<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): June 12, 1997
------------------------------
i2 TECHNOLOGIES, INC.
- --------------------------------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
Delaware 0-28030 75-2294945
- --------------------------------------------------------------------------------
(State or other jurisdiction (Commission (IRS Employer
of incorporation) File Number) Identification No.
909 E. Las Colinas Blvd., 16th Floor, Irving,Texas 75039
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Company's telephone number, including area code: (214) 860-6000
-------------------------------
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report.)
<PAGE> 2
ITEM 5. OTHER EVENTS.
On May 15, 1997, i2 Technologies, Inc. (the "Registrant") acquired
Think Systems Corporation, a New Jersey corporation ("Think"), by statutory
merger of a wholly owned subsidiary of the Registrant with and into Think (the
"Think Merger"). In connection with the Think Merger, the Registrant entered
into an agreement to acquire all of the outstanding capital stock of Think
Systems Private Limited, an Indian corporation ("Think India") controlled by
the former principal shareholders of Think, in exchange for approximately
36,000 shares of the Registrant's Common Stock. The acquisition of Think India
is subject to a number of conditions, including requisite Indian regulatory
approval.
Also on May 15, 1997, the Registrant acquired Optimax Systems
Corporation, a Delaware corporation ("Optimax"), by statutory merger of a
wholly owned subsidiary of the Registrant with and into Optimax.
The Registrant is currently undertaking to file Form S-3 registration
statements under the Securities Act of 1933 to register a portion of the shares
issued in connection with each merger. Additional information regarding each
merger is presented in the Registrant's previously filed Current Report on Form
8-K, dated May 15, 1997.
Each merger was accounted for as a pooling of interests. In
accordance with Securities and Exchange Commission requirements, the Registrant
is providing supplemental selected financial data, supplemental management's
discussion and analysis of financial condition and results of operations and
supplemental consolidated financial statements which give retroactive effect to
the mergers and include the combined operations of the Registrant, Think, Think
India and Optimax for all periods presented. The supplemental consolidated
financial statements will become the historical financial statements of the
Registrant after financial statements that include the date of consummation of
the mergers are issued.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(c) Exhibits.
<TABLE>
<CAPTION>
No. Description
--- -------------
<S> <C>
11.1 Supplemental Statement of Computation of Net Income per Share.
23.1 Consent of Ernst & Young LLP.
27.1 Supplemental Financial Data Schedule.
99.1* Supplemental Selected Financial Data of the Registrant as of and for
the Years ended December 31, 1992, 1993, 1994, 1995 and 1996.
99.2 Supplemental Management's Discussion and Analysis of Financial
Condition and Results of Operations of the Registrant for the Years
ended December 31, 1994, 1995 and 1996.
</TABLE>
-2-
<PAGE> 3
<TABLE>
<S> <C> <C>
99.3 The following Supplemental Consolidated Financial Statements of
the Registrant:
Page
------
1. Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . F-1
2. Supplemental Consolidated Balance Sheets
as of December 31, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . F-2
3. Supplemental Consolidated Statements of
Income for the Years Ended December 31,
1994, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . F-3
4. Supplemental Consolidated Statements of
Stockholders' Equity for the Years Ended
December 31, 1994, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . F-4
5. Supplemental Consolidated Statements of
Cash Flows for the Years Ended
December 31, 1994, 1995 and 1996 .... . . . . . . . . . . . . . . . . . F-5
6. Notes to Supplemental Consolidated Financial
Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-6
</TABLE>
_________________________
*To be filed by amendment.
-3-
<PAGE> 4
SIGNATURES
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 HEREUNTO DULY AUTHORIZED.
i2 TECHNOLOGIES, INC.
Dated: June 12, 1997 By: /s/ DAVID F. CARY
---------------------------------------
David F. Cary,
Vice President and
Chief Financial Officer
-4-
<PAGE> 5
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<S> <C>
11.1 Supplemental Statement of Computation of Net Income per Share.
23.1 Consent of Ernst & Young LLP.
27.1 Supplemental Financial Data Schedule.
99.1* Supplemental Selected Financial Data of the Registrant as of and for
the Years ended December 31, 1992, 1993, 1994, 1995 and 1996.
99.2 Supplemental Management's Discussion and Analysis of Financial
Condition and Results of Operations of the Registrant for the Years
ended December 31, 1994, 1995 and 1996.
99.3 The following Supplemental Consolidated Financial Statements of the
Registrant:
Page
-----
1. Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . F-1
2. Supplemental Consolidated Balance Sheets
as of December 31, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . F-2
3. Supplemental Consolidated Statements of
Income for the Years Ended December 31,
1994, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . F-3
4. Supplemental Consolidated Statements of
Stockholders' Equity for the Years Ended
December 31, 1994, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . F-4
5. Supplemental Consolidated Statements of
Cash Flows for the Years Ended
December 31, 1994, 1995 and 1996 . . . . . . . . . . . . . . . . . . . . F-5
6. Notes to Supplemental Consolidated Financial
Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-6
</TABLE>
_________________________
*To be filed by amendment.
<PAGE> 1
EXHIBIT 11.1
i2 TECHNOLOGIES, INC.
SUPPLEMENTAL STATEMENT OF COMPUTATION OF NET INCOME PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------
1994 1995 1996
------- ------- -------
PRIMARY NET INCOME PER SHARE (1):
<S> <C> <C> <C>
Weighted average number of common shares outstanding 19,343 19,542 27,714
Common shares issuable on exercise of stock options,
net of shares assumed to be repurchased at the
average market price (2) 5,619 8,082 4,060
Common shares related to SAB No. 64 and 83 (2) (3) 909 909 --
------- ------- -------
Weighted average common and common
equivalent shares outstanding 25,871 28,533 31,774
======= ======= =======
Net income $ 1,736 $ 3,065 $ 7,202
======= ======= =======
Net income per share $ 0.07 $ 0.11 $ 0.23
======= ======= =======
FULLY DILUTED NET INCOME PER SHARE:
Weighted average number of common shares outstanding 19,343 19,542 27,714
Common shares issuable on exercise of stock options,
net of shares assumed to be repurchased at the
year-end market price, if higher than the
average market price (2) 6,188 8,240 4,125
Common shares related to SAB No. 64 and 83 (2) (3) 909 909 --
------- ------- -------
Weighted average common and common
equivalent shares outstanding 26,440 28,691 31,839
======= ======= =======
Net income $ 1,736 $ 3,065 $ 7,202
======= ======= =======
Net income per share $ 0.07 $ 0.11 $ 0.23
======= ======= =======
</TABLE>
(1) The Company reports primary net income per share as the effect of dilutive
securities is less than 3%.
(2) In computing these amounts, the funds used in applying the treasury stock
method include the compensation related to stock options which will be
charged to expense in the future.
(3) Common and common equivalent shares issued within 12 months of the initial
filing of the Company's Registration Statement on Form S-1 are included in
this line item for the years ended December 31, 1994 and 1995. See Note 2
of Notes to Supplemental Consolidated Financial Statements.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements on
Form S-8 (File Nos. 333-03703, 333-27009 and 333-28147) of i2 Technologies,
Inc. of our report dated June 12, 1997, with respect to the supplemental
consolidated financial statements of i2 Technologies, Inc. included in this
Current Report on Form 8-K dated June 12, 1997.
ERNST & YOUNG LLP
Dallas, Texas
June 12, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 36,078
<SECURITIES> 18,031
<RECEIVABLES> 34,884
<ALLOWANCES> 1,269
<INVENTORY> 0
<CURRENT-ASSETS> 90,943
<PP&E> 13,061
<DEPRECIATION> 4,127
<TOTAL-ASSETS> 101,133
<CURRENT-LIABILITIES> 32,119
<BONDS> 0
0
0
<COMMON> 7
<OTHER-SE> 68,641
<TOTAL-LIABILITY-AND-EQUITY> 68,648
<SALES> 57,508
<TOTAL-REVENUES> 87,916
<CGS> 151
<TOTAL-COSTS> 18,782
<OTHER-EXPENSES> 59,463
<LOSS-PROVISION> 344
<INTEREST-EXPENSE> 243
<INCOME-PRETAX> 11,476
<INCOME-TAX> 4,274
<INCOME-CONTINUING> 7,202
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,202
<EPS-PRIMARY> 0.23
<EPS-DILUTED> 0.23
</TABLE>
<PAGE> 1
EXHIBIT 99.2
i2 TECHNOLOGIES, INC.
SUPPLEMENTAL MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The discussion and analysis below contains forward-looking statements,
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, that involve risks and uncertainties,
such as statements of the plans, objectives, expectations and intentions of i2
Technologies, Inc. (the "Company"). The forward-looking statements in this
discussion and analysis are made in reliance upon safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. The section below entitled
"Factors That May Affect Future Results" sets forth certain factors that could
cause actual future results of the Company to differ materially from those
statements.
OVERVIEW
The Company develops, markets and sells client/server-based decision
support software products for supply chain management and related applications.
The Company also provides services such as consulting, training and maintenance
related to these products. Supply chain management encompasses the planning and
scheduling of manufacturing and related logistics, from raw materials
procurement through work-in-process to customer delivery to demand forecasting.
Incorporated in 1989, the Company's primary business initially consisted of
providing software development services for customers with proprietary
mainframe or mini-computer systems. The Company's activities during its early
stages of operations focused on the development of standard software solutions
to provide decision support to manufacturing companies. These efforts
culminated in the development of a supply chain management software solution
that was introduced into the market in 1992 as Rhythm(R). Since the
introduction of Rhythm, the Company has continued to focus significant
resources on the development of additional functionalities and features to the
Rhythm software. As a result, the Company has transitioned its primary business
from that of a provider of services to a provider of software products.
Rhythm enables customers to model complex, multi-site supply chains
and rapidly generate integrated solutions to supply chain problems such as
demand forecasting, production bottlenecks, supply interruptions and customer
order changes. Rhythm utilizes a unique, constraint-based methodology which
simultaneously considers a broad range of constraints -- from machine
capabilities to individual customer commitments to changing revenue forecasts
- -- to optimize all aspects of the supply chain including manufacturing and
logistics.
Since inception, the Company has significantly increased its
investment in sales and marketing, service and support, research and
development and general and administrative staff and accelerated such
investment beginning in the last quarter of 1995. As a result of the
foregoing, the Company's revenues in 1996 were substantially higher than the
levels achieved in 1995. However, the Company has experienced decreases in
operating margins in 1995 and 1996 as a result of such increased staffing. In
order to capture additional market share, the Company expects to continue to
increase staffing levels and incur additional associated costs in future
periods. However, there can be no assurance that the Company's revenues will
grow in future periods or that the Company will maintain the substantial growth
rates in revenues it realized in 1996.
The sales cycle for the Company's products is typically six to nine
months, and license fee revenues for a particular period are substantially
dependent on orders received and software functionality delivered in that
period. Furthermore, the Company has experienced, and expects to continue to
experience, significant variation in the size of individual sales. As a result
of these and other factors, the Company's results have varied significantly in
the past and are likely to be subject to significant fluctuations in the
future. Accordingly, the Company believes that period- to-period comparisons of
its results of operations are not necessarily indicative of the results to be
expected for any future period.
In May 1997, the Company acquired Think Systems Corporation, a New
Jersey corporation ("Think"), through a statutory merger of a wholly owned
subsidiary of the Company with and into Think (the "Think Merger"). Think
provides premium demand chain solutions, including an integrated line of
flexible, client/server-based software applications, for sales, marketing and
logistics departments representing a variety of industries,
1
<PAGE> 2
including consumer packaged goods, high technology, pharmaceutical, apparel,
automotive and other product-driven specializations. In connection with the
Think Merger, the Company entered into an agreement to acquire Think Systems
Private Limited, an Indian corporation ("Think India") controlled by the former
principal shareholders of Think, in exchange for approximately 36,000 shares of
the Company's common stock. The Think Merger culminates an ongoing
relationship commenced pursuant to a January 1996 agreement between the Company
and Think to integrate Think's FYI Planner demand management decision support
software and the Company's Rhythm suite of planning and optimization software
products. The Company intends to continue to integrate Think's software
products with the Company's Rhythm family of products. At the time of the
Think Merger, Think employed approximately 95 people and Think India employed
approximately 50 people. Approximately 3.823 million shares of the Company's
common stock are issuable to the former Think shareholders and optionholders in
exchange for the all of the capital stock of Think and all unexpired and
unexercised options to acquire Think capital stock. The acquisition of Think
India is subject to a number of conditions, including requisite Indian
regulatory approval.
Also in May 1997, the Company acquired Optimax Systems Corporation, a
Delaware corporation ("Optimax"), through a statutory merger of a wholly owned
subsidiary of the Company with and into Optimax (the "Optimax Merger").
Optimax develops, markets and implements supply chain sequencing software using
unique genetic algorithms for customer-driven, make-to-order manufacturing.
The Company expects to integrate Optimax's product offerings with the Company's
Rhythm suite of software products. At the time of the Optimax Merger, Optimax
employed approximately 25 people. Approximately 1.373 million shares of the
Company's common stock are issuable to the former Optimax shareholders and
optionholders in exchange for the all of the capital stock of Optimax and all
unexpired and unexercised options to acquire Optimax capital stock.
The Company expects to incur approximately $5.3 million in certain
expenses related to these transactions. These costs include, among other
things, investment banking, legal and accounting fees and expenses. The
Company anticipates that these expenses will be recorded in the second quarter
of 1997.
For accounting purposes, the business combinations were treated as a
pooling of interests. Accordingly, the Supplemental Consolidated Financial
Statements and Supplemental Selected Financial Data included elsewhere as
exhibits to this Form 8-K give retroactive effect to the mergers and include
the combined operations of the Company, Think, Think India and Optimax for all
periods presented. The following discussion and analysis should be read in
conjunction with such Supplemental Consolidated Financial Statements.
In April 1997, the Company completed the acquisition of the Operations
Planning Group ("OPG"), a business activity of Computer Sciences Corporation,
for a cash purchase price of $1.0 million. OPG provides operation planning
environment optimization software for planning and scheduling for customers in
the consumer packaged goods industry. The acquisition will be accounted for
under the purchase accounting method, and a substantial portion of the purchase
price will be recorded as in-process research and development and expensed
during the second quarter of 1997.
2
<PAGE> 3
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
percentages of total revenues represented by certain items reflected in the
Company's Supplemental Consolidated Statements of Income:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1994 1995 1996
------ ------ -------
<S> <C> <C> <C>
Revenues:
Software licenses ................... 69.2 % 67.2 % 65.4%
Services ............................ 23.5 22.2 25.3
Maintenance ......................... 7.3 10.6 9.3
----- ----- -----
Total revenues ................... 100.0 100.0 100.0
Costs and expenses:
Cost of software licenses ........... 0.7 0.5 0.2
Cost of services and maintenance .... 15.5 18.4 21.2
Sales and marketing ................. 30.8 32.3 38.4
Research and development ............ 17.5 18.0 19.3
General and administrative .......... 13.6 15.2 9.9
----- ----- -----
Total costs and expenses ......... 78.1 84.4 89.0
----- ----- -----
Operating income ....................... 21.9 15.6 11.0
Other income (expense), net ............ (0.6) (0.4) 2.1
----- ----- -----
Income before income taxes ............. 21.3 15.2 13.1
Provision for income taxes ............. 9.1 5.2 4.9
----- ----- -----
Net income ............................. 12.2 % 10.0 % 8.2%
===== ===== =====
</TABLE>
REVENUES
The Company's revenues consist of software license revenues, service
revenues and maintenance revenues. Software license revenues consist of sales
of software licenses which are recognized upon execution of a contract and
shipment of the software, provided that no significant vendor obligations
remain outstanding, amounts are due within one year and collection is
considered probable by management. Service revenues are primarily derived from
fees for consulting and training services and are recognized as the services
are performed. Maintenance revenues are derived from customer support
agreements generally entered into in connection with initial license sales and
subsequent renewals. Maintenance revenues are recognized ratably over the term
of the maintenance period. Payments for maintenance fees are generally made in
advance.
Total revenues increased 188.0% to $87.9 million in 1996 from $30.5
million in 1995, and increased 114.9% in 1995 from $14.2 million in 1994. The
Company currently derives substantially all of its revenues from Rhythm
licenses and related services and maintenance. The Company expects that Rhythm
related revenues will continue to account for substantially all of the
Company's revenues in the foreseeable future. As a result of the Company's
dependence on the continued market acceptance of Rhythm and enhancements
thereto, there can be no assurance that total revenues will continue to
increase at the rates experienced in prior periods, if at all.
SOFTWARE LICENSES. Revenues from software licenses increased 180.0%
to $57.5 million in 1996 from $20.5 million in 1995, and increased 108.8% in
1995 from $9.8 million in 1994. Software license revenues constituted 65.4%,
67.2% and 69.2% of total revenues in 1996, 1995 and 1994, respectively. The
significant increases in software license revenues were primarily due to
growing market acceptance of the Company's software products, a substantial
investment in the Company's infrastructure and continued expansion into new
geographic and vertical markets. To date, sales of software licenses have
principally been derived from direct sales to customers. Although the Company
believes that direct sales will continue to account for a majority of software
license revenues, the Company's strategy is to increase the level of indirect
sales activities. The Company expects that sales of its software products
through sales
3
<PAGE> 4
alliances, distributors, resellers and other indirect channels will increase as
a percentage of software license revenues. However, there can be no assurance
that the Company's efforts to expand indirect sales will be successful.
SERVICES. Revenues from services increased 228.5% to $22.2 million in
1996 from $6.8 million in 1995, and increased 103.0% in 1995 from $3.3 million
in 1994. Service revenues constituted 25.3%, 22.2%, and 23.5% of total revenues
in 1996, 1995, and 1994, respectively. The significant increases in the dollar
amount of service revenues were primarily due to the significant increase in
the number of Rhythm licenses sold and a significant investment in the
Company's consulting organization as a result of the increased demand for the
Company's products. The increases in 1996 were also due to an increase in the
use of third party consultants to provide implementation services to the
Company's customers which has allowed the Company to more rapidly penetrate
international markets. Service revenues as a percentage of total revenues have
fluctuated, and are expected to continue to fluctuate on a period-to-period
basis based upon the demand for implementation, training and consulting
services.
MAINTENANCE. Revenues from maintenance increased 153.6% to $8.2
million in 1996 from $3.2 million in 1995, and increased 211.3% in 1995 from
$1.0 million in 1994. Maintenance revenues constituted 9.3%, 10.6% and 7.3% of
total revenues in 1996, 1995 and 1994, respectively. The significant increases
in maintenance revenues were primarily due to the continued increase in the
number of Rhythm licenses sold and a high percentage of maintenance agreement
renewals. The Company expects that the dollar amount of maintenance revenues
will continue to increase, but should not vary significantly from the
percentage of total revenues achieved in 1996.
CONCENTRATION OF REVENUES. During 1996, one customer accounted for
approximately 13% of total revenues. During 1995, this same customer accounted
for approximately 11% of total revenues, while one other customer accounted for
approximately 10% of total revenues. The Company believes that the loss of
either of these customers would not have a material adverse effect upon the
Company's business, operating results or financial condition.
INTERNATIONAL REVENUES. The Company recognized $20.6 million, $2.2
million and $1.3 million of international revenues in 1996, 1995 and 1994,
representing approximately 23%, 7% and 9% of total revenues, respectively. The
Company's international revenues were primarily generated from customers
located in Asia, Canada and Europe. In 1996, revenues from customers located in
Europe accounted for approximately 13% of total revenues. The significant
increase in international revenues in 1996 was primarily due to the
international expansion of the Company's sales operations which began in the
last quarter of 1995. The Company believes that continued growth and
profitability will require expansion of its sales in international markets.
In order to successfully increase international sales, the Company has utilized
and will continue to utilize substantial resources to expand existing foreign
operations, establish additional foreign operations and hire additional
personnel.
COSTS AND EXPENSES
COST OF SOFTWARE LICENSES. Cost of software licenses consists
primarily of (i) the cost of reproduction and delivery of the software, (ii)
the cost of user documentation and (iii) royalty fees associated with
third-party software included with the sales of Rhythm. Cost of software
licenses was $151,000, $135,000 and $95,000 in 1996, 1995 and 1994,
representing 0.3%, 0.7% and 1.0% of software license revenues, respectively.
Although the Company has not incurred significant expense obligations under its
agreements with third-party software vendors, the Company expects to include
third-party software with sales of Rhythm to the extent requested by customers.
COST OF SERVICES AND MAINTENANCE. Cost of services and maintenance
consists primarily of costs associated with consulting and training services.
Cost of services and maintenance also includes the cost of providing software
maintenance to customers such as hotline telephone support, new releases of
software and updated user documentation, none of which costs have been
significant to date. Cost of services and maintenance was $18.6 million, $5.6
million and $2.2 million in 1996, 1995 and 1994, representing 61.3%, 56.1% and
50.3% of total services and maintenance revenues, respectively. The increases
in cost of services and maintenance both in dollar amount and as a percentage
of total services and maintenance revenues were primarily due to the increase
in the number of consultants, product support and training staff and the
increased use of third-party consultants to provide implementation services.
In addition, consultants were hired during 1995 and 1996 to expand into
different geographic and vertical markets and major consulting and support
centers were established in Canada, Europe and Japan in 1996. The Company
expects to
4
<PAGE> 5
continue to increase the number of its consulting, product support and training
staff in the foreseeable future as a means to expand into these different
geographic and vertical markets. To the extent that the Company's license
sales do not increase at anticipated rates, the hiring of additional
consultants could adversely affect the Company's gross margins.
SALES AND MARKETING. Sales and marketing expenses include personnel
costs, commissions, office facilities, travel, promotional events such as trade
shows, seminars and technical conferences, advertising and public relations
programs. Sales and marketing expenses were $33.7 million, $9.9 million and
$4.4 million in 1996, 1995 and 1994, representing 38.4%, 32.3% and 30.8% of
total revenues, respectively. The increases in sales and marketing expenses
both in dollar amount and as a percentage of total revenues were primarily due
to (i) increased staffing as the Company established new domestic and
international sales offices and expanded its existing direct sales force, (ii)
increased sales commissions as a result of significantly higher revenues and
(iii) increased marketing and promotional activities. The Company expects to
continue to significantly increase its sales and marketing activities in order
to expand its international sales operations and to enter into new vertical
markets. The Company believes that the dollar amount of sales and marketing
expenses will continue to increase, but should not vary significantly as a
percentage of total revenues from the level experienced in 1996.
RESEARCH AND DEVELOPMENT. Research and development expenses were
$17.0 million, $5.5 million and $2.5 million in 1996, 1995 and 1994,
representing 19.3%, 18.0% and 17.5% of total revenues, respectively. The
increases in research and development expenses both in dollar amount and as a
percentage of total revenues were primarily due to the hiring of additional
research and development personnel and other related costs incurred in
connection with expanding the Company's research and development department.
The Company expects that the dollar amount of research and development expenses
will continue to increase as the Company continues to invest in developing new
products, applications and product enhancements for new industrial markets.
In accordance with Statement of Financial Accounting Standards No. 86,
software development costs are expensed as incurred until technological
feasibility has been established, at which time such costs are capitalized
until the product is available for general release to customers. To date, the
establishment of technological feasibility of the Company's products and
general release of such software have substantially coincided. As a result,
software development costs qualifying for capitalization have been
insignificant, and therefore, the Company has not capitalized any software
development costs.
GENERAL AND ADMINISTRATIVE. General and administrative expenses
include the personnel and other costs of the finance, human resources,
information systems, administrative and executive departments of the Company
and the fees and expenses associated with the legal, accounting and other
requirements. General and administrative expenses were $8.7 million, $4.6
million and $1.9 million in 1996, 1995 and 1994, representing 9.9%, 15.2% and
13.6% of total revenues, respectively. The increases in the dollar amount of
general and administrative expenses were primarily the result of increased
staffing and related costs associated with the growth of the Company's business
during these periods. The decrease in general and administrative expenses as a
percentage of total revenues in 1996 was primarily due to the substantial
increase in total revenues and the Company's ability to leverage its base of
resources to support a larger organization. The increase in general and
administrative expenses as a percentage of total revenues in 1995 was primarily
due to the continued development of its corporate management and related
support functions and its move to a larger facility. The Company expects that
the dollar amount of general and administrative expenses will continue to
increase in the foreseeable future.
OTHER INCOME (EXPENSE). Other income (expense) consists primarily of
interest income on short-term investments and overnight repurchase agreements
offset by interest expense on the Company's outstanding debt. Other income
(expense) was $1.8 million, ($117,000) and ($83,000) in 1996, 1995 and 1994,
representing 2.1%, (0.4%) and (0.6%) of total revenues, respectively. The
increases in other income (expense) both in dollar amount and as a percentage
of total revenues in 1996 were primarily due to interest earned on higher
balances of cash, cash equivalents and short-term investments resulting from
net proceeds of the initial public offering of the Company's common stock which
was completed in May 1996 and a decrease in interest expense due to the
repayment of a majority of the Company's outstanding debt in June 1996.
5
<PAGE> 6
PROVISION FOR INCOME TAXES. The Company recorded income tax expense
of $4.3 million, $1.6 million and $1.3 million in 1996, 1995 and 1994,
respectively. The Company's effective income tax rates were 37.2%, 34.1% and
42.7% in 1996, 1995 and 1994, respectively. The Company's effective income tax
rate was higher in 1996 than in 1995 due to the non-deductibility of the
amortization of deferred compensation expense and higher effective state income
tax rates. The Company's effective income tax rate was lower in 1995 than in
1996 and 1994 due to Canadian research and development tax credits and lower
effective state income tax rates. The Company's effective income tax rate was
higher in 1994 than in 1996 and 1995 due to operating losses incurred by Think
for which no income tax benefits were recognized due to Think's status as an
S-Corporation.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has primarily financed its operations
and met its capital expenditure requirements through cash flows from
operations, long-term borrowings and through sales of equity securities. Cash
flows from operations were $6.7 million, $3.4 million and $3.3 million in 1996,
1995 and 1994, respectively. Net repayments of borrowings were $1.8 million in
1996 and net proceeds from borrowings were $283,000 and $980,000 in 1995 and
1994, respectively. Cash flows from sales of equity securities were $50.6
million and $3.2 million in 1996 and 1995, respectively. The Company purchased
approximately $7.8 million, $3.0 million and $1.4 million of computer and
office equipment in 1996, 1995 and 1994, respectively. At December 31, 1996,
the Company did not have any material commitments for capital expenditures.
At December 31, 1996, the Company had $58.8 million of working
capital, including $36.1 million in cash and cash equivalents and $18.0 million
in short-term investments, as compared to $6.2 million of working capital as of
December 31, 1995. The increase in working capital was primarily attributed to
the Company's initial public offering which was completed in May 1996 which
generated net proceeds of $43.7 million after deducting offering expenses and
the underwriting discount and Think's issuance of preferred stock in October
1996 which generated net proceeds of $5.1 million. Think's preferred stock was
exchanged for shares of the Company's common stock in connection with the Think
Merger.
Accounts receivable, net of allowance for doubtful accounts, increased
to $33.6 million at December 31, 1996 from $10.0 million at December 31, 1995
primarily due to a significant increase in revenues during 1996 and extended
payment terms of several new license agreements. Based upon the nature of the
Company's customers and its past collection experience, the Company does not
expect to encounter collection difficulties with respect to such accounts that
would have a material effect on the Company's financial position or results of
operations.
Average days' sales outstanding was 76 days for the year ended
December 31, 1996 as compared to 82 days for the year ended December 31, 1995.
The decrease in average days outstanding was primarily due to the collection of
several large trade receivable balances outstanding at December 31, 1995.
Average days' sales outstanding increased in the second half of 1996 primarily
due to a significant increase in receivables from customers located in foreign
countries which tend to have longer payment terms compared to customers located
in the United States. Average days' sales outstanding can fluctuate for a
variety of reasons including the timing and billing of receivables in which the
related revenues may not yet be recognizable. Total deferred revenue increased
to $19.2 million at December 31, 1996 from $8.8 million at December 31, 1995
primarily as a result of payments received from several customers for software
expected to be delivered during 1997.
The Company's revolving credit agreement with NationsBank of Texas,
N.A. (the "Lender"), which was amended and extended until June 1, 1998, is
unsecured and contains customary restrictive covenants, including covenants
requiring the Company to maintain certain financial ratios. The revolving
credit agreement is not subject to a borrowing base limitation and the
borrowings thereunder bear interest at the Lender's prime lending rate (8.25%
at December 31, 1996). At December 31, 1996, the Company had $100,000 of
borrowings outstanding under the revolving credit agreement, and the maximum
amount of borrowings allowable under the revolving credit agreement was $3.0
million. In June 1996, the Company repaid approximately $1.2 million of
outstanding borrowings under other credit agreements with the Lender.
6
<PAGE> 7
The Company continues to review acquisition and joint venture
candidates with leading-edge products and technologies that could enhance the
Company's product offering. The technologies associated with the products of
the acquired businesses would be incorporated into the Company's existing
internally developed products or would be used in developing new client/server,
open systems products. Any material acquisition or joint venture could result
in a decrease to the Company's working capital depending on the amount, timing
and nature of the consideration to be paid.
The Company believes that existing cash and cash equivalent balances,
short-term investment balances, available borrowings under the revolving credit
agreement and potential cash flow from operations will satisfy the Company's
working capital and capital expenditure requirements for at least the next 12
months. However, any material acquisitions of complementary businesses,
products or technologies could require the Company to obtain additional sources
of financing.
FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to the other information in this Form 8-K, the following
factors should be considered in evaluating the Company and its business.
POTENTIAL FOR SIGNIFICANT FLUCTUATIONS IN QUARTERLY RESULTS; OPERATING LEVERAGE
The Company's quarterly revenues, expenses and operating results have
varied significantly in the past and are likely to vary significantly from
quarter to quarter in the future. Because the purchase of a supply chain
management software solution generally involves a significant commitment of
capital, the sales cycle associated with the purchase of the Company's products
is typically six to nine months and subject to a number of significant risks,
including customers' budgetary constraints, timing of budget cycles and
concerns about the introduction of new products by the Company or its
competitors, factors over which the Company has little or no control.
Furthermore, purchases of the Company's products may be deferred or canceled in
the event of a downturn in any potential customer's business or the economy in
general. As a result, the timing of significant orders is unpredictable and,
like many software companies, the Company typically realizes a significant
portion of its software license revenues in the last month of a quarter. In
addition, the amount of revenues associated with particular licenses can vary
significantly based upon the number of software modules purchased and the
number of sites and users involved in the installation. The Company has
experienced and may continue to experience from time to time very large,
individual license sales which can cause significant variations in quarterly
license revenues. Moreover, small delays in customer orders can cause
significant variability in the Company's license revenues and results of
operations for any particular period.
The Company's expense levels are based, in part, on its expected
future revenues. If revenues are below expectations, operating results and net
income are likely to be adversely and disproportionately affected because a
significant portion of the Company's expenses do not vary with revenues. The
Company may choose to reduce prices or invest significant resources in research
and development efforts in response to competition or to pursue new market
opportunities. There can be no assurance that revenues will grow in future
periods, that they will grow at historical rates, or that the Company will
maintain positive operating margins in future quarters.
PRODUCT CONCENTRATION; DEPENDENCE ON EMERGING MARKET FOR SUPPLY CHAIN
MANAGEMENT SOFTWARE
The Company currently derives substantially all of its revenues from
Rhythm licenses and related services. The Company expects that Rhythm-related
revenues, including maintenance and consulting contracts, will continue to
account for substantially all of the Company's revenues for the foreseeable
future. As a result, the Company's future operating results are dependent upon
continued market acceptance of Rhythm and enhancements thereto. There can be
no assurance that Rhythm will achieve continued market acceptance. A decline
in demand for, or market acceptance of, Rhythm as a result of competition,
technological change or other factors would have a material adverse effect on
the Company's business, operating results and financial condition.
Although demand for Rhythm has grown in recent years, the market for
supply chain management software is still emerging and there can be no
assurance that it will continue to grow or that, even if the market does grow,
businesses will continue to adopt Rhythm. The Company has spent, and intends
to continue to spend, considerable resources educating potential customers
about supply chain management in general and about the features and functions
of Rhythm in particular. However, there can be no assurance that such
expenditures will enable Rhythm to
7
<PAGE> 8
achieve any additional degree of market acceptance. If the market for Rhythm
fails to grow or grows more slowly than the Company currently anticipates, the
Company's business, operating results and financial condition would be
materially adversely affected.
MANAGEMENT OF GROWTH
The Company's business has continued to grow rapidly in the last
three years, particularly in 1996, which has resulted in substantial growth in
the number of its employees, the scope of its operating and financial systems
and the geographic distribution of its operations and customers. This recent
rapid growth has placed, and if such growth continues will continue to place, a
significant strain on the Company's management and operations. Accordingly, the
Company's future operating results will depend on the ability of its officers
and other key employees to continue to implement and improve its operational,
customer support and financial control systems, and to effectively expand,
train and manage its employee base. There can be no assurance that the Company
will be able to manage any future expansion successfully, and any inability to
do so would have a material adverse effect on the Company's business, operating
results and financial condition.
INTEGRATION OF RECENT ACQUISITIONS
The acquisitions of Think and Optimax involve the integration of three
companies that have previously operated independently. Among the factors
considered by the Company's Board of Directors in connection with its approval
of each acquisition was the opportunity for the Company to broaden its product
offering and provide a more comprehensive solution by incorporating the Think
and Optimax software solutions into Rhythm. However, no assurance can be given
that the Company will not encounter difficulties in integrating the respective
operations of the Company, Think and Optimax or that the benefits expected from
such integration will be realized. In addition, there can be no assurance that
the Company will not experience the loss of key Think and Optimax personnel.
Failure to successfully integrate Think's and Optimax's respective operations
into the Company's operations could have a material adverse effect on the
Company's business, operating results and financial condition.
DEPENDENCE UPON KEY PERSONNEL
The Company's future operating results depend in significant part upon
the continued service of a relatively small number of key technical and senior
management personnel, few of whom are bound by an employment agreement. The
Company's future success also depends on its continuing ability to attract and
retain other highly qualified technical and managerial personnel. Competition
for such personnel is intense, and the Company has at times in the past
experienced difficulty in recruiting qualified personnel. There can be no
assurance that the Company will retain its key technical and managerial
employees or that it will be successful in attracting, assimilating and
retaining other highly qualified technical and managerial personnel in the
future. The loss of any member of the Company's key technical and senior
management personnel or the inability to attract and retain additional
qualified personnel could have a material adverse effect on the Company's
business, operating results and financial condition.
COMPLEXITY OF SOFTWARE PRODUCTS; RAPID TECHNOLOGICAL CHANGE AND NEW PRODUCTS
Rhythm is a client/server solution which can operate on platforms from
Digital Equipment, Hewlett-Packard, IBM, Sun Microsystems, Solaris and
Microsoft and can access data from most widely used SQL (structured query
language) databases, including Informix, Oracle and Sybase. Based upon demand
in the marketplace, the Company may identify additional platforms on which to
port its software products; however, such platforms may not be architecturally
compatible with Rhythm's software product design. Therefore, no assurance can
be given concerning the continued successful porting of the Company's software
products on these or additional platforms, the timing of completion of any such
ports or the acceptance of the Company's applications in the marketplace.
The market for the Company's software products is characterized by
rapid technological advances, evolving industry standards in computer hardware
and software technology, changes in customer requirements and frequent new
product introductions and enhancements. The Company's future success will
depend upon its ability to continue to enhance its current product line and to
develop and introduce new products that keep pace with technological
developments, satisfy increasingly sophisticated customer requirements and
achieve market acceptance. There can be no assurance that the Company will be
successful in developing and marketing, on a timely and cost-effective basis,
fully functional product enhancements or new products that respond to
technological advances by others, or that its new products will achieve market
acceptance. The Company's failure to successfully develop and market product
enhancements or new products could have a material adverse effect on the
Company's business, operating results and financial condition.
8
<PAGE> 9
As a result of the complexities inherent in client/server computing
environments and the broad functionality and performance demanded by customers
for supply chain management products, major new products and product
enhancements can require long development and testing periods. In addition,
software programs as complex as those offered by the Company may contain
undetected errors or "bugs" when first introduced or as new versions are
released that, despite testing by the Company, are discovered only after a
product has been installed and used by customers. While the Company has on
occasion experienced delays in the scheduled introduction of new and enhanced
products and products containing bugs, to date the Company's business has not
been materially adversely affected by delays or the release of products
containing errors. There can be no assurance, however, that errors will not be
found in future releases of the Company's software, or that any such errors
will not impair the market acceptance of these products and adversely affect
the Company's business, operating results and financial condition.
While the Company generally takes steps to avoid interruptions of
sales often associated with the pending availability of new products, customers
may delay their purchasing decisions in anticipation of the general
availability of new or enhanced Rhythm products, which could have a material
adverse effect on the Company's business and operating results. Moreover,
significant delays in the general availability of such new releases,
significant problems in the installation or implementation of such new
releases, or customer dissatisfaction with such new releases, could have a
material adverse effect on the Company's business, operating results and
financial condition.
COMPETITION
The Company's products are targeted at the emerging market for supply
chain management software solutions. The Company's competitors are diverse and
offer a variety of solutions directed at various segments of the supply chain
as well as the enterprise as a whole. These competitors include (i) smaller
independent companies which have developed or are attempting to develop
advanced planning and scheduling software which complement or compete with
Manufacturing Resource Planning ("MRP") solutions, (ii) other business
application software vendors who may broaden their product offerings by
internally developing, or by acquiring or partnering with independent
developers of, advanced planning and scheduling software, (iii) internal
development efforts by corporate information technology departments, (iv)
companies offering standardized or customized products on mainframe and/or
mid-range computer systems, and (v) enterprise resource application software
vendors such as Baan Company N.V., Oracle Corporation, PeopleSoft, Inc. and SAP
AG which currently offer sophisticated Enterprise Resource Planning ("ERP")
solutions that incorporate MRP modules or advanced planning and scheduling
software. In connection with specific customer solicitations, ERP vendors have
from time to time jointly marketed the Company's products as a complement to
their own systems. However, the Company believes that many of these ERP
vendors are focusing significant resources on increasing the functionality of
their own MRP modules, and at least two ERP vendors have recently acquired
independent developers of advanced planning and scheduling software utilizing
object-oriented technology. Ultimately, such products may permit ERP vendors
to offer MRP modules with functionality comparable or superior to Rhythm. To
the extent such ERP vendors develop or acquire functionally comparable or
superior MRP modules, their significant installed base and ability to offer a
complete enterprise-wide solution would provide a significant competitive
advantage over the Company.
The principal competitive factors affecting the market for the
Company's products include vendor and product reputation, architecture,
functionality and features, ease of use, quality of support, product quality,
performance and price. Based on these factors, the Company believes that it
has competed effectively to date. In order to be successful in the future, the
Company must continue to respond promptly and effectively to the challenges of
technological change and competitors' innovations. Many of the Company's
competitors have longer operating histories, significantly greater financial,
technical, marketing and other resources, greater name recognition, and a
larger installed base of customers than the Company. There can be no assurance
that the Company will be able to compete successfully with existing or new
competitors or that competition will not have a material adverse effect on the
Company's business, operating results and financial condition.
INTELLECTUAL PROPERTY RIGHTS; USE OF LICENSED TECHNOLOGY
The Company relies primarily on a combination of copyright, trademark
and trade secret laws, confidentiality procedures and contractual provisions to
protect its proprietary rights. In addition, the Company generally licenses
Rhythm products to end users in object code (machine-readable) format, and the
Company's license agreements generally allow the use of Rhythm products solely
by the customer for internal purposes without the right to sublicense or
transfer the Rhythm products. However, the Company believes that the foregoing
measures afford only limited protection. 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 exist, software piracy can be expected
to be a problem. In addition, the laws of some foreign countries do not
protect the Company's proprietary rights to as great an extent as the laws of
the United States. Furthermore, there can be no assurance that the Company's
competitors will not independently develop technology similar to that of the
Company. The Company may increasingly be subject to claims of intellectual
property infringement as the number of products and competitors in the
Company's industry segment grows and the functionality of products in different
industry segments overlaps. Although the Company is not aware that any of its
products infringes upon the proprietary rights of third parties, there can be
no assurance that third parties will not claim infringement by the Company with
respect to current or future products. Any such claims, with or without merit,
could be time-consuming, result in costly litigation, 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 or at all, which could have a material adverse
effect upon the Company's business, operating results and financial condition.
The Company has in the past and may in the future resell certain
software which it licenses from third parties. 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 of these software licenses could result in delays or reductions in product
shipments until equivalent software could be identified, licensed and
integrated, which could adversely affect the Company's business, operating
results and financial condition.
INTERNATIONAL OPERATIONS AND CURRENCY FLUCTUATIONS
The Company derived approximately 23%, 7% and 9% of its total revenues
from customers located outside of the United States in 1996, 1995 and 1994,
respectively. The Company believes that continued growth and profitability
will require expansion of its sales in international markets. In order to
successfully expand international sales, the Company must establish additional
foreign operations and hire additional personnel. International expansion of
the Company's operations has required, and will continue to require, the
Company to translate its software and manuals into foreign languages. To date,
the Company has translated its software into Asian, European and Latin American
languages. To the extent that the Company is unable to expand its
international operations or translate its software and manuals into foreign
languages in a timely manner, it is likely to adversely impact the Company's
operating results. In addition, even if international operations are
successfully expanded, there can be no assurance that the Company will be able
to maintain or increase international market demand for its products.
The Company's international operations are subject to risks inherent
in international business activities, including, in particular, management of
an organization spread over various countries, longer accounts receivable
payment cycles in certain countries, compliance with a variety of foreign laws
and regulations, unexpected changes in regulatory requirements, overlap of
different tax structures, foreign currency exchange rate fluctuations and
general economic conditions. To date, the Company's revenues from
international operations have primarily been denominated in United States
dollars. However, to the extent significant sales have been in the past or are
in the future denominated in foreign currencies, the Company has implemented
and intends in the future to implement hedging programs to mitigate its
exposure to foreign currency fluctuations. As a result of the continued
expansion of the Company's international operations, the fluctuations in the
value of foreign currencies in which the Company conducts its business have
caused and will continue to cause currency transaction gains and losses. To
date, currency transaction gains and losses have not been material. However,
due to the number of foreign currencies involved, the constantly changing
currency exposures and volatility of currency exchange rates, the Company
cannot predict the effect of exchange rate fluctuations upon future operating
results. Other risks associated with international operations include import
and export licensing requirements, trade restrictions and changes in tariff
rates.
PRODUCT LIABILITY
While 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 that such limitation of liability
provisions may not be effective under the laws of certain jurisdictions.
Although the Company has not experienced any product liability claims to date,
there can be no assurance that the Company will not be subject to such claims
in the future. A successful product liability claim brought against the
Company could have a material adverse effect on the Company's business,
operating results and financial condition. Moreover, defending such a suit,
regardless of its merits, could entail substantial expense and require the time
and attention of key management personnel, either of which could have a
material adverse effect on the Company's business, operating results and
financial condition.
9
<PAGE> 10
POSSIBLE VOLATILITY OF MARKET PRICE
The market price of the Common Stock may be significantly affected by
factors such as quarterly variations in the Company's results of operations,
the announcement of new products or product enhancements by the Company or its
competitors, technological innovations by the Company or its competitors, and
general market conditions or market conditions specific to particular
industries. In particular, the stock prices for many companies in the
technology and emerging growth sectors have experienced wide fluctuations which
have often been unrelated to the operating performance of such companies. Such
fluctuations may adversely affect the market price of the Common Stock.
CONTROL BY MANAGEMENT
Sanjiv S. Sidhu, the Company's Chairman and Chief Executive Officer,
and Kanna ("Ken") N. Sharma, the Company's Vice Chairman and Executive Vice
President, beneficially own approximately 54.6% and 12.8%, respectively, of the
Company's outstanding Common Stock. Consequently, Messrs. Sidhu and Sharma
(and Mr. Sidhu in particular) are able to control the outcome of all matters
submitted for stockholder action, including the election of members to the
Company's Board of Directors and the approval of significant change in control
transactions, and effectively control the management and affairs of the
Company, which may have the effect of delaying or preventing a change in
control of the Company.
ANTI-TAKEOVER PROVISIONS
The Company's Certificate of Incorporation, as amended (the
"Charter"), and Bylaws, as amended (the "Bylaws"), contain certain provisions
that may have the effect of discouraging, delaying or preventing a change in
control of the Company or unsolicited acquisition proposals that a stockholder
might consider favorable, including provisions: authorizing the issuance of
"blank check" preferred stock; providing for a Board of Directors with
staggered, three-year terms; requiring super-majority voting to effect certain
amendments to the Charter and Bylaws; limiting the persons who may call special
meetings of stockholders; prohibiting stockholder action by written consent;
and establishing advance notice requirements for nominations for election to
the Board of Directors or for proposing matters that can be acted upon at
stockholder meetings. Certain provisions of Delaware law and the Company's
stock option plans may also have the effect of discouraging, delaying or
preventing a change in control of the Company or unsolicited acquisition
proposals.
10
<PAGE> 1
EXHIBIT 99.3
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
i2 Technologies, Inc.
We have audited the accompanying supplemental consolidated balance sheets of i2
Technologies, Inc. (formed as a result of the merger of i2 Technologies, Inc.,
Think Systems Corporation, Think Systems Private Limited and Optimax Systems
Corporation) as of December 31, 1995 and 1996, and the related supplemental
consolidated statements of income, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1996. The
supplemental consolidated financial statements give retroactive effect to the
merger of i2 Technologies, Inc., Think Systems Corporation, Think Systems
Private Limited and Optimax Systems Corporation on May 15, 1997, which has been
accounted for using the pooling of interests method as described in the notes
to the supplemental consolidated financial statements. These supplemental
financial statements are the responsibility of the management of i2
Technologies, Inc. Our responsibility is to express an opinion on these
supplemental consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatements. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the supplemental consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of i2 Technologies, Inc. at December 31, 1995 and 1996, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1996, after giving retroactive effect to
the merger of i2 Technologies, Inc., Think Systems Corporation, Think Systems
Private Limited and Optimax Systems Corporation, as described in the notes to
the supplemental consolidated financial statements, in conformity with
generally accepted accounting principles.
ERNST & YOUNG LLP
Dallas, Texas
June 12, 1997
F-1
<PAGE> 2
i2 TECHNOLOGIES, INC.
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1995 1996
--------- ---------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 7,383 $ 36,078
Short-term investments -- 18,031
Accounts receivable, net of allowance for doubtful accounts
of $925 and $1,269, respectively 9,969 33,615
Notes receivable - stockholders -- 1,000
Income tax receivable 1,151 --
Prepaid and other current assets 560 2,219
Deferred income taxes 401 --
--------- ---------
Total current assets 19,464 90,943
Furniture and equipment, net 3,726 8,934
Deferred income taxes and other assets 132 1,256
--------- ---------
Total assets $ 23,322 $ 101,133
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,203 $ 4,583
Accrued liabilities 994 4,390
Accrued compensation and related expenses 1,311 3,794
Current portion of long-term debt 278 --
Due to stockholders 525 --
Current portion of deferred revenue 8,546 18,932
Income taxes payable 422 363
Deferred income taxes -- 57
--------- ---------
Total current liabilities 13,279 32,119
Long-term debt 1,075 100
Deferred revenue 291 266
--------- ---------
Total liabilities 14,645 32,485
--------- ---------
Commitments
Stockholders' equity:
Preferred Stock, $.001 par value, 5,000,000 shares authorized,
none issued -- --
Common Stock, $.00025 par value, 50,000,000 shares
authorized, 25,697,184 and 28,883,410 shares issued
and outstanding, respectively 6 7
Additional paid-in capital 5,180 58,074
Deferred compensation (1,739) (1,865)
Retained earnings 5,230 12,432
--------- ---------
Total stockholders' equity 8,677 68,648
--------- ---------
Total liabilities and stockholders' equity $ 23,322 $ 101,133
========= =========
</TABLE>
See accompanying notes.
F-2
<PAGE> 3
i2 TECHNOLOGIES, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1994 1995 1996
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Software licenses $ 9,833 $ 20,535 $ 57,508
Services 3,334 6,767 22,230
Maintenance 1,036 3,225 8,178
-------- -------- --------
Total revenues 14,203 30,527 87,916
-------- -------- --------
Costs and expenses:
Cost of software licenses 95 135 151
Cost of services and maintenance 2,200 5,606 18,631
Sales and marketing 4,381 9,866 33,724
Research and development 2,483 5,506 17,005
General and administrative 1,931 4,648 8,734
-------- -------- --------
Total costs and expenses 11,090 25,761 78,245
-------- -------- --------
Operating income 3,113 4,766 9,671
Other income (expense), net (83) (117) 1,805
-------- -------- --------
Income before income taxes 3,030 4,649 11,476
Provision for income taxes 1,294 1,584 4,274
-------- -------- --------
Net income $ 1,736 $ 3,065 $ 7,202
======== ======== ========
Net income per share $ 0.07 $ 0.11 $ 0.23
Weighted average common and common
equivalent shares outstanding 25,871 28,533 31,774
</TABLE>
See accompanying notes.
F-3
<PAGE> 4
i2 TECHNOLOGIES, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
----------------- PAID-IN DEFERRED RETAINED STOCKHOLDER'S
SHARES AMOUNT CAPITAL COMPENSATION EARNINGS EQUITY
-------- ------- ----------- ------------ -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 19,342 $ 5 $ 176 $ -- $ 599 $ 780
Net income -- -- -- -- 1,736 1,736
------ ---- -------- -------- -------- --------
Balance at December 31, 1994 19,342 5 176 -- 2,335 2,516
Exercise of stock options 5,703 1 323 -- -- 324
Deferred compensation related to
stock options -- -- 1,810 (1,810) -- --
Amortization of deferred compensation -- -- -- 71 -- 71
Issuance of Think and Optimax preferred
stock which was exchanged for
common stock in merger 652 -- 2,871 -- -- 2,871
Distributions to Think stockholders -- -- -- -- (170) (170)
Net income -- -- -- -- 3,065 3,065
------ ---- -------- -------- -------- --------
Balance at December 31, 1995 25,697 6 5,180 (1,739) 5,230 8,677
Exercise of stock options and issuance
under stock purchase plan 519 -- 1,816 -- -- 1,816
Common stock issued, net of offering
costs of $4,288 2,390 1 43,715 -- -- 43,716
Tax benefit of stock options -- -- 1,353 -- -- 1,353
Deferred compensation related to
stock options -- -- 910 (910) -- --
Amortization of deferred compensation -- -- -- 784 -- 784
Issuance of Think preferred stock
which was exchanged for common
stock in merger 277 -- 5,100 -- -- 5,100
Net income -- -- -- -- 7,202 7,202
------ ---- -------- -------- -------- --------
Balance at December 31, 1996 28,883 $ 7 $ 58,074 $ (1,865) $ 12,432 $ 68,648
====== ==== ======== ======== ======== ========
</TABLE>
See accompanying notes.
F-4
<PAGE> 5
i2 TECHNOLOGIES, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1994 1995 1996
-------- -------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,736 $ 3,065 $ 7,202
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 494 1,059 2,611
Provision for losses on receivables 829 66 344
Amortization of deferred compensation -- 71 784
Deferred income taxes 109 (646) (3)
Tax benefit of stock options -- -- 1,353
Changes in operating assets and liabilities:
Accounts receivable (2,588) (6,213) (23,990)
Income tax receivable -- (1,151) 535
Prepaid and other assets (199) (365) (1,706)
Accounts payable 171 561 3,380
Accrued liabilities 380 310 3,396
Accrued compensation and related expenses 392 905 2,483
Income taxes payable (106) 324 (59)
Deferred revenue 2,037 5,384 10,361
-------- -------- --------
Net cash provided by operating activities 3,255 3,370 6,691
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Notes receivable - stockholders -- -- (1,000)
Purchases of furniture and equipment (1,351) (3,034) (7,819)
Proceeds from the sale of furniture and equipment 23 -- --
Purchases of short-term investments -- -- (37,531)
Proceeds from sale of short-term investments -- -- 19,500
-------- -------- --------
Net cash used in investing activities (1,328) (3,034) (26,850)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from revolving line of credit 450 500 --
Payments on revolving line of credit -- (850) --
Proceeds from long-term debt 550 3,110 400
Payments on long-term debt (89) (2,642) (1,653)
Advances from stockholders, net 69 165 (525)
Distributions to stockholders -- (170) --
Issuance of Think and Optimax preferred stock which
was exchanged for common stock in merger -- 2,871 5,100
Net proceeds from sale of common stock
and exercise of stock options -- 324 45,532
-------- -------- --------
Net cash provided by financing activities 980 3,308 48,854
-------- -------- --------
Net increase in cash and cash equivalents 2,907 3,644 28,695
Cash and cash equivalents at beginning of period 832 3,739 7,383
-------- -------- --------
Cash and cash equivalents at end of period $ 3,739 $ 7,383 $ 36,078
======== ======== ========
</TABLE>
See accompanying notes.
F-5
<PAGE> 6
i2 TECHNOLOGIES, INC.
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
1. THE COMPANY
i2 Technologies, Inc. (the "Company"), incorporated in 1989, develops,
markets and sells client/server-based decision support software products for
supply chain management and related applications. The Company also provides
services such as consulting, training and maintenance. The Company's products
and services are primarily provided to large and medium sized manufacturing and
distribution companies which operate in many industries located throughout the
world.
In May 1997, the Company acquired Think Systems Corporation ("Think"),
a demand planner developer; acquired Optimax Systems Corporation ("Optimax"), a
scheduling and sequencing software company; and entered into an agreement to
acquire Think Systems Private Limited ("Think India"), an offshore development
house (see Note 3).
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. The accompanying consolidated financial
statements include the accounts of the Company and its subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation.
USE OF ESTIMATES. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS. Cash equivalents
are highly liquid investments with insignificant interest rate risk and
original maturities of 90 days or less and are stated at amounts which
approximate fair value, based on quoted market prices. At December 31, 1995,
cash equivalents consist principally of overnight repurchase agreements. At
December 31, 1996, cash equivalents consist principally of overnight repurchase
agreements and highly liquid debt securities of corporations, municipalities
and the U.S. Government.
The Company accounts for its cash equivalents and short-term
investments under Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." Management
determines the appropriate classification of debt securities at the time of
purchase and reevaluates such designation as of each subsequent balance sheet
date. The Company considers its debt securities as "available-for-sale" and, in
accordance with SFAS No. 115, would record its investments at fair value.
However, as the difference between cost and fair value was immaterial at
December 31, 1996, no adjustment has been made to the historical carrying value
of the investments and no unrealized gains or losses have been recorded as a
separate component of stockholders' equity. Realized gains and losses to date
have not been material. The cost of debt securities sold is based on the
specific identification method.
At December 31, 1995, the Company had no investment in debt
securities. At December 31, 1996, the Company's debt securities include $14.5
million from the U.S. Government, $16.7 million from state and local
municipalities and $9.0 million from corporations, all of which mature within
one year. At December 31, 1996, $22.2 million of debt securities were included
in cash equivalents.
F-6
<PAGE> 7
CONCENTRATION OF CREDIT RISK. Financial instruments which potentially
subject the Company to a concentration of credit risk principally consist of
accounts receivable. As of December 31, 1995, approximately 44% of accounts
receivable were concentrated with three customers. As of December 31, 1996,
approximately 27% of accounts receivable were concentrated with three different
customers. The Company generally does not require collateral on accounts
receivable as the Company's customers are generally large, well established
companies. The Company periodically performs credit evaluations of its
customers and maintains reserves for potential losses.
FURNITURE AND EQUIPMENT. Furniture and equipment are stated at cost.
Depreciation expense is calculated using the straight-line method over seven
years for office furniture and fixtures and three years for computer equipment.
REVENUE RECOGNITION. The Company's revenues consist of software
license revenues, service revenues and maintenance revenues. Software license
revenues consist of sales of software licenses which are recognized upon
execution of a contract and shipment of the software, provided that no
significant vendor obligations remain outstanding, amounts are due within one
year and collection is considered probable by management. Service revenues are
derived from fees for consulting and training services and are recognized as
services are performed. Maintenance revenues are derived from customer support
agreements generally entered into in connection with the initial license sales
and subsequent renewals. Maintenance revenues are recognized ratably over the
term of the maintenance period. Payments for maintenance fees are generally
made in advance.
Customer payment terms vary. Amounts received in advance of satisfying
revenue recognition criteria are classified in current and long-term
liabilities as deferred revenue in the accompanying consolidated balance
sheets.
The Company generally warrants that its products will function
substantially in accordance with documentation provided to customers for
approximately six to twelve months following initial shipment to the customer.
As of December 31, 1996, the Company had not incurred any significant expenses
related to warranty claims.
COST OF SERVICES AND MAINTENANCE REVENUES. Cost of services and
maintenance consists primarily of costs associated with consulting and training
services. Cost of services and maintenance also includes the cost of providing
software maintenance to customers such as hotline telephone support, new
releases of software and updated user documentation.
SOFTWARE DEVELOPMENT COSTS. In accordance with SFAS No. 86,
"Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed," software development costs are expensed as incurred until
technological feasibility has been established, at which time such costs are
capitalized until the product is available for general release to customers. To
date, the establishment of technological feasibility of the Company's products
and general release of such software have substantially coincided. As a result,
software development costs qualifying for capitalization have been
insignificant and therefore, the Company has not capitalized any software
development costs.
NET INCOME PER SHARE. Net income per common share is computed based
upon the weighted average number of common shares outstanding and the effect of
dilutive common stock equivalents from the exercise of stock options using the
treasury stock method. In accordance with Securities and Exchange Commission
Staff Accounting Bulletins and Staff Policy, common and common equivalent
shares issued during the twelve month period prior to the date of the initial
filing of the Company's Registration Statement on Form S-1 have been included
in the net income per share calculations for 1994 and 1995 as if they were
outstanding for the entire period using the treasury stock method. Share and
per share amounts for 1994 and 1995 have been adjusted to reflect two stock
splits during 1995 (see Note 7). Fully diluted earnings per share is the same
as, or not materially different from, primary earnings per share and
accordingly, is not presented. The computation also gives retroactive effect
to the exchange of common shares in connection with the Think, Think India and
Optimax mergers (see Note 3).
F-7
<PAGE> 8
STOCK-BASED COMPENSATION PLANS. The Company has elected to continue to
account for its stock-based compensation plans utilizing the provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," because, as discussed in Note 7, the alternative fair value
accounting provided for under SFAS No. 123, "Accounting for Stock-Based
Compensation," requires use of option valuation models that were not developed
for use in valuing employee stock options. However, SFAS No. 123 requires
disclosure of pro forma information regarding net income and net income per
share based on fair value accounting for stock-based compensation plans.
FOREIGN CURRENCY TRANSLATION. The Company has determined that the
functional currency of each of its foreign subsidiaries is the local currency.
The financial statements of its foreign subsidiaries are translated into U.S.
dollars using the current rate method in accordance with SFAS No. 52, "Foreign
Currency Translation." To date, translation adjustments and foreign currency
gains and losses have not been significant and accordingly, have not been
separately presented.
3. BUSINESS COMBINATIONS
On May 15, 1997, the Company entered into definitive agreements to
merge with Think and Optimax and to acquire Think India. Under the terms of
these agreements, the Company will issue 3,823,337 shares, 1,372,618 shares and
35,663 shares of its common stock for all the outstanding capital stock and all
unexpired and unexercised options of Think, Optimax and Think India,
respectively. The acquisition of Think India is subject to a number of
conditions, including requisite Indian regulatory approval. The Company
expects to obtain the necessary regulatory approvals by the end of 1997.
Think provides premium demand chain solutions, including an integrated
line of flexible, client/server-based software applications, for sales,
marketing and logistics departments representing a variety of industries
including consumer packaged goods, high technology, pharmaceutical, apparel,
automotive and other product driven specializations. Think India is controlled
by the former principal shareholders of Think and is engaged primarily in
research and development services provided to Think. Optimax develops, markets
and implements supply chain sequencing software using unique genetic algorithms
for customer-driven, make-to-order manufacturing.
Each of these business combinations was accounted for as a pooling of
interests, and accordingly, the supplemental consolidated financial statements
give retroactive effect to the mergers and include the combined operations of
i2 Technologies, Think, Optimax and Think India for all periods presented. The
following is a summary of the results of operations of the separate entities
for periods prior to the mergers (in thousands):
<TABLE>
<CAPTION>
i2 Technologies
(Prior to Think Pooling
Mergers) Think Optimax India Adjustments Combined
--------------- -------- -------- ------ ----------- --------
<S> <C> <C> <C> <C> <C> <C>
1996:
Revenues $ 76,342 $ 11,376 $ 2,504 $ 789 $ (3,095) $ 87,916
Net income (loss) 6,092 (128) 48 203 987 7,202
1995:
Revenues $ 25,946 $ 4,977 $ 1,104 $ 665 $ (2,165) $ 30,527
Net income (loss) 3,774 58 51 169 (987) 3,065
1994:
Revenues $ 11,498 $ 2,272 $ 433 $ 340 $ (340) $ 14,203
Net income (loss) 2,186 (390) (123) 63 -- 1,736
</TABLE>
F-8
<PAGE> 9
Pooling adjustments have been recorded to eliminate (i) revenues and
expenses associated with software license royalties, consulting services and
maintenance charges provided to i2 Technologies by Think, and (ii) revenues and
expenses associated with research and development services provided to Think by
Think India.
The Company expects to incur approximately $5.3 million in certain
expenses related to these transactions. These costs include, among other
things, investment banking, legal and accounting fees and expenses. The
Company anticipates that these expenses will be recorded in the second quarter
of 1997.
On April 1, 1997, the Company completed the acquisition of the
Operations Planning Group ("OPG"), a business activity of Computer Sciences
Corporation ("CSC"), for a cash purchase price of $1.0 million. OPG provides
operation planning environment ("OPE") optimization software for planning and
scheduling for customers in the consumer packaged goods industry. The Company
has assumed and is committed to the contractual obligations of the OPE customer
base in return for maintenance revenue, and as part of the agreement, all
employees of OPG became employees of the Company. The acquisition will be
accounted for under the purchase accounting method, and a substantial portion
of the purchase price will be recorded as in-process research and development
and expensed during the second quarter of 1997. Additionally, the Company has
agreed to make available a certain amount of consulting revenue opportunities
to CSC within a three-year period from the date of the acquisition. If the
agreed upon consulting revenue opportunities are not made available to CSC, the
Company will be required to make an additional cash payment to CSC at the end
of the three-year period equal to the gross profit typically realized on such
consulting revenue. Such payment, if any, would be recorded as an increase in
the purchase price.
4. FURNITURE AND EQUIPMENT
Furniture and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
-------- --------
<S> <C> <C>
Computer equipment $ 4,724 $ 10,498
Furniture and fixtures 1,041 2,563
-------- --------
5,765 13,061
Less accumulated depreciation (2,039) (4,127)
-------- --------
$ 3,726 $ 8,934
======== ========
</TABLE>
5. BORROWINGS
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
-------- --------
<S> <C> <C>
Revolving Credit Agreement $ 100 $ 100
Term Note 753 --
New Equipment Credit Agreement 500 --
-------- --------
1,353 100
Less current maturities (278) --
-------- --------
$ 1,075 $ 100
======== =========
</TABLE>
F-9
<PAGE> 10
The Company's revolving credit agreement (the "Revolving Credit
Agreement") with NationsBank of Texas, N.A. (the "Lender"), which was amended
and extended until June 1, 1998, is unsecured and is no longer subject to a
borrowing base limitation. The maximum amount of borrowings under the Revolving
Credit Agreement is $3.0 million, and the Revolving Credit Agreement provides
for a commitment fee of 1/2 of 1% of the average daily unused portion of the
commitment amount. At December 31, 1996, the Company had $100,000 of borrowings
outstanding under the Revolving Credit Agreement which bear interest at the
Lender's prime lending rate (8.25% at December 31, 1996). The Revolving Credit
Agreement contains certain financial covenants and restrictions as to various
matters including the Company's ability to make certain investments or incur
additional indebtedness and the maintenance of specified levels of tangible net
worth and certain financial ratios. At December 31, 1996, the Company was in
compliance with such covenants and restrictions.
In June 1996, the Company repaid all of the outstanding balances under
the Term Note and the New Equipment Credit Agreement of approximately $1.2
million.
Cash paid for interest in 1994, 1995 and 1996 was approximately
$86,000, $255,000 and $248,000, respectively.
6. COMMITMENTS
The Company leases its office facilities and certain office equipment
under operating leases which expire at various dates through 2001. Some of the
Company's leases provide for escalating minimum rent. Rent expense is
recognized on a straight-line basis over the life of such leases. The Company
has renewal options for most of its operating leases. Total rent expense
incurred during 1994, 1995 and 1996 was approximately $244,000, $580,000 and
$2.1 million, respectively.
Future minimum lease payments under all noncancellable operating
leases as of December 31, 1996 are as follows (in thousands):
<TABLE>
<S> <C> <C>
1997 $ 3,018
1998 2,815
1999 2,115
2000 1,729
2001 161
--------
Total minimum lease payments $ 9,838
========
</TABLE>
7. STOCKHOLDERS' EQUITY
INITIAL PUBLIC OFFERING. In May 1996, the Company completed the
initial public offering of its Common Stock. A total of 2,390,400 shares of
Common Stock were sold by the Company resulting in net proceeds to the Company
of $43.7 million after deducting expenses of the offering of $745,000 and the
underwriting discount.
STOCK SPLITS. In April 1995 and again in December 1995, the Company's
Common Stock was split two-for-one. All share and per share amounts have been
adjusted to reflect both stock splits as though they had occurred at the
beginning of the initial period presented.
EMPLOYEE STOCK PURCHASE PLAN. In March 1996, the Board adopted and the
stockholders approved an Employee Stock Purchase Plan. In November 1996, the
Board adopted an International Employee Stock Purchase Plan for employees of
its wholly-owned subsidiaries. The Employee Stock Purchase Plan and the
International Employee Stock Purchase Plan (collectively, the "Purchase Plans")
are designed to allow eligible employees of the Company to purchase shares of
Common Stock through periodic payroll deductions. The Company has reserved
500,000 shares of Common Stock for issuances under the Purchase Plans.
F-10
<PAGE> 11
Payroll deductions may not exceed the lesser of 15% of a participant's
base salary or $21,250 per year, and employees may purchase a maximum of 1,000
shares per purchase period under the Purchase Plans. The purchase price per
share will be 85% of the lesser of the fair market value of the Common Stock on
the start of the purchase period or the fair market value at the end of the
purchase period. Participation may be terminated at any time by the employee
and automatically ends upon termination of employment with the Company. Six
month offering periods will commence on each November 1 and May 1, except for
the initial offering period which commenced on April 25, 1996 and ended on
October 31, 1996. Under the Purchase Plans, 60,145 shares were issued in
connection with the offering period ended October 31, 1996.
1992 STOCK PLAN. Under the Company's 1992 Stock Plan, the Company's
Board of Directors (the "Board") granted incentive stock options to employees
of the Company and nonqualified options to a consultant of the Company. The
options generally vest over a four year period commencing on or before the date
of grant.
1995 STOCK OPTION/STOCK ISSUANCE PLAN. In September 1995, the
stockholder and the Board approved the 1995 Stock Option/Stock Issuance Plan
(the "1995 Plan") which replaced the 1992 Stock Plan. All options outstanding
under the 1992 Stock Plan were incorporated into the 1995 Plan. Under the 1995
Plan, the amount of shares of Common Stock originally reserved for issuance was
10,000,000 shares which was subsequently increased to 12,000,000 shares. The
1995 Plan is divided into the following three equity programs: (i) the
Discretionary Option Grant Program, (ii) the Stock Issuance Program and (iii)
the Automatic Option Grant Program.
The Discretionary Option Grant Program provides for the grant of
incentive stock options ("Incentive Options") to employees of the Company and
for the grant of nonqualified stock options to employees, directors and
consultants of the Company. Exercise prices may not be less than 100% and 85%
of the fair market value at the date of grant for Incentive Options and
nonqualified options, respectively. Options granted under the Discretionary
Option Grant Program generally vest in four equal annual increments and expire
after ten years. Some options granted under the Discretionary Option Grant
Program are immediately exercisable, subject to a right of repurchase by the
Company at the original exercise price for all unvested shares.
Under the Stock Issuance Program, the Board or a committee of the
Board (the "Plan Administrator") may grant shares of the Company's Common Stock
to any person at any time, at such price and on such terms as established by
the Plan Administrator. The purchase price per share cannot be less than 85% of
the fair market value of the Company's Common Stock on the issuance date.
Under the Automatic Option Grant Program, each person who is first
elected or appointed as a non-employee Board member shall automatically be
granted a nonqualified option to purchase 1,000 common shares of the Company.
On the date of each Annual Stockholders Meeting each non-employee Board member
shall automatically be granted an additional option to purchase 1,000 shares of
the Company's Common Stock, subject to certain conditions.
THINK STOCK OPTION PLANS. Think's Board of Directors have adopted and
the shareholders have approved incentive stock option plans for employees,
directors and consultants of Think (the "Think Plans"). Under the Think Plans,
the Board of Directors granted incentive and nonqualified stock options to
employees, directors and consultants at prices not less than the estimated fair
market value of Think's common stock at the date of grant.
In connection with the acquisition of Think, all of the options
outstanding under the Think Plans were assumed by the Company and immediately
vested.
F-11
<PAGE> 12
OPTIMAX STOCK OPTION PLAN. During 1996, Optimax's Board of Directors
adopted and the shareholders approved the Optimax Systems Corporation Stock
Option Plan (the "Optimax Stock Option Plan"). Under the Optimax Stock Option
Plan, the Board of Directors granted nonqualified stock options to employees of
Optimax at prices equal to the estimated fair market value of Optimax's common
stock on the date of grant. The options generally vest over a five year period
commencing on or before the date of grant. In connection with the acquisition
of Optimax, all such options were assumed by the Company.
Option activity under the Company's stock option plans, including
Think and Optimax, is as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
SHARES ------------------------------
AVAILABLE NUMBER WEIGHTED-AVERAGE
FOR GRANT OF SHARES EXERCISE PRICE
--------- ------------------------------
<S> <C> <C> <C>
Balance, December 31, 1993 784,668 7,612,180 $ 0.02
Granted (1,124,132) 1,124,132 0.10
Canceled 486,000 (486,000) 0.03
--------- ---------
Balance, December 31, 1994 146,536 8,250,312 0.03
Authorized 1,603,152 --
Granted (1,125,667) 1,125,667 0.63
Exercised -- (5,703,242) 0.06
Canceled 23,300 (23,300) 0.05
--------- ---------
Balance, December 31, 1995 647,321 3,649,437 0.17
Authorized 2,683,125 --
Granted (1,606,317) 1,606,317 9.71
Issued (615) -- 14.33
Exercised -- (458,058) 1.66
Canceled 87,672 (87,672) 11.71
--------- ---------
Balance, December 31, 1996 1,811,186 4,710,024 3.07
========= =========
</TABLE>
Under the 1995 Plan, each outstanding option and unvested stock
issuance will be subject to accelerated vesting under certain circumstances
upon an acquisition of the Company in a stockholder-approved merger or asset
sale. In addition, the Plan Administrator has the discretion to accelerate
vesting of outstanding options upon consummation of any other transaction which
results in a change in control of the Company.
During 1995 and 1996, 595,359 shares were purchased under options with
a weighted-average exercise price of $1.44 per share for which the optionee was
not vested as of December 31, 1996. These purchased but unvested shares are
held in escrow until the optionee vests in the shares and the optionee has all
rights as a shareholder with respect to these shares. These shares are reported
as issued and outstanding in the accompanying consolidated financial
statements.
All options outstanding at December 31, 1996 are Incentive Options
except for 381,822 options which are nonqualified options.
F-12
<PAGE> 13
Other information regarding options outstanding as of December 31,
1996 is as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
NUMBER OF WEIGHTED AVERAGE REMAINING
SHARES EXERCISE PRICE CONTRACTUAL LIFE
---------- ---------------- ----------------
<S> <C> <C> <C>
Exercise price of $0.0175 - $12.11 4,391,974 $ 1.12 6.63 yrs.
Exercise price of $24.375 - $37.50 318,050 29.88 9.77
---------
Total options outstanding 4,710,024 3.07 6.84
=========
</TABLE>
As of December 31, 1996, 3,051,412 shares underlying options were
exercisable at prices ranging from $0.0175 to $12.11 per share with a weighted
average exercise price of $1.07 per share, and 1,000 shares underlying options
were exercisable at a price of $29.00 per share. As of December 31, 1995,
2,467,172 shares underlying options were exercisable at a weighted average
exercise price of $0.16 per share.
The Company recorded deferred compensation expense of $1.8 million and
$910,000 in 1995 and in the first quarter of 1996, respectively, for the
difference between the grant price and the deemed fair market value of the
Company's Common Stock underlying certain options granted. These amounts are
being amortized over the vesting period of the individual options, generally
four years.
PRO FORMA NET INCOME AND NET INCOME PER SHARE. Pro forma information
regarding net income and net income per share has been determined as if the
Company had accounted for its employee stock options and shares issued under
the Purchase Plans using the fair value method of SFAS No. 123. The fair value
for the stock options issued under the 1995 Plan was estimated at the date of
grant using a Black-Scholes option pricing model with the following
weighted-average assumptions for 1995 and 1996, respectively: risk-free
interest rates of 6.32% and 6.17%; a volatility factor of the expected market
price of the Company's Common Stock of 0.46; a weighted-average expected life
of the option of 4 years; and no dividend yields. The fair value of the stock
options issued under the 1996 Think Plan was estimated at the date of grant
using the minimum value method for non-public companies permitted by SFAS No.
123 with the following assumptions: weighted-average risk-free interest rates
of 6.5%; no dividends; and a weighted-average expected life of the options of 7
years. The fair value of stock options issued under the Optimax Stock Option
Plan is not presented as the impact is immaterial.
The fair value for the shares issued under the Purchase Plans was
estimated as of the initial day of the purchase period using a Black-Scholes
option pricing model with the following weighted-average assumptions: a risk
free interest rate of 5.22%; a volatility factor of the expected market price
of the Company's Common Stock of 0.46; a weighted-average expected life of the
purchase right of 0.5 years; and no dividend yields. The weighted-average fair
value of the purchase rights granted under the Purchase Plans during 1996 was
$6.15.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value estimate,
in management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options and
Purchase Plan shares.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period and the
estimated fair value of the Purchase Plan shares is amortized to expense over
the purchase period.
F-13
<PAGE> 14
The Company's pro forma information follows (in thousands, except per
share amounts):
<TABLE>
<CAPTION>
1995 1996
------ ------
<S> <C> <C>
Pro forma net income $3,083 $6,281
Pro forma net income per share 0.11 0.20
</TABLE>
The pro forma disclosures only include the effect of options granted
subsequent to January 1, 1995. Accordingly, the effects of applying SFAS No.
123 for the pro forma disclosures are not indicative of future effects of such
application.
Information regarding exercise prices and fair values of options
granted is as follows:
<TABLE>
<CAPTION>
1995 1996
-------- ----------
<S> <C> <C>
Number of options issued at fair market value of stock 181,800 1,296,047
Weighted-average exercise price per share $ 0.13 $ 11.15
Weighted-average fair value of options 0.06 4.55
Number of options issued at less than fair market value of stock 943,867 310,270
Weighted-average exercise price per share $ 0.72 $ 3.69
Weighted-average fair value of options 2.10 4.21
</TABLE>
8. INCOME TAXES
The Company's provision for income taxes consists of the following (in
thousands):
<TABLE>
<CAPTION>
1994 1995 1996
------- ------- --------
<S> <C> <C> <C>
Current:
Federal $ 1,175 $ 1,730 $ 3,630
State 11 455 390
Foreign -- 37 264
Deferred:
Federal (71) (477) 272
State 179 (101) (79)
Foreign -- (60) (203)
------- ------- -------
Total $ 1,294 $ 1,584 $ 4,274
======= ======= =======
</TABLE>
F-14
<PAGE> 15
The Company's provision for income taxes reconciles to the amount
computed by applying the statutory U.S. federal rate of 34% to income before
income taxes as follows (in thousands):
<TABLE>
<CAPTION>
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Expense computed at statutory rate $ 1,030 $ 1,581 $ 3,902
State taxes, net of federal tax benefit 106 139 266
Stock option compensation -- -- 215
Research and development tax credits (24) (175) (144)
Losses for which no tax benefits were recognized due to
Think's status as an S-Corporation 133 -- --
Other 49 39 35
------- ------- -------
Provision for income taxes $ 1,294 $ 1,584 $ 4,274
======= ======= =======
</TABLE>
Deferred tax assets and liabilities at December 31, 1995 and December
31, 1996 are comprised of the following (in thousands):
<TABLE>
<CAPTION>
1995 1996
------ --------
<S> <C> <C>
Deferred tax assets:
Foreign tax credits $ -- $ 612
Deferred revenue 888 848
Accrued liabilities 42 136
Bad debt allowance 163 229
Domestic net operating loss carryforwards 180 312
International net operating loss carryforwards -- 186
Research and development tax credits 67 78
Other 19 150
------- -------
Total deferred tax asset 1,359 2,551
------- -------
Deferred tax liabilities:
Depreciation (94) (127)
State income taxes (35) (28)
Cash method of accounting, net (627) (1,212)
Other (106) (68)
------- -------
Total deferred tax liability (862) (1,435)
------- -------
Net deferred tax asset $ 497 $ 1,116
======= =======
</TABLE>
The Company considers the earnings of foreign subsidiaries to be
permanently reinvested outside the United States. Accordingly, no United States
income tax on these earnings has been provided. The Company believes that any
United States income taxes due upon the repatriation of such earnings would be
fully offset by foreign tax credits.
At December 31, 1996, certain foreign subsidiaries of the Company have
net operating loss carryforwards for tax purposes totaling approximately
$831,000 which may be used to offset future taxable income of the subsidiaries.
Approximately $95,000 and $178,000 expire in the years 2002 and 2003,
respectively. The remaining carryforwards have no expiration.
F-15
<PAGE> 16
The Company paid income taxes of approximately $1.3 million, $3.1
million and $2.0 million in 1994, 1995 and 1996, respectively.
9. EMPLOYEE RETIREMENT PLAN
The Company has established 401(k) retirement plans (the "Retirement
Plans") that cover a majority of the Company's employees. Each eligible
employee may contribute up to 18% of their compensation, subject to certain
limitations, to the Retirement Plans. The Company may make contributions to the
Retirement Plans at the discretion of the Board. As of December 31, 1996, no
contributions had been made by the Company.
10. INTERNATIONAL OPERATIONS
International revenues were approximately $1.3 million, $2.2 million
and $20.6 million in 1994, 1995 and 1996, respectively. The Company's
international revenues were primarily generated from customers located in Asia,
Canada and Europe. In 1996, revenues from customers located in Europe accounted
for 13% of total revenues. Total assets from international operations, composed
primarily of accounts receivable, were $11.4 million or 11% of total assets as
of December 31, 1996.
11. MAJOR CUSTOMERS
During 1995, two customers accounted for approximately 11% and 10% of
total revenues. During 1996, one customer accounted for approximately 13% of
total revenues. This customer also accounted for approximately 11% of total
revenues in 1995.
12. RELATED PARTY TRANSACTIONS
As of December 31, 1996, the Company had $1.0 million of notes
receivable from certain of its common stockholders. These notes bore interest
at 6.78% and were repaid in May 1997.
Due to stockholders represents advances from stockholders which bear
interest at 8% and are due on demand. As of December 31, 1995, the Company had
$525,000 of such advances outstanding, which included accrued interest. All
outstanding amounts were repaid during 1996.
F-16
