 percent of
total revenue for the quarter ended June 30, 1999, as compared to 52 percent of
total revenue in the same prior year quarter. United States revenue increased by
78 percent to $15.4 million for the quarter ended June 30, 1999 from $8.6
million in the same prior year quarter. Significant growth in software license
revenue, as well as in domestic maintenance and services revenue contributed to
the increase.
LICENSE FEES REVENUE. The Company's license fees revenue increased 48
percent to $12.3 million for the quarter ended June 30, 1999 from $8.3 million
for the same quarter in the prior year. The growth in license fees revenue was
primarily the result of sales of the Company's enterprise application
integration ("EAI") products.
MAINTENANCE AND SERVICES REVENUE. The Company's services revenue
increased less than 1 percent to $9.9 million for the quarter ended June 30,
1999 from $9.8 million for the same quarter in the prior year. The increase in
total maintenance and services revenue was primarily a result of the growing
installed base in the Company's software products and the associated increase
12
<PAGE>
in demand for maintenance, training and consulting services, partially offset
by the redirection of consulting resources in the U.S. away from revenue
generating activity to developing adapters for the integration marketplace.
Services revenue as a percentage of total revenue may vary between periods as
a result of changes in demand for the Company's services and changes in the
rate of growth of license fees revenue.
INTERNATIONAL REVENUE. International revenue includes all revenue other
than from the United States. International revenue includes sales from the
Company's direct sales organizations in Europe, Canada and Australia and export
sales through distributors and resellers in Europe, Asia and other areas of the
world. Direct sales through the Company's European, Canadian and Australian
subsidiaries totaled $6.2 million for the quarter ended June 30, 1999, as
compared to $6.9 million for the same quarter in the prior year. The table below
sets forth the Company's export sales data from the United States for the
quarters ended June 30, 1999 and 1998.
<TABLE>
<CAPTION>
---------------------------------------
(in thousands)
Three months ended June 30,
---------------------------------------
1999 1998
---- ----
<S> <C> <C>
Total export revenue $ 586 $2,630
Total direct revenue 6,190 6,890
----- -----
Total International $6,776 $9,520
---------------------------------------
</TABLE>
The decrease in international revenue for the quarter ended June 30,
1999, as compared to the same quarter in the prior year, is primarily the result
of softness of license fees revenue in Europe, as well as lower revenue in Asia
and Canada. The economic crises in Asia has not had a material impact on the
Company's revenue. Revenue from Asian markets was less then 5 percent of total
revenue for each of the periods presented. The Company expects that
international license and related maintenance and services revenue will continue
to account for a significant portion of its total revenue in the future. The
Company believes that in order to increase sales opportunities and market share,
it will be required to continue to selectively expand its international sales
organization. The Company has committed and continues to commit significant
management time and financial resources to developing direct and indirect
international sales and support channels. There can be no assurance, however,
that the Company will be able to maintain or increase international market
demand for Forte and related products. To the extent that the Company is unable
to do so in a timely manner, the Company's international sales will be limited,
and the Company's business, operating results and financial condition would be
materially and adversely affected.
COST OF REVENUE
COST OF LICENSE FEES REVENUE. Cost of license fees revenue consists
primarily of royalties paid to third-party vendors, product packaging,
documentation and production. Cost of license fees revenue was $328,000 for the
quarter ended June 30, 1999, as compared to $234,000 for the same quarter in the
prior year. The increase, as compared to the same quarter in the prior year, was
primarily due to royalties paid to third party vendors. Additionally, cost of
license fees revenue varies as a percentage of license fees revenue because
costs of media production and product packaging have not been material and have
been expensed as incurred. Such costs are dependent
13
<PAGE>
on the number of new releases in a given quarter.
COST OF MAINTENANCE AND SERVICES REVENUE. Cost of maintenance and
services revenue consists primarily of personnel-related and facilities costs
incurred in providing customer support, training and consulting services, as
well as third-party costs incurred in providing training and consulting
services. Cost of maintenance and services revenue was $5.5 million for the
quarter ended June 30, 1999, as compared to $4.9 million for the same quarter in
the prior year. Cost of maintenance and services revenue represented 56 percent
and 50 percent of maintenance and services revenue, respectively, for the
comparative quarters. The cost of services as a percentage of services revenue
may vary between periods due to the mix of services provided by the Company and
the extent to which external contractors are used to provide those services.
OPERATING EXPENSES
SALES AND MARKETING. Sales and marketing expense consists primarily of
salaries, commissions and bonuses earned by sales and marketing personnel, field
office expenses, travel and entertainment, promotional expenses and advertising.
Sales and marketing expense increased to $11.1 million for the quarter ended
June 30, 1999 from $10.0 million for the same quarter in the prior year. This
increase was primarily the result of severance expenses incurred on behalf of
the Company's worldwide sales organization in order to achieve greater
productivity, and was additionally the result of increased expenses incurred to
promote the Company's EAI products and soon to be released Java products. Sales
and marketing expense represented 50 percent of total revenue for the quarter
ended June 30, 1999, as compared to 55 percent of total revenue for the same
quarter in the prior year. The Company anticipates continuing to control the
increase to expense primarily through limiting the increase in headcount.
PRODUCT DEVELOPMENT. Product development expense consists primarily of
salaries and other personnel-related expense, and depreciation of development
equipment. The Company believes that a significant level of investment for
product development is required to remain competitive. Product development
expense amounted to $4.2 million for the quarter ended June 30, 1999, as
compared to $4.1 million for the same quarter in the prior year. Product
development expense represented 19 percent of total revenue for the quarter
ended June 30, 1999, as compared to 23 percent for the same quarter in the prior
year. The decrease in the percentage of product development expense to total
revenue for the quarter ended June 30, 1999, as compared to the same quarter in
the prior year, was primarily due to an increase in total revenue. The Company
anticipates that it will continue to devote substantial resources to product
development activities. All costs incurred in the research and development of
software products, and enhancements to existing software products have been
expensed as incurred.
GENERAL AND ADMINISTRATIVE. General and administrative expense
consists of costs for the Company's human resources, finance, information
technology and general management functions. General and administrative expense
increased to $1.7 million for the quarter ended June 30, 1999, from $1.4 million
for the same quarter in the prior year. General and administrative expense
represented 8 percent of total revenue for each of the quarters ended June 30,
1999 and June 30, 1998, respectively. The increase in general and administrative
expense from prior year was primarily attributable to an increase in the
allowance for uncollectible accounts and other administrative costs. The Company
believes that its general and administrative expense will
14
<PAGE>
increase in dollar amount in the future as a result of the expansion of the
Company's administrative staff to support its growing operations.
PROVISION FOR INCOME TAXES. There was no material provision for federal
or state income taxes for the quarters ended June 30, 1999 and June 30, 1998,
respectively, as the Company incurred net operating losses, and there can be no
assurance that the Company will realize the benefit of the net operating loss
carryforwards. The Company's provision for income taxes in fiscal 2000 primarily
represents foreign income tax withholdings on certain license fees paid to the
Company by foreign licensees.
RISKS ASSOCIATED WITH THE YEAR 2000 ISSUE. The Year 2000 Issue is the
result of computer programs being written using two digits rather than four to
define the applicable year. Any of the Company's computer programs or hardware
that have date-sensitive software or embedded chips may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company's plan to resolve the Year 2000 Issue involves the
following four phases: assessment, remediation, testing, and implementation. At
present, the Company has completed its assessment of all systems that could be
significantly affected by the Year 2000, including the Company's products, its
internal Information Technology, supplier and service provider compliance and
operating equipment with embedded chips or software (e.g. laptop computers). The
Company has also completed the remediation phase and is currently in the testing
and implementation phases of the process. The Company has prepared a method of
providing 100 percent field access and Year 2000 upgrade to all of its global
desktop computer systems which is now in the testing phase. Business
applications are now 100 percent compliant and are using Year 2000 dates.
Communications systems (i.e. Web, firewall, networks, telephone and voice mail)
are now 100 percent compliant with the latest software upgrades. A Year 2000 lab
has been implemented, including an IBM OS390 machine, UNIX, NT and Windows
technologies, and is in dedicated use for the remainder of calendar year 1999.
Engineering support technology is being approached in a staged Year 2000
implementation allowing for upgrade of development platforms in coordination
with, and without interruption of, new product development. Year 2000
implementation of Engineering support platforms is currently on schedule with
full implementation expected by the end of October 1999. The Company has
established a Year 2000 Issue Team which is representative across operating
departments and is coordinating the completion of Year 2000 implementation (via
a Year 2000 laboratory used for testing key environments) and testing across all
platforms. Periodic follow-up meetings are held whereby the current status is
updated and documented, and assignments are prescribed for the following week.
The costs incurred in addressing the Year 2000 Issue are being expensed
as incurred in compliance with generally accepted accounting principles. To
date, such costs only include the salary expenses of Forte employees associated
with the project. None of these costs are expected to materially impact the
results of operations in any one period. Funding of these costs will come from
the Company's normal working capital.
15
<PAGE>
The Company believes that its products are fully Year 2000 compliant.
All Forte products use four digit years for all internal manipulations and
representations. In addition, for customers who require the storage and
manipulation of two digit years, the Company's current products provide the
ability to specify a range of years for comparison and calculation. For example,
the customer may specify that the years 0-39 are interpreted as 2000-2039 and
the years 40-99 are interpreted as 1940-1999. Using this feature, a customer can
save on the amount of data stored and manipulated by the Company. The Company
regularly runs regression tests on its software, including tests for the above
functionality at the rollover to the Year 2000. Based on the above, it is not
expected that the Company's products will be adversely affected by date changes
in the Year 2000. However, there can be no assurance that the Company's products
contain, or will contain all features and functionality considered necessary by
customers, distributors, resellers and system integrators to be Year 2000
compliant.
The Company believes that Year 2000 issues may affect the purchasing
patterns of customers and potential customers in a variety of ways. Many
companies are expending significant resources to correct or patch their current
software systems for Year 2000 compliance. These expenditures may result in
reduced funds available to purchase enterprise application software products
such as those offered by the Company. Conversely, Year 2000 issues may cause
other companies to accelerate purchases of application development and
deployment software to replace non-Year 2000 compliant applications, causing a
short-term increase in demand for the Company's products. There is no assurance
that such an increase in demand will be realized, or that companies will resume
application development if and when they resolve their Year 2000 issues. Either
of the foregoing could have a material adverse effect upon the Company's
business, operating results and financial condition. Further, the Company
believes that, as the second half of calendar year 1999 approaches, some of its
current and potential customers may reduce or suspend a significant amount of
their development, deployment and integration projects in favor of an intense
focus and increased efforts on their Year 2000 Issue compliance projects. This
would have a material adverse effect on the Company's business, financial
performance and cash resources.
The Company has queried its significant suppliers and service providers
that do not share information systems with the Company. To date, the Company is
not aware of any supplier or service provider with a Year 2000 Issue that would
materially impact the Company's business, operating results or financial
condition. However, the Company has no means of ensuring that suppliers and
service providers will be Year 2000 ready. The inability of suppliers and
service providers to complete their Year 2000 resolution process in a timely
fashion could materially impact the Company. The effect of non-compliance by any
of the Company's suppliers or service providers is not determinable.
The Company has identified certain critical applications and has
classified potential disasters. The Company has provided a list of requirements
and priorities including, for example, customer service, billing and invoicing,
and engineering.
Although the Company is not aware of any material operational issues or
costs associated with preparing its internal systems for the Year 2000, there
can be no assurance that the Company will not experience serious unanticipated
negative consequences and/or material costs caused by undetected errors or
defects in the technology used in its internal systems, which include
third-party software and hardware technology. Management of the Company believes
it has an effective
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program in place to resolve the Year 2000 Issue in a timely manner. However,
disruptions in the economy generally resulting from Year 2000 issues could
also materially adversely affect the Company. The Company could be subject to
litigation for computer systems product failure, for example, equipment
shutdown or failure to properly date business records. The amount of
potential liability and lost revenue cannot be reasonably estimated.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations and investments in equipment and
leasehold improvements through an initial public offering of common stock on
March 11, 1996 with net proceeds of $34.3 million. The Company used cash of $3.2
million in operating activities for the quarter ended June 30, 1999, as compared
to cash used in operating activities of $2.5 million for the same prior year
quarter. The net cash used in operating activities during the quarter ended June
30, 1999 resulted primarily from the net loss for the period, increases in
accounts receivable, and prepaid expenses and other assets, partially offset by
increases in deferred revenue, and accrued expenses and other liabilities.
The Company's investing activities consisted primarily of the
maturities of interest-bearing securities representing a shift from short-term
investments to cash equivalents, as well as purchases of property and equipment
and an additional loan extension to an executive officer. Capital expenditures
were $0.3 million for the three months ended June 30, 1999, as compared to $0.2
million for the same prior year period. Capital expenditures consisted of
purchases of computer equipment and office furniture. At June 30, 1999, the
Company did not have any material commitments for capital expenditures.
At June 30, 1999, the Company had $23.4 million in cash, cash
equivalents, and short-term investments and $32.2 million in working capital.
The Company believes that its existing cash, cash equivalents, and short-term
investments will be adequate to meet its cash needs for at least the next 12
months. The Company, however, may require additional funds to support its
working capital requirements or for other purposes and may seek to raise such
additional funds through public or private equity financings or from other
sources. There can be no assurance that additional financing will be available
at all or that, if available, such financing will be obtainable on terms
favorable to the Company and would not be dilutive. Further, the Company
believes that, in the remainder of calendar year 1999, some of its current and
potential customers may reduce or suspend a significant amount of their
development, deployment and integration projects in favor of an intense focus
and increased efforts on their Year 2000 Issue compliance projects. This would
have a material adverse effect on the Company's business, financial performance
and cash resources.
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BUSINESS RISKS
IN EVALUATING THE COMPANY'S BUSINESS, READERS SHOULD CAREFULLY CONSIDER
THE BUSINESS RISKS DISCUSSED IN THIS SECTION IN ADDITION TO THE OTHER
INFORMATION PRESENTED IN THIS QUARTERLY REPORT ON FORM 10-Q. THIS REPORT ON FORM
10-Q CONTAINS FORWARD-LOOKING STATEMENTS WHICH REFLECT THE COMPANY'S CURRENT
VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL PERFORMANCE. IN THIS REPORT,
THE WORDS "ANTICIPATE," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE," AND OTHER
SIMILAR EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. THESE FORWARD-LOOKING
STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, INCLUDING THOSE
DISCUSSED BELOW, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
HISTORICAL RESULTS OR THOSE ANTICIPATED.
LIMITED OPERATING HISTORY; HISTORY OF OPERATING LOSSES. The Company was
founded in February 1991 and first shipped product in August 1994. After
achieving profitability from December 1995 through March 31, 1997, the Company
incurred net losses for each subsequent quarter through the quarter ended June
30, 1998. The Company has reported a modest profit for each of the three
quarters ended September 30, 1998, December 31, 1998 and March 31, 1999,
respectively, but has again incurred a net loss in the quarter ended June 30,
1999. At June 30, 1999, the Company had an accumulated deficit of $31.5 million.
A substantial portion of the accumulated deficit is due to the deployment of
significant resources to the Company's product development, sales and marketing
organizations. The Company expects to continue to devote substantial resources
in these areas and as a result will need to significantly increase revenue to
return to profitability. There can be no assurance that any of the Company's
business strategies will be successful or that the Company will be profitable in
any future quarter or period.
POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; UNCERTAINTY OF
FUTURE OPERATING RESULTS; SEASONALITY. The Company's quarterly operating results
have varied significantly in the past and are likely to vary significantly in
the future, depending on factors such as the size and timing of significant
orders and their fulfillment, demand for the Company's products, changes in
pricing policies by the Company or its competitors, the number, timing and
significance of product enhancements and new product announcements by the
Company and its competitors, the ability of the Company to develop, introduce
and market new and enhanced versions of the Company's products on a timely
basis, the rate of adoption and use of the Company's products by third-party
system integrators and value added resellers, changes in the level of operating
expenses, changes in the Company's sales incentive plans, budgeting cycles of
its customers, customer order deferrals due to intervening information
technology projects of a higher priority such as, the Year 2000 Issue, or in
anticipation of enhancements or new products offered by the Company or its
competitors or other causes, the cancellation of licenses during the warranty
period or non-renewal of maintenance agreements, product life cycles, software
bugs and other product quality problems, personnel changes, changes in the
Company's strategy, the level of international expansion, seasonal trends, and
general domestic and international economic and political conditions, among
others. A significant portion of the Company's total revenue has been, and the
Company believes will continue to be, derived from a limited number of orders
placed by large organizations, and the timing of such orders and their
fulfillment has caused and could continue to cause material fluctuations in the
Company's operating results, particularly on a quarterly basis. In addition,
competition for sales personnel is intense, and there can be no assurance that
the Company can
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retain its existing sales personnel or that it can attract, assimilate and
retain highly qualified sales personnel in the future. The timing of the
Company's hiring of new sales personnel and the rate at which new sales
people become productive could also cause material fluctuations in the
Company's quarterly operating results. Due to the foregoing factors,
quarterly revenue and operating results are difficult to forecast. Revenue is
also difficult to forecast because the market for distributed enterprise
application integration and development software products is rapidly
evolving, and the Company's sales cycle, from initial evaluation to purchase
and the provision of support services, is lengthy and varies substantially
from customer to customer. Product orders are typically shipped shortly after
receipt of the order, and consequently, order backlog at the beginning of any
quarter has in the past represented only a small portion of that quarter's
total revenue. As a result, license fees revenue in any quarter is
substantially dependent on orders booked and shipped in that quarter. Due to
all of the foregoing, revenue for any future quarter is not predictable with
any significant degree of accuracy. Accordingly, the Company believes that
period-to-period comparisons of its operating results are not necessarily
meaningful and should not be relied upon as indications of future
performance. The prior revenue growth experienced by the Company should not
be considered indicative of future revenue growth, if any, or of future
operating results. Failure by the Company, for any reason, to increase total
revenue would have a material adverse effect on the Company's business,
operating results and financial condition.
To achieve its quarterly revenue objectives, the Company is dependent
upon obtaining orders in any given quarter for shipment in that quarter.
Furthermore, the Company has often recognized a substantial portion of its
revenue in the last month, or even weeks or days, of a quarter. The Company's
expense levels are based, in significant part, on the Company's expectations as
to future revenue and are therefore relatively fixed in the short term. If
revenue levels fall below expectations, net income or loss is likely to be
disproportionately adversely affected because a proportionately smaller amount
of the Company's expense varies with its revenue. There can be no assurance that
the Company will be able to maintain profitability on a quarterly or annual
basis in the future. Due to all the foregoing factors, it is likely that in some
future quarter the Company's operating results will be below the expectations of
public market analysts and investors. In such event, the price of the Company's
Common Stock would likely be materially and adversely affected.
The operating results of many software companies reflect seasonal
trends, and the Company expects to be affected by such trends in the future.
RISKS ASSOCIATED WITH THE YEAR 2000 ISSUE. The Year 2000 Issue is the
result of computer programs being written using two digits rather than four to
define the applicable year. Any of the Company's computer programs or hardware
that have date-sensitive software or embedded chips may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company's plan to resolve the Year 2000 Issue involves the
following four phases: assessment, remediation, testing, and implementation. At
present, the Company has completed its assessment of all systems that could be
significantly affected by the Year 2000, including the
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Company's products, its internal Information Technology, supplier and service
provider compliance and operating equipment with embedded chips or software
(e.g. laptop computers). The Company has also completed the remediation phase
and is currently in the testing and implementation phases of the process. The
Company has prepared a method of providing 100 percent field access and Year
2000 upgrade to all of its global desktop computer systems which is now in
the testing phase. Business applications are now 100 percent compliant and
are using Year 2000 dates. Communications systems (i.e. Web, firewall,
networks, telephone and voice mail) are now 100 percent compliant with the
latest software upgrades. A Year 2000 lab has been implemented, including an
IBM OS390 machine, UNIX, NT and Windows technologies, and is in dedicated use
for the remainder of calendar year 1999. Engineering support technology is
being approached in a staged Year 2000 implementation allowing for upgrade of
development platforms in coordination with, and without interruption of, new
product development. Year 2000 implementation of Engineering support
platforms is currently on schedule with full implementation expected by the
end of October 1999. The Company has established a Year 2000 Issue Team which
is representative across operating departments and is coordinating the
completion of Year 2000 implementation (via a Year 2000 laboratory used for
testing key environments) and testing across all platforms. Periodic
follow-up meetings are held whereby the current status is updated and
documented, and assignments are prescribed for the following week.
The costs incurred in addressing the Year 2000 Issue are being expensed
as incurred in compliance with generally accepted accounting principles. None of
these costs are expected to materially impact the results of operations in any
one period. Funding of these costs will come from the Company's normal working
capital.
The Company believes that its products are fully Year 2000 compliant.
All Forte products use four digit years for all internal manipulations and
representations. In addition, for customers who require the storage and
manipulation of two digit years, the Company's current products provide the
ability to specify a range of years for comparison and calculation. For example,
the customer may specify that the years 0-39 are interpreted as 2000-2039 and
the years 40-99 are interpreted as 1940-1999. Using this feature, a customer can
save on the amount of data stored and manipulated by the Company. The Company
regularly runs regression tests on its software, including tests for the above
functionality at the rollover to the Year 2000. Based on the above, it is not
expected that the Company's products will be adversely affected by date changes
in the Year 2000. However, there can be no assurance that the Company's products
contain, or will contain, all features and functionality considered necessary by
customers, distributors, resellers and system integrators to be Year 2000
compliant.
The Company believes that the purchasing patterns of customers and
potential customers may be affected by Year 2000 issues in a variety of ways.
Many companies are expending significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase enterprise application software products
such as those offered by the Company. Conversely, Year 2000 issues may cause
other companies to accelerate purchases of application development and
deployment software to replace non-Year 2000 compliant applications, causing a
short-term increase in demand for the Company's products. There is no assurance
that such an increase in demand will be realized, or that companies will resume
application development if and when they resolve their Year 2000 issues. Either
of the foregoing could have a material adverse effect upon the Company's
business,
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operating results and financial condition. Further, the Company believes
that, as the second half of calendar year 1999 approaches, some of its
current and potential customers may reduce or suspend a significant amount of
their development, deployment and integration projects in favor of an intense
focus and increased efforts on their Year 2000 Issue compliance projects.
This would have a material adverse effect on the Company's business,
financial performance and cash resources.
The Company has queried its significant suppliers and service providers
that do not share information systems with the Company. To date, the Company is
not aware of any supplier or service provider with a Year 2000 Issue that would
materially impact the Company's business, operating results or financial
condition. However, the Company has no means of ensuring that suppliers and
service providers will be Year 2000 ready. The inability of suppliers and
service providers to complete their Year 2000 resolution process in a timely
fashion could materially impact the Company. The effect of non-compliance by any
of the Company's suppliers or service providers is not determinable.
The Company has prepared a draft contingency plan for certain critical
applications and expects to have a finalized draft in the near future. This
business recovery plan discusses classified disasters and provides a list of
priorities including, for example, customer service, billing and invoicing, and
engineering.
Although the Company is not aware of any material operational issues or
costs associated with preparing its internal systems for the Year 2000, there
can be no assurance that the Company will not experience serious unanticipated
negative consequences and/or material costs caused by undetected errors or
defects in the technology used in its internal systems, which include
third-party software and hardware technology. Management of the Company believes
it has an effective program in place to resolve the Year 2000 Issue in a timely
manner. However, disruptions in the economy generally resulting from Year 2000
issues could also materially adversely affect the Company. The Company could be
subject to litigation for computer systems product failure, for example,
equipment shutdown or failure to properly date business records. The amount of
potential liability and lost revenue cannot be reasonably estimated.
PRODUCT CONCENTRATION; IMPACT OF MARKET FACTORS. All of the Company's
revenue has been attributable to sales of Forte and related products and
services. The Company currently expects Forte and related products and services
to account for all or substantially all of the Company's future revenue. As a
result, factors adversely affecting the pricing of or demand for Forte and
related products, such as competition or technological change, could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company's future financial performance will depend, in
significant part, on the successful development, introduction and customer
acceptance of new and enhanced versions of Forte and related products. There can
be no assurance that the Company will continue to be successful in marketing the
Forte product, related products or other products. The Company's prior revenue
growth should not be considered indicative of future revenue growth, as there
can be no assurance that the market for Forte and related products, or the
market for products used in the integration, development, deployment and
management of distributed applications, will continue to grow. Recently,
industry analysts and competitors have noted that market demand in the
enterprise application development sector appears to be slowing, and predicted
that the prior success achieved by that sector may not continue in future
periods, due to a variety of factors
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including but not limited to (1) a diversion of customer resources from
enterprise application development to the Year 2000 Issue and other higher
priority information technology projects, (2) a general shortage of qualified
programmers and a shift of available programming resources from corporate
users to systems integrators, (3) market confusion caused by the complex and
rapidly changing mix of alternative technologies for enterprise application
development, and (4) the increased availability and popularity of packaged
software applications. Additionally, recent instability in the economies and
financial markets in the Asia-Pacific region, which had previously been
regarded as a potentially strong source of revenue growth for enterprise
software vendors, has introduced additional uncertainty concerning the
sector. If the market for Forte and related products or enterprise
application integration and development products used in enterprise computing
fails to grow, or grows more slowly than the Company currently anticipates,
the Company's business, operating results and financial condition would be
materially and adversely affected.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a
significant degree upon the continuing contributions of its key management,
sales, marketing, software development and customer support personnel, and its
ability to attract and retain such highly-skilled personnel. The loss of key
personnel could materially and adversely affect the Company. Competition for
qualified personnel is intense, particularly in the sales and software
development areas, and there can be no assurance that the Company can retain its
existing personnel or that it can attract, assimilate and retain additional
highly qualified personnel in the future. The timing of the Company's hiring of
new sales personnel and the rate at which new sales people become productive
could also cause material fluctuations in the Company's quarterly operating
results. The Company has at times experienced and continues to experience
difficulty in recruiting and retaining qualified personnel. Competitors and
others have in the past and may in the future attempt to recruit the Company's
employees. Failure to attract and retain key personnel could have a material
adverse effect on the Company's business, operating results and financial
condition.
RISKS ASSOCIATED WITH EXPANDING DISTRIBUTION. To date, the Company has
sold its products through its direct and indirect sales force, systems
integrators, distributors and value added resellers. The Company's customers and
potential customers often rely on third-party system integrators and value added
resellers to develop and deploy distributed applications. The Company's ability
to achieve significant revenue growth in the future will depend in large part on
its success in recruiting, training and retaining sufficient sales personnel and
establishing and maintaining relationships with distributors, resellers and
systems integrators. Although the Company is currently investing, and plans to
continue to invest significant resources to maintain and selectively expand its
sales force and to develop relationships with third-party distributors,
resellers and systems integrators, the Company has at times experienced and
continues to experience difficulty in recruiting and retaining qualified sales
personnel and in establishing necessary third-party relationships. There can be
no assurance that the Company will be able to successfully hire, train and
retain needed sales personnel or develop and maintain sufficient third-party
relationships, or that such efforts will result in an increase in revenue. Any
failure by the Company to maintain a sufficiently large and trained sales force
and continue to establish other distribution channels would materially and
adversely affect the Company's business, operating results and financial
condition.
COMPETITION. The market for distributed software used in the
development, deployment,
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integration and management of distributed applications is intensely
competitive and characterized by rapidly changing technology, evolving
industry standards, frequent new product introductions and rapidly changing
customer requirements. Distributed applications that can be developed and
deployed using the Company's Forte environment can also be implemented by
integrating a combination of application development tools and more powerful
server programming techniques such as stored procedures in relational
databases and C or C++ programming, along with networking and database
middleware to connect the various components. As such, the Company
effectively experiences its primary competition from potential customers'
decisions to pursue this type of approach as opposed to utilizing an
application environment such as Forte. As a result, the Company must
continuously educate existing and prospective customers, and third-party
systems integrators on whom prospective customers are increasingly relying
for expertise, on the advantages of the Company's products over the approach
of integrating a combination of products. There can be no assurance that
these customers, potential customers or systems integrators will perceive
sufficient value in the Company's products to justify purchasing or
recommending them.
The Company has also experienced and expects to continue to experience
increased competition from a number of vendors that market software products
specifically targeted for building distributed applications. Actual and
potential competitors include: providers of application development software,
such as Compuware/Uniface, Dynasty Technologies, Inc., IBM Corporation,
Microsoft Corporation, NAT Systems, Inc., Oracle Corporation, Seer Technologies,
Inc., Sterling Software, Inc., and the Powersoft unit of Sybase, Inc.; web-based
development tools targeting production enterprise Internet applications;
middleware companies advocating a middleware-centric approach to building
enterprise applications; developers of packaged applications and application
components, templates and frameworks; and integration software vendors.
Many of these competing vendors have or will have significantly greater
financial, technical, marketing and other resources than the Company, and may be
able to respond more quickly to new or emerging technologies. Also, many current
and potential competitors have greater name recognition and more extensive
customer bases that could be leveraged, thereby gaining market share to the
Company's detriment. The Company expects to face additional competition as other
established and emerging companies enter the distributed application development
market and new products and technologies are introduced. Increased competition
could result in price reductions, fewer customer orders, reduced gross margins
and loss of market share, any of which could materially and adversely affect the
Company's business, operating results and financial condition. In addition,
current and potential competitors may make strategic acquisitions or establish
cooperative relationships among themselves or with third-parties, thereby
increasing the ability of their products to address the needs of the Company's
prospective customers. Accordingly, it is possible that new competitors or
alliances among current and new competitors may emerge and rapidly gain
significant market share. Such competition could materially and adversely affect
the Company's ability to sell additional licenses and maintenance and support
renewals on terms favorable to the Company. Further, competitive pressures could
require the Company to reduce the price of Forte licenses and related products
and services, which could materially and adversely affect the Company's
business, operating results and financial condition. There can be no assurance
that the Company will be able to compete successfully against current and future
competitors, and the failure to do so would have a material adverse effect upon
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the Company's business, operating results and financial condition.
The principal competitive factors affecting the market for Forte are
ease of application development, deployment and management functionality and
features, product architecture, product performance, reliability and
scaleability, product quality, price and customer support. The Company believes
it presently competes favorably with respect to each of these factors. However,
the Company's market is still evolving and there can be no assurance that the
Company will be able to compete successfully against current and future
competitors and the failure to do so successfully will have a material adverse
effect upon the Company's business, operating results and financial condition.
NEW ACCOUNTING STANDARDS. In December 1998, SOP 98-9, "Modification of SOP 97-2,
Software Revenue Recognition, With Respect to Certain Transactions," was issued.
SOP 98-9 amends paragraphs 11 and 12 of SOP 97-2 to require recognition of
revenue using the "residual method" when (1) there is evidence of "vendor
specific objective evidence" ("VSOE") of fair value for all undelivered elements
in a multiple-element arrangement that is not accounted for using long-term
contract accounting, (2) VSOE of fair value does not exist for one or more of
the delivered elements in the arrangement and (3) all revenue recognition
criteria in SOP 97-2 other than the requirement for VSOE of the fair value of
each delivered element of the arrangement are satisfied. Under the residual
method, (1) the fair market value is applied to all the undelivered items based
on their previously determined VSOE of fair values and is deferred until earned
based on other sections of SOP 97-2, and (2) the difference between the total
contract value and the amount deferred for the undelivered elements is
recognized as revenue related to the delivered elements. The provisions of SOP
98-9 are being applied to all transactions in the Company's current fiscal year
ending March 31, 2000.
Such implementation guidance may necessitate substantial changes in the
Company's business practices in order for the Company to continue to recognize a
substantial portion of its license fees revenue upon delivery of its software
products. Such changes may reduce demand, extend sales cycles, increase
administrative costs and otherwise adversely affect operations. In addition, the
Company may be put at a competitive disadvantage relative to foreign based
competitors not subject to U.S. generally accepted accounting principles.
LENGTHY SALES CYCLE. The Company's products are typically used to
develop applications that are critical to a customer's business, and the
purchase of the Company's products is often part of a customer's larger business
process reengineering initiative or implementation of distributed computing. As
a result, the license and implementation of the Company's software products
generally involves a significant commitment of management attention and
resources by prospective customers. Accordingly, the Company's sales process is
often subject to delays associated with a long approval process that typically
accompanies significant initiatives or capital expenditures. In addition, there
are a large number of alternative methods or technologies to develop
applications which can require significant time for potential customers to
evaluate, and implementation of a favorable decision to license the Company's
products may be subject to delay due to higher priority projects such as Year
2000 compliance. For these and other reasons, the sales cycle associated with
the license of the Company's products is often lengthy and subject to a number
of significant delays over which the Company has little or no control. There can
be no assurance that the Company will not experience these and additional delays
in the future. Therefore, the Company believes that its
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quarterly operating results are likely to vary significantly in the future.
RISK ASSOCIATED WITH NEW VERSIONS AND NEW PRODUCTS; RAPID TECHNOLOGICAL
CHANGE. The software market in which the Company competes is characterized by
rapid technological change, frequent introductions of new products, changes in
customer demands and evolving industry standards. The introduction of products
embodying new technologies and the emergence of new industry standards can
render existing products obsolete and unmarketable. For example, the Company's
customers have adopted a wide variety of hardware, software, database,
networking and Internet-based platforms, and as a result, to gain broad market
acceptance, the Company has had to support Forte on many of such platforms. The
Company's customers use the Company's proprietary development language to
develop applications using the Company's products, and customers may desire to
utilize other widely-used programming languages to develop Internet-based and
other distributed applications. The Company's future success will depend upon
its ability to address the increasingly sophisticated needs of its customers by
supporting existing and emerging hardware, software, programming language,
database, networking and Internet-based platforms and by developing and
introducing enhancements to Forte, related products and new products on a timely
basis that keep pace with such technological developments and emerging industry
standards and changing customer requirements. There can be no assurance that the
Company will be successful in developing and marketing enhancements to Forte and
related products that respond to technological change, evolving industry
standards or changing customer requirements, that the Company will not
experience difficulties that could delay or prevent the successful development,
introduction and sale of such enhancements or that such enhancements will
adequately meet the requirements of the marketplace and achieve any significant
degree of market acceptance. The Company has in the past experienced delays in
the release dates of enhancements to Forte. If release dates of any future Forte
enhancements or new products are delayed or if when released they fail to
achieve market acceptance, the Company's business, operating results and
financial condition would be materially and adversely affected. In addition, the
introduction or announcement of new product offerings or enhancements by the
Company or the Company's competitors may cause customers to defer or forgo
purchases of current versions of Forte and related products, which could have a
material adverse effect on the Company's business, operating results and
financial condition.
LIMITED DEPLOYMENT; DEPENDENCE ON SYSTEM INTEGRATORS AND VALUE ADDED
RESELLERS. The Company first shipped Forte in August 1994. To date, only a
limited number of the Company's customers have completed the development and
deployment of distributed applications using Forte and related products. If any
of the Company's customers are not able to successfully develop and deploy
distributed applications with Forte and related products, the Company's
reputation could be damaged, which could have a material adverse effect on the
Company's business, operating results and financial condition. In addition, the
Company expects that a significant percentage of its future revenue will be
derived from sales to existing customers. If existing customers have difficulty
deploying applications built with Forte and related products or for any other
reason are not satisfied with Forte products, the Company's business, operating
results and financial condition would be materially and adversely affected. The
Company's customers and potential customers often rely on third-party system
integrators and value added resellers to develop and deploy distributed
applications. If the Company is unable to adequately train a sufficient
number of system integrators and value added resellers or if, for any reason,
a large number of such integrators and value added resellers adopt a product
or technology other than Forte, the Company's business, operating results
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and financial condition would be materially and adversely affected.
RISK OF SOFTWARE DEFECTS. Software products as internally complex as
Forte and related products frequently contain errors or defects, especially when
first introduced or when new versions or enhancements are released. Despite
extensive product testing by the Company, the Company has discovered software
errors in its releases after their introduction. Although the Company has not
experienced material adverse effects resulting from any such defects or errors
to date, there can be no assurance that, despite testing by the Company and by
current and potential customers, defects and errors will not be found in current
versions, new versions, new product or enhancements to existing products after
commencement of commercial shipments, resulting in loss of revenue or delay in
market acceptance, which could have a material adverse effect upon the Company's
business, operating results and financial condition.
PRODUCT LIABILITY. The Company markets Forte to customers for the
development, deployment and management of distributed applications. The
Company's license agreements with its customers typically contain provisions
designed to limit the Company's exposure to potential product liability claims.
It is possible, however, that the limitation of liability provisions contained
in the Company's license agreements may not be effective as a result of existing
or future federal, state or local laws or ordinances, or unfavorable judicial
decisions. Although the Company has not experienced any product liability claims
to date, the sale and support of Forte by the Company may entail the risk of
such claims, which are likely to be substantial in light of the use of Forte in
business-critical applications. A successful product liability claim brought
against the Company could have a material adverse effect upon the Company's
business, operating results and financial condition.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. Revenue from foreign
subsidiaries and export sales accounted for 31 percent and 52 percent of the
Company's total revenue for the quarters ended June 30, 1999 and 1998,
respectively. The Company currently has international sales offices located in
Australia, Belgium, Canada, France, Germany, Holland, Switzerland, and the
United Kingdom which have generated substantially all direct international
revenue recognized by the Company to date. The Company believes that in order to
increase sales opportunities and regain profitability, it will be required to
continue to expand its international operations. The Company has committed, and
continues to commit, significant management time and financial resources to
developing direct and indirect international sales and support channels. There
can be no assurance, however, that the Company will be able to maintain or
increase international market demand for Forte and related products. To the
extent that the Company is unable to do so in a timely manner, the Company's
international sales will be limited, and the Company's business, operating
results and financial condition would be materially and adversely affected.
International operations are subject to inherent risks, including the
impact of possible recessionary environments in economies outside the United
States, costs of localizing products for foreign markets, longer accounts
receivable collection periods and greater difficulty in accounts receivable
collection, unexpected changes in regulatory requirements, difficulties and
costs of staffing and managing foreign operations, reduced protection for
intellectual property rights in some countries, potentially adverse tax
consequences, political and economic instability, the introduction of the Euro,
and the difficulty in maintaining effective communications due to distance,
language and cultural barriers. There can be no assurance that the Company or
its
26
<PAGE>
distributors or resellers will be able to sustain or increase international
revenue from licenses or from maintenance and service, or that the foregoing
factors will not have a material adverse effect on the Company's future
international revenue and, consequently, on the Company's business, operating
results and financial condition. The Company's direct international revenue
is generally denominated in local currencies. The Company does not currently
engage in hedging activities. Revenue generated by the Company's distributors
and resellers are generally paid to the Company in United States dollars.
Although exposure to currency fluctuations to date has been insignificant,
there can be no assurance that fluctuations in currency exchange rates in the
future will not have a material adverse impact on revenue from international
sales and thus the Company's business, operating results and financial
condition.
PROPRIETARY RIGHTS, RISKS OF INFRINGEMENT AND SOURCE CODE RELEASE. The
Company relies primarily on a combination of patent, copyright and trademark
laws, trade secrets, confidentiality procedures and contractual provisions to
protect its proprietary rights. The Company also believes that factors such as
the technological and creative skills of its personnel, new product
developments, frequent product enhancements, name recognition and reliable
product maintenance are essential to establishing and maintaining a technology
leadership position. The Company seeks to protect its software documentation and
other written materials under trade secret and copyright laws, which afford only
limited protection. The Company currently has one issued United States patent
that expires in 2012 and corresponding patent applications pending in Canada,
Australia, Japan and several member countries within the European Patent
Organization. There can be no assurance that the Company's patent will not be
invalidated, circumvented or challenged, that the rights granted thereunder will
provide competitive advantages to the Company or that any of the Company's
pending or future patent applications, whether or not being currently challenged
by applicable governmental patent examiners, will be issued with the scope of
the claims sought by the Company, if at all. Furthermore, there can be no
assurance that others will not develop technologies that are similar or superior
to the Company's technology or design around the patents owned by the Company.
The Company has obtained registration of the FORTE trademark in seven countries
and has trademark registration applications pending in numerous additional
countries. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or to
obtain and use information that the Company regards as proprietary. Policing
unauthorized use of the Company's products is difficult, and while the Company
is unable to determine the extent to which piracy of its software products
exists, software piracy can be expected to be a persistent problem. In addition,
the laws of some foreign countries do not protect the Company's proprietary
rights as fully as do the laws of the United States. There can be no assurance
that the Company's means of protecting its proprietary rights in the United
States or abroad will be adequate or that competition will not independently
develop similar technology. The Company has entered into source code escrow
agreements with a limited number of its customers and resellers requiring
release of source code in certain circumstances. Such agreements generally
provide that such parties will have a limited, non-exclusive right to use such
code in the event that there is a bankruptcy proceeding by or against the
Company, if the Company ceases to do business or if the Company fails to meet
its support obligations. In addition, Compaq (formerly Digital Equipment
Corporation) and Mitsubishi Corporation ("Mitsubishi") each currently possess
copies of Forte source code for certain limited purposes, subject to the terms
of separate written agreements each company has entered into with the Company.
Compaq has an option to purchase a non-exclusive, fully-paid license of the
Forte source code. Compaq's option becomes exercisable if the Company is
acquired and the acquiror fails to agree to assume the
27
<PAGE>
Company's contractual obligations to Compaq. The provision of source code may
increase the likelihood of misappropriation by third parties.
The Company is not aware that it is infringing any proprietary rights
of third-parties. There can be no assurance, however, that third-parties will
not claim infringement by the Company of their intellectual property rights. The
Company expects that software product developers will increasingly be subject to
infringement claims as the number of products and competitors in the Company's
industry segment grows and the functionality of products in different industry
segments overlaps. Any such claims, with or without merit, could be time
consuming to defend, result in costly litigation, divert management's attention
and resources, cause product shipment delays or require the Company to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company, if at all. In
the event of a successful claim of product infringement against the Company and
failure or inability of the Company to license the infringed or similar
technology, the Company's business, operating results and financial condition
would be materially and adversely affected.
The Company relies upon certain software that it licenses from
third-parties, including software that is integrated with the Company's
internally developed software and used in Forte to perform key functions. There
can be no assurance that these third-party software licenses will continue to be
available to the Company on commercially reasonable terms. The loss of, or
inability to maintain, any such software licenses could result in shipment
delays or reductions until equivalent software could be developed, identified,
licensed and integrated which would materially and adversely affect the
Company's business, operating results and financial condition.
VOLATILITY OF STOCK PRICE. The Company's Common Stock has experienced
significant price volatility and such volatility may occur in the future.
Factors, such as announcements of the introduction of new products by the
Company or its competitors and quarter-to-quarter variations in the Company's
operating results, as well as market conditions in the technology and emerging
growth company sectors, may have a significant impact on the market price of the
Company's Common Stock. Further, the stock market has experienced extreme
volatility that has particularly affected the market prices of equity securities
of many high technology companies and that often has been unrelated or
disproportionate to the operating performance of such companies. These market
fluctuations may adversely affect the price of the Common Stock.
EFFECT OF CERTAIN CHARTER PROVISIONS; ANTI-TAKEOVER EFFECTS OF RIGHTS
PLAN, CERTIFICATE OF INCORPORATION, DELAWARE LAW AND CERTAIN AGREEMENTS. The
Company's Board of Directors has the authority to issue up to 5,000,000 shares
of Preferred Stock and to determine the price, rights, preferences, privileges
and restrictions, including voting and conversion rights of such shares, without
any further vote or action by the Company's stockholders. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any Preferred Stock that may be issued in the
future. The issuance of Preferred Stock could have the effect of making it more
difficult for a third-party to acquire a majority of the outstanding voting
stock of the Company. The Company has no current plans to issue shares of
Preferred stock. Further, the Company has adopted a stockholder rights plan
that, in conjunction with certain provisions of the Company's Certificate of
Incorporation and of Delaware law, could delay or make more difficult a merger,
tender offer, or proxy contest involving the Company.
28
<PAGE>
PART II
ITEM 1. LEGAL PROCEEDINGS
The Company is not aware of any pending or threatened litigation that
could have a material adverse effect upon the Company's business, operating
results or financial condition.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial data schedule.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K have been filed during the quarter
ended June 30, 1999.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, as amended,
the Registrant has duly caused this Report on Form 10-Q to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Oakland,
State of California, on this 13th day of August, 1999.
FORTE SOFTWARE, INC.
By:
Bob L. Corey
SENIOR VICE PRESIDENT, CHIEF FINANCIAL OFFICER,
SECRETARY AND DIRECTOR (PRINCIPAL FINANCIAL AND
ACCOUNTING OFFICER)
30
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