<PAGE>
Filed pursuant to Rule 424(b)(1)
Registration No. 333-27087
3,500,000 SHARES
[LOGO OF PERITUS APPEARS HERE]
COMMON STOCK
Of the 3,500,000 shares of Common Stock offered hereby, 2,800,000 shares are
being sold by the Company and 700,000 shares are being sold by the Selling
Stockholders. The Company will not receive any of the proceeds from the sale
of shares by the Selling Stockholders. See "Principal and Selling
Stockholders."
Prior to this offering, there has been no public market for the Common Stock
of the Company. See "Underwriting" for a discussion of factors considered in
determining the initial public offering price. The Common Stock has been
approved for quotation on the Nasdaq National Market under the symbol "PTUS."
SEE "RISK FACTORS" COMMENCING ON PAGE 7 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK
OFFERED HEREBY.
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Proceeds to
Price to Underwriting Proceeds to Selling
Public Discount(1) Company(2) Stockholders
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share......... $16.00 $1.12 $14.88 $14.88
Total(3).......... $56,000,000 $3,920,000 $41,664,000 $10,416,000
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
(1) See "Underwriting" for information concerning indemnification of the
Underwriters and other matters.
(2) Before deducting expenses payable by the Company, estimated at $875,000.
(3) Certain Selling Stockholders of the Company have granted to the
Underwriters a 30-day option to purchase up to 525,000 additional shares
of Common Stock solely to cover over-allotments, if any. If the
Underwriters exercise this option in full, the Price to Public will total
$64,400,000, the Underwriting Discount will total $4,508,000 and the
Proceeds to Selling Stockholders will total $18,228,000. See
"Underwriting."
The shares of Common Stock are offered by the several Underwriters named
herein, subject to receipt and acceptance by them and subject to their right
to reject any order in whole or in part. It is expected that delivery of the
certificates representing such shares will be made against payment therefor at
the offices of Montgomery Securities on or about July 8, 1997.
----------------
MONTGOMERY SECURITIES
WESSELS, ARNOLD & HENDERSON
H.C. WAINWRIGHT & CO., INC.
July 2, 1997
<PAGE>
Inside Front Cover:
The inside front cover depicts a computer screen shot of the Peritus
AutoEnhancer/2000 Software. Underneath the heading is the following text: The
Peritus AutoEnhancer/2000 software automates identification of date-sensitive
variables, correction of source code and generation of programs that convert
data and create bridges. The screen shot labels the tasks (Set Up
Identification; Analyze Data Access; Prepare Seed List; Propagate Seeds; Add
Seeds; Approve Identification Phase), steps (Build Renovation Directory; PILate;
Review PILation Messages; Complete Identification Setup) and functions
(described below) depicted on the screen. There are a number of arrows emanating
from the screen that describe the various functions in the Company's
AutoEnhancer/2000 software:
Segmentation:
-------------
Load the software to be renovated into the renovation center, put it under
source code control and verify its completeness.
Identification:
---------------
Convert the source code to PIL, augment the seed list using the adaptive
seed generator and propagate the seed information through the software to
identify the date-sensitive variables.
Correction:
-----------
Correct the source code according to the correction strategy selected (data
expansion, logic correction or a hybrid).
Bridge:
-------
Build the required bridges by generating wrappers, filters and converters.
Adaptation:
-----------
Identify and annotate the date-sensitive job control and note any record
size changes.
Verification:
-------------
Reconcile the correction audit trail and compare the compile results from
the pre- and post-renovation source code.
Packaging:
----------
Package the renovated source code and generated source code for return to
the client.
The Powered by Peritus logo is in the lower right corner of the page.
Gatefold Graphic
The gatefold graphic is a matrix composed of rows and columns and entitled
"Year 2000 Mass Change Renovation -- Powered by Peritus." The left column of the
matrix identifies each of the four rows: (i) Phases, (ii) Tasks, (iii)
Technology and (iv) Capacity. The first row (Phases) identifies the phases of a
year 2000 renovation: assessment, correction and test. The second row (Tasks)
describes the tasks of each phase: (i) under assessment--perform inventory,
analyze business exposure, resolve dispositions, analyze impact and plan
renovation; (ii) under correction--identify date-sensitive variables, correct
code, generate bridges and generate data converters; and (iii) under test--
perform unit tests, perform system tests and deploy into production. The third
row (Technology) describes the technology with the following text: The
AutoEnhancer/2000 software is designed to be interoperable with third party
assessment and testing tools. The diagram indicates that the technology for an
assessment phase is provided by third party assessment tool providers, the
technology for the correction phase (and part of the assessment and test phases)
resides with Peritus AutoEnhancer/2000 and the technology for the test phase
resides with third party test tool providers. The last row (Capacity) describes
the capacity of a year 2000 renovation with the following text: Peritus licenses
its AutoEnhancer/2000 software directly and indirectly to end users and value
added integrators. As of April 30, 1997, the AutoEnhancer/2000 software was
installed in more than 45 installations. The last row of the graph shows
graphical representations of various renovation centers: clients, value added
integrators (VAI's) and Peritus.
----------------
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK
OFFERED HEREBY, INCLUDING THE ENTRY OF STABILIZING BIDS, SYNDICATE COVERING
TRANSACTIONS OR THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information, including "Risk Factors" and the Consolidated Financial Statements
and the Notes thereto, appearing elsewhere in this Prospectus. Except as
otherwise noted herein, all information in this Prospectus (i) reflects the
filing in May 1997 of Articles of Amendment to the Company's Articles of
Organization redesignating the Company's Class A Voting Common Stock as Common
Stock (the "Common Stock"), (ii) gives effect upon the closing of this offering
to the lapse of the Redeemable Common Stock Right and the conversion of the
Company's Class B Non-Voting Common Stock (the "Class B Common Stock"), Series
A Convertible Preferred Stock and Series B Convertible Preferred Stock
(together, the "Convertible Preferred Stock") into an aggregate of 3,822,903
shares of Common Stock and (iii) assumes no exercise of the Underwriters' over-
allotment option. See "Description of Capital Stock," "Underwriting" and Note
10 of Notes to the Company's Consolidated Financial Statements.
THE COMPANY
Peritus Software Services, Inc. ("Peritus" or the "Company") provides
software products and services that enable organizations to improve the
productivity, quality and effectiveness of their information technology ("IT")
systems maintenance or "software evolution" functions. The Company's solutions,
which employ software tools, methodologies and processes, are designed to
automate the labor-intensive processes involved in conducting "mass change" and
other software maintenance tasks. In 1996, the Company released its first
software product, its AutoEnhancer/2000 software, which is aimed at the most
pressing mass change challenge, the "year 2000 problem." The Company licenses
this software directly to end users as well as through consultants, systems
integrators (together, "value added integrators") and distributors. The Company
also provides software maintenance outsourcing services to large organizations
that seek to enhance the productivity of their IT systems and application
software maintenance functions.
Organizations worldwide are faced with the challenge of modifying, enhancing
and adapting their IT systems and evolving their software to respond to a
changing and more competitive business environment. This challenge has
increased with the broadening complexity of IT and the continued evolution of
mainframe systems, as well as the advent of distributed, client/server
computing and the proliferation of third-party enterprise software
applications. One of the most crucial software evolution challenges facing IT
departments is the cost-effective implementation of mass changes to application
systems and their associated databases. Examples of mass change problems
include the year 2000 problem, which is the inability of certain computer
systems to properly interpret dates for the year 2000 and beyond, the European
Union's expected conversion to the euro currency, the anticipated expansion in
the number of digits in Japan's telephone numbers and the extension of the
number of digits or other characters in zip codes, product codes and account
numbers.
According to its January 1993 ADM Research Note, Gartner Group, Inc.
estimated that, within the established worldwide IT infrastructure, up to 200
billion lines of COBOL software code have been written to support applications,
many of which are mission-critical. In addition, between 60% to 80% of the
average annual IT application development budget is spent on the maintenance of
legacy applications. Although the maintenance function within IT departments
has received little management attention historically, the impending year 2000
problem, with an estimated cost of between $300 and $600 billion to fix,
represents the most significant IT maintenance challenge to date.
The Company's AutoEnhancer/2000 software is designed to automate the critical
correction phase of a year 2000 renovation. The Company has entered into
agreements with a number of leading value added integrators and distributors,
including Bull HN Information Systems Inc., a related party, CIBER, Inc.,
Computer Sciences Corp., IBM Global Services and Keane, Inc., which license the
Company's software tool for use in serving their clients. The Company also
licenses its AutoEnhancer/2000 software tool directly to end users, including
Metropolitan Life Insurance Company and Merrill Lynch, Pierce, Fenner & Smith
Incorporated, which are
3
<PAGE>
employing the tool in-house as part of their year 2000 renovation efforts.
During 1996 and the three months ended March 31, 1997, revenue from the
licensing of the AutoEnhancer/2000 software represented 33.9% and 52.7% of the
Company's total revenue, respectively, and the Company expects that such
license revenue will continue to represent a significant percentage of its
total revenue for the foreseeable future. In June 1997, the Company entered
into a joint marketing agreement with VIASOFT, Inc., a provider of enterprise
application management solutions, to form a joint marketing arrangement that
would combine complementary product and services offerings in a "best practice"
suite of year 2000 solutions.
The Company's software maintenance outsourcing services are provided on a
fixed-fee basis and employ the Company's proprietary software tools,
methodologies and processes to generate productivity gains through the
automation of the software evolution process. Under maintenance outsourcing
engagements, the Company typically assumes responsibility for providing
software maintenance services for the client. Productivity gains can be
realized through contract pricing that guarantees reductions in IT costs and/or
measurable improvements in the quality and throughput of maintenance tasks. The
Company provides its outsourcing services pursuant to multi-year engagements to
a number of large organizations, including Advanced Micro Devices, Inc., Bull
HN Information Systems Inc., a related party, Computervision Corporation,
MicroAge Computer Center, Inc., NYNEX and Stratus Computer, Inc. The Company
also provides its productivity-enhancing maintenance techniques to clients that
maintain their source code in-house through the Company's technology transfer
services.
The Company's objective is to establish leadership in providing solutions
based on software tools and methodologies that significantly enhance the
productivity of the software evolution process. The Company intends to
accomplish this goal by developing additional product extensions from its core
technology that are aimed at specific mass change challenges. In addition, the
Company intends to leverage the relationships developed through its year 2000
products and services into long-term outsourcing engagements and future mass
change sales opportunities.
Peritus is a Massachusetts corporation organized in August 1991. The
Company's principal executive offices are located at 304 Concord Road,
Billerica, Massachusetts 01821-3485, and its telephone number is (508)
670-0800.
THE OFFERING
<TABLE>
<C> <S>
Common Stock offered by the Company................ 2,800,000 shares
Common Stock offered by the Selling Stockholders... 700,000 shares
Common Stock to be outstanding after the offering.. 12,822,304 shares (1)
Use of proceeds.................................... For (i) repayment of
certain existing
indebtedness, (ii)
research and development,
(iii) working capital and
other general corporate
purposes and (iv) possible
acquisitions.
Nasdaq National Market symbol...................... PTUS
</TABLE>
- --------
(1) Based on the number of shares of Common Stock outstanding on June 30, 1997.
Excludes an aggregate of 3,012,957 shares of Common Stock reserved under
the Company's 1992 Long-Term Incentive Plan, all of which shares were
subject to outstanding options as of June 30, 1997 at a weighted average
exercise price of $2.28 per share. Also excludes an aggregate of 2,350,000
shares of Common Stock reserved under the Company's 1997 Stock Incentive
Plan, 1997 Director Stock Option Plan and 1997 Employee Stock Purchase
Plan, 469,500 of which shares were subject to outstanding options as of
June 30, 1997 at an exercise price of $10.00 per share. Also excludes
312,500 shares of Common Stock issuable upon the exercise of outstanding
warrants as of June 30, 1997 at an exercise price of $1.60 per share. See
"Management--Executive Compensation" and Notes 10 through 14 of Notes to
the Company's Consolidated Financial Statements.
4
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------------ ---------------
1992 1993 1994 1995 1996 1996 1997
----- ------ ------ ------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenue:
Outsourcing services... $ 746 $1,798 $7,130 $16,400 $10,190 $ 2,244 $2,519
License................ -- -- -- -- 6,526 -- 4,144
Other services......... 117 433 742 2,105 2,519 404 1,196
----- ------ ------ ------- ------- ------- ------
Total revenue (1).... 863 2,231 7,872 18,505 19,235 2,648 7,859
Cost of revenue:
Outsourcing services... 517 841 4,700 9,602 8,488 2,234 2,045
License................ -- -- -- -- 162 -- 127
Other services......... 103 306 319 2,421 2,931 506 1,289
----- ------ ------ ------- ------- ------- ------
Total cost of
revenue............. 620 1,147 5,019 12,023 11,581 2,740 3,461
----- ------ ------ ------- ------- ------- ------
Gross profit (loss)...... 243 1,084 2,853 6,482 7,654 (92) 4,398
Total operating
expenses................ 357 889 2,209 6,189 12,398 2,762 3,942
----- ------ ------ ------- ------- ------- ------
Income (loss) from
operations.............. (114) 195 644 293 (4,744) (2,854) 456
Net income (loss)........ $(112) $ 188 $ 305 $ 55 $(4,921) $(2,712) $ 406
Pro forma net income
(loss) per share (2).... $ (0.46) $ 0.03
Weighted average shares
used to compute pro
forma net income (loss)
per share (2)........... 10,695 12,711
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1997
------------------------
PRO FORMA
ACTUAL AS ADJUSTED (3)
------- ---------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............................. $ 5,022 $44,731
Working capital........................................ 8,406 48,115
Total assets........................................... 15,712 55,421
Long-term debt, net of current portion................. 1,476 533
Redeemable stock....................................... 12,546 --
Stockholders' equity (deficit)......................... (3,160) 50,038
</TABLE>
- --------
(1) Revenue (in thousands) from related parties in the years ended December 31,
1992, 1993, 1994, 1995 and 1996 and the three months ended March 31, 1996
and 1997 was $745, $824, $4,317, $10,124, $6,443, $1,179 and $975,
respectively. See the Company's Consolidated Financial Statements.
(2) See Note 2 of Notes to the Company's Consolidated Financial Statements for
an explanation of the determination of pro forma net income (loss) per
share.
(3) Gives effect to (i) the conversion of all outstanding shares of Class B
Common Stock and Convertible Preferred Stock into Common Stock and the
lapse of the Redeemable Common Stock Right upon the closing of this
offering, and (ii) the sale by the Company of the 2,800,000 shares of
Common Stock offered hereby, and the application of a portion of the
estimated net proceeds therefrom to repay certain indebtedness, after
deducting the underwriting discount and estimated offering expenses. See
"Use of Proceeds."
5
<PAGE>
FORWARD-LOOKING STATEMENTS
Information contained in this Prospectus includes "forward-looking
statements" that are based largely on the Company's current expectations and
are subject to a number of risks and uncertainties. The Company faces many
risks and uncertainties, including without limitation those described in this
Prospectus under the caption "Risk Factors." Because of these many risks and
uncertainties, the Company's actual results may differ materially from any
results presented in or implied by the forward-looking statements included in
this Prospectus.
----------------
Peritus is a registered trademark of the Company, Automate: 2000 is a
registered service mark of the Company and AutoEnhancer/2000 is a trademark of
the Company. Other trademarks and service marks used in this Prospectus are the
property of their respective owners.
6
<PAGE>
RISK FACTORS
In addition to the other information in this Prospectus, the following
factors should be considered carefully in evaluating an investment in the
Common Stock offered hereby.
LIMITED OPERATING HISTORY; NET LOSS
The Company was founded in August 1991 and began operations in 1992. Most of
the Company's revenue to date has been attributable to software maintenance
outsourcing and other services, and the Company had no license revenue prior
to 1996. The Company's software maintenance AutoEnhancer/2000 software, which
the Company anticipates will provide the principal source of new license
revenue for the foreseeable future, has a limited history of client acceptance
and use. Accordingly, the Company has only a limited operating history upon
which an evaluation of the Company and its prospects can be based. The
Company's prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by organizations in their early stage of
development, particularly companies in new and rapidly evolving markets. To
address these risks, the Company must, among other things, respond to
competitive developments, continue to attract, retain and motivate qualified
management and other employees, continue to upgrade its technologies and
commercialize products and services that incorporate such technologies and
achieve market acceptance for its products and services. There can be no
assurance that the Company will be successful in addressing such risks. The
Company incurred a net loss of $4,921,000 during 1996, and there can be no
assurance that the Company will achieve or sustain profitability.
POTENTIAL FLUCTUATIONS IN QUARTERLY PERFORMANCE
The Company's revenue and operating results have varied substantially from
quarter to quarter. The Company's quarterly operating results may continue to
fluctuate due to a number of factors, including the timing, size and nature of
the Company's individual outsourcing, technology transfer, insourcing and
licensing transactions; unforeseen difficulties in performing such
transactions; the performance of the Company's value added integrators and
distributors; the timing of the introduction and the market acceptance of new
services, products or product enhancements by the Company or its competitors;
the relative proportions of revenue derived from license fees and professional
services; changes in the Company's operating expenses; personnel changes;
foreign currency exchange rates and fluctuations in economic and financial
market conditions.
The timing, size and nature of individual outsourcing, technology transfer,
insourcing and licensing transactions are important factors in the Company's
quarterly operating results. Many such transactions involve large dollar
amounts, and the sales cycle for these transactions is often lengthy and
unpredictable. In addition, the sales cycle associated with these transactions
is subject to a number of uncertainties, including clients' budgetary
constraints, the timing of clients' budget cycles and clients' internal
approval processes. There can be no assurance that the Company will be
successful in closing such large transactions on a timely basis or at all. In
addition, as the Company begins to derive a greater proportion of total
revenue from license revenue, the Company may realize a disproportionate
amount of its revenue and income in the last month of each quarter and, as a
result, the magnitude of quarterly fluctuations may not become evident until
late in, or at the end of, a given quarter. Accordingly, delays in product
delivery or in the closing of sales near the end of a quarter could cause
quarterly revenue and, to a greater degree, operating results to fall
substantially short of anticipated levels. Most of the Company's outsourcing
engagements are performed on a fixed-price basis and, therefore, the Company
bears the risk of cost overruns and inflation. A significant percentage of the
Company's revenue derived from these engagements is recognized on the
percentage-of-completion method, which requires revenue to be recorded over
the term of a client contract. A loss is recorded at the time when current
estimates of project costs exceed unrecognized revenue. The Company's
operating results may be adversely affected by inaccurate estimates of
contract completion costs.
The Company's expense levels are based, in part, on its expectations as to
future revenue and are fixed, to a large extent, in the short term. As a
result, the Company may be unable to adjust spending in a timely manner to
compensate for any unexpected revenue shortfall. Accordingly, any significant
shortfall in revenue in relation to the Company's expectations would have an
immediate and material adverse effect on the Company's business,
7
<PAGE>
financial condition and results of operations. In addition, the Company plans
to increase operating expenses to expand its research and development, client
technical support and professional services staff, sales force and
administrative infrastructure. The timing of such expansion and the rate at
which new personnel become productive could cause material fluctuations in
quarterly and annual results of operations.
Due to all of the foregoing factors, the Company believes that period-to-
period comparisons of its operating results are not necessarily meaningful and
that such comparisons cannot be relied upon as indicators of future
performance. There can be no assurance that future revenue and operating
results will not vary substantially. It is also possible that in some future
quarter the Company's operating results will be below the expectations of
public market analysts and investors. In either case, the price of the
Company's Common Stock could be materially adversely affected. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
DEPENDENCE ON YEAR 2000 MARKET
The growth in the Company's revenue in 1996 and the three months ended March
31, 1997 resulted primarily from increased demand for the Company's services
and products relating to resolution of the year 2000 problem. Although the
Company believes that the market for products and services relating to the
year 2000 problem will grow as the year 2000 approaches, there can be no
assurance that this market will develop to the extent anticipated by the
Company, if at all. Significant expense for sales and marketing may be
required to inform potential clients of the year 2000 problem and the need for
products and services addressing the problem. There can be no assurance that
the year 2000 solution providers will devote the resources necessary to
effectively inform potential clients of this problem or that potential clients
will understand or acknowledge the problem. In addition, affected
organizations may not be willing or able to allocate the resources, financial
or otherwise, to address the problem in a timely manner. Many organizations
may attempt to resolve the problem internally rather than contract with
outside firms such as the Company and value added integrators to which the
Company licenses its software products. Due to these factors, development of
the market for year 2000 products and services is uncertain and unpredictable.
If the market for year 2000 products and services fails to grow, or grows more
slowly than anticipated, the Company's business, financial condition and
results of operations could be materially adversely affected.
NEED TO DEVELOP ADDITIONAL PRODUCTS AND SERVICES
The Company currently generates significant revenue from, and devotes
significant resources to, products and services that address the year 2000
problem. Although the Company believes that the demand for its products and
services relating to the year 2000 problem will continue to exist for some
time after the year 2000, this demand will diminish significantly over time
and will eventually disappear. There can be no assurance that the Company will
be able to expand successfully its business beyond the year 2000 market.
Specifically, there can be no assurance that mass change markets such as those
associated with Europe's expected conversion to the euro currency or Japan's
anticipated telephone number expansion will develop or reach the size
currently estimated or that the Company will successfully develop or market
products and services capable of handling such mass changes. The failure to
diversify and develop additional products and services would have a material
adverse effect on the Company's business, financial condition and results of
operations.
CONCENTRATION OF CLIENTS AND CREDIT RISK; RELATED PARTY TRANSACTIONS
To date, the Company's revenue has been dependent on a few major clients,
Bull HN Information Systems Inc., a related party ("Bull"), Stratus Computer,
Inc. ("Stratus"), Computervision Corporation ("Computervision"), Metropolitan
Life Insurance Company ("Met Life"), IBM Global Services ("IBM") and Merrill
Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch"). During the three
months ended March 31, 1997, Merrill Lynch, Met Life and IBM represented
approximately 26.1%, 14.0% and 10.6% of the Company's total revenue,
respectively. During 1996, Bull, Merrill Lynch and Stratus represented
approximately 29.0%, 14.6% and 12.1% of the Company's total revenue,
respectively. During 1995, Bull, Stratus and Computervision represented
approximately 50.3%, 12.9% and 11.0% of the Company's total revenue,
respectively. During 1994, Bull and Computervision represented approximately
51.7% and 29.3% of the
8
<PAGE>
Company's total revenue, respectively. In addition, the Company's ten largest
clients represented approximately 82.2%, 77.9%, 90.5% and 92.1% of the
Company's total revenue in the three months ended March 31, 1997 and the years
ended December 31, 1996, 1995 and 1994, respectively. Most of the Company's
contracts with its clients are terminable at will by either party upon written
notice in accordance with the terms of the contract, at which time payment for
services rendered to date is due. In addition, certain contracts provide for
limited price protection and related notice provisions that could require the
Company to adjust the pricing provisions of these contracts. To date, the
Company has not made any such adjustments. Although the Company's largest
clients have varied from period to period, the Company anticipates that its
results of operations in any given period will continue to depend to a
significant extent upon revenue from a small number of clients. There can be
no assurance that the Company's major clients will continue to purchase
products and services from the Company at current levels, if at all, or that
the Company will be able to replace revenue from such clients with revenue
from other clients. The loss of, or a significant reduction in revenue from,
any of the Company's major clients could have a material adverse effect on the
Company's business, financial condition and results of operations. In
addition, with such a large percentage of the Company's revenue attributable
to a small number of clients, the loss of one or more major clients could have
a material adverse effect on the Company's liquidity. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Liquidity and Capital Resources," "Certain Transactions" and Note 8 of Notes
to the Company's Consolidated Financial Statements.
MANAGEMENT OF GROWTH
The Company's business has grown significantly in size and complexity over
the past three years. Total revenue increased from $7,872,000 in 1994 to
$19,235,000 in 1996. In addition, the number of employees increased from 130
to 229 during the same period, and the Company expects to hire additional
personnel during 1997. The growth in the size and complexity of the Company's
business as well as its client base has placed and is expected to continue to
place a significant strain on the Company's management and operations. Certain
members of the Company's senior management team have been with the Company for
less than a year, and the Company's senior management has had limited
experience in managing publicly traded companies. The Company anticipates that
continued growth, if any, will require it to recruit and hire a substantial
number of new development, managerial, finance, sales and marketing and
support personnel. Competition for such personnel is intense, and there can be
no assurance that the Company will be successful in hiring or retaining such
personnel. The Company's ability to compete effectively and to manage future
growth, if any, will depend on its ability to continue to implement and
improve operational, financial and management information systems on a timely
basis and to expand, train, motivate and manage its work force. There can be
no assurance that the Company's personnel, systems, procedures and controls
will be adequate to support the Company's operations.
DEPENDENCE UPON THIRD-PARTY CHANNELS; POTENTIAL FOR CHANNEL CONFLICT
The Company offers its products and services directly to end users through
its sales force and indirectly through third-party channels, which include
value added integrators and distributors. Although sales through third-party
channels accounted for only 16.6% of the Company's total revenue in the three
months ended March 31, 1997, the Company expects to rely to a significant
degree on its value added integrators and distributors to provide sales and
marketing presence and name recognition, as well as the resources necessary to
offer large-scale, comprehensive software maintenance solutions, including
solutions relating to the year 2000 problem. Although the Company dedicates
significant resources to develop its indirect channels, there can be no
assurance that the Company will be able to attract and retain a sufficient
number of qualified firms to successfully sell and market its products. While
the Company has granted exclusive marketing rights to certain distributors in
defined geographic territories, these firms are not prohibited from entering
into similar arrangements with the Company's competitors. The failure of the
Company to maintain its current third-party channels or develop other third-
party channels, the Company's inability to adequately support the requirements
of its third-party channels, the development of competitive products and
services by the Company's value added integrators and distributors or the
entry by such firms into alliances with competitors of the Company would
substantially limit the Company's ability to provide its products and services
and, accordingly, would have a material adverse effect on the Company's
business, financial condition and results of operations.
9
<PAGE>
In June 1997, the Company entered into a joint marketing agreement with
VIASOFT, Inc. ("VIASOFT") to form a joint marketing arrangement that would
combine complementary product and service offerings in a "best practice" suite
of year 2000 solutions. There can be no assurance, however, that such
marketing arrangement will yield a suite of year 2000 solutions or that such
solutions will be accepted by the marketplace. There also can be no assurance
that the Company will enter into "best practice" marketing arrangements with
any other firm or that any such arrangements would be successful.
Selling through indirect channels may also limit the Company's contacts with
end users of its products and services. As a result, the Company's ability to
accurately forecast sales, evaluate client satisfaction and recognize emerging
client requirements may be hindered. The Company's strategy of selling its
products directly to end users and indirectly through third-party channels may
result in distribution channel conflicts. The Company's direct sales efforts
may compete with those of its indirect channels and, to the extent different
value added integrators and distributors target the same clients, they may
also come into conflict with each other. There can be no assurance that
channel conflicts will not materially adversely affect its relationship with
existing value added integrators or distributors or adversely affect its
ability to attract new value added integrators and distributors. In addition,
if the Company is successful in increasing product sales through third-party
channels, the Company expects that any material increase in the Company's
indirect sales as a percentage of total revenue may materially adversely
affect the Company's average selling prices and gross margins due to
potentially lower average license fees from indirect channels. See "Business--
Sales and Marketing."
COMPETITION
The market for the Company's products and services is intensely competitive
and is characterized by rapid change in technology and user needs and the
frequent introduction of new products. The anticipated growth in the mass
change and year 2000 industries is expected to attract additional competitors,
some of which may offer additional products and services. There are no
significant barriers to entry in the year 2000 industry. In addition, the
Company faces competition in the software maintenance outsourcing services
market. A number of the Company's competitors are more established, benefit
from greater name recognition and have substantially greater financial,
technical and marketing resources than those of the Company and certain of the
Company's value added integrators and distributors. As a result, there can be
no assurance that the Company's products and services, including the solutions
offered by the Company's value added integrators and distributors, will
compete effectively with those of their respective competitors. The Company's
value added integrators and distributors may also offer or develop products
and services that compete with the Company's products and services. There can
be no assurance that such value added integrators and distributors will not
give higher priority to the sales of these or other competitive products and
services. See "Business--Competition."
COMPETITIVE MARKET FOR TECHNICAL PERSONNEL
The future success of the Company's growth strategy will depend to a
significant extent on its ability to attract, train, motivate and retain
highly skilled software professionals, particularly project managers, software
engineers and other senior technical personnel. The Company believes that
there is a shortage of, and significant competition for, software development
professionals with the skills and experience necessary to perform the services
offered by the Company. The Company's ability to maintain and renew existing
engagements and obtain new business depends, in large part, on its ability to
hire and retain technical personnel with the IT skills that keep pace with
continuing changes in software evolution, industry standards and technologies
and client preferences. The inability to hire additional qualified personnel
could impair the Company's ability to satisfy its growing client base,
requiring an increase in the level of responsibility for both existing and new
personnel. There can be no assurance that the Company will be successful in
retaining current or future employees.
FIXED-PRICE, FIXED-TIME FRAME CONTRACTS
As a core element of its business philosophy, the Company's strategy is to
offer its outsourcing and technology transfer services on fixed-price, fixed-
time frame contracts, rather than contracts in which payment to the Company is
determined solely on a time-and-materials basis. These contracts are
terminable by either party
10
<PAGE>
generally upon prior written notice. Although the Company uses its proprietary
tools and methodologies and its past project experience to reduce the risks
associated with estimating, planning and performing the fixed-price projects,
the Company's standard outsourcing and technology transfer agreements provide
for a fixed-fee based on projected reductions in a client's maintenance costs
and increases in a client's maintenance productivity. The Company's failure to
estimate accurately the resources, costs and time required for a project or
its failure to complete its contractual obligations within the time frame
committed could have a material adverse effect on the Company's business,
financial condition and results of operations.
POTENTIAL FOR CONTRACT LIABILITY
The Company's products and services relating to software maintenance,
especially solutions addressing the year 2000 problem, involve key aspects of
its clients' computer systems. A failure in a client's system could result in
a claim for substantial damages against the Company, regardless of the
Company's responsibility for such failure. The Company attempts to limit
contractually its liability for damages arising from negligent acts, errors,
mistakes or omissions in rendering its products and services. Despite this
precaution, there can be no assurance that the limitations of liability set
forth in its contracts would be enforceable or would otherwise protect the
Company from liability for damages. Additionally, the Company maintains
general liability insurance coverage, including coverage for errors and
omissions. However, there can be no assurance that such coverage will continue
to be available on acceptable terms, or will be available in sufficient
amounts to cover one or more large claims, or that the insurer will not
disclaim coverage as to any future claim. The successful assertion of one or
more large claims against the Company that exceed available insurance coverage
or changes in the Company's insurance policies, including premium increases or
the imposition of large deductible or co-insurance requirements, could have a
material adverse effect on the Company's business, financial condition and
results of operations. Furthermore, litigation, regardless of its outcome,
could result in substantial cost to the Company and divert management's
attention from the Company's operations. Any contract liability claim or
litigation against the Company could, therefore, have a material adverse
effect on the Company's business, financial condition and results of
operations.
SOFTWARE ERRORS OR BUGS
The Company's software products and tools are highly complex and
sophisticated and could from time to time contain design defects or software
errors that could be difficult to detect and correct. Errors, bugs or viruses
may result in loss of or delay in market acceptance, a failure in a client's
system or loss or corruption of client data. Although the Company has not
experienced material adverse effects resulting from any software defects or
errors, there can be no assurance that, despite testing by the Company and its
clients, errors will not be found in new products, which errors could have a
material adverse effect upon the Company's business, financial condition and
results of operations.
INTEGRATION OF ACQUISITIONS
In January 1996, the Company acquired Vista Technologies Incorporated, a
developer of computer-aided engineering software. Although the Company has no
existing commitments or agreements regarding any acquisitions, it may in the
future seek acquisitions of businesses, products and technologies that are
complementary to those of the Company. There can be no assurance that the
Company will ultimately effect any such acquisition, or that the Company will
be able to integrate successfully into its operations any business that it may
acquire. The process of integrating an acquired company's business into the
Company's operations may result in ongoing and extraordinary operating
difficulties and expenditures, may absorb significant management attention
that would otherwise be available for the ongoing development of the Company's
business and may result in charges to operating results. In addition, future
acquisitions by the Company could result in potentially dilutive issuances of
equity securities, the incurrence of debt and contingent liabilities and
amortization expenses related to goodwill and other intangible assets, any of
which could have a material adverse effect on the Company's business,
financial condition and results of operations. Acquisitions also involve other
risks, including entering markets in which the Company has limited or no
direct prior experience and the potential loss of key employees. There can be
no assurance that a given acquisition, whether or not consummated, would not
have a material adverse effect on the Company's business, financial condition
and results of operations.
11
<PAGE>
LIMITED PROTECTION OF PROPRIETARY RIGHTS
The Company relies on a combination of patent, copyright, trademark and
trade secret laws and license agreements to establish and protect its rights
in its software products and proprietary technology. In addition, the Company
currently requires its employees and consultants to enter into nondisclosure
and assignment of invention agreements to limit use of, access to and
distribution of its proprietary information. There can be no assurance that
the Company's means of protecting its proprietary rights in the United States
or abroad will be adequate. The laws of some foreign countries may not protect
the Company's proprietary rights as fully or in the same manner as do the laws
of the United States. Also, despite the steps taken by the Company to protect
its proprietary rights, it may be possible for unauthorized third parties to
copy aspects of the Company's products, reverse engineer, develop similar
technology independently or obtain and use information that the Company
regards as proprietary. Furthermore, there can be no assurance that others
will not develop technologies similar or superior to the Company's technology
or design around the proprietary rights owned by the Company.
The Company has entered into license agreements with a limited number of
clients that allow these clients access to and use of the Company's
AutoEnhancer/2000 software source code for certain purposes. Access to the
Company's source code may increase the likelihood of misappropriation or
misuse by third parties.
The Company has filed two patent applications with the United States Patent
and Trademark Office (the "PTO") pertaining to technologies, processes and
methodologies with respect to the Company's software. Neither of these patents
has been granted and there can be no assurance that a patent will be issued
pursuant to either of these applications or that, if granted, such patent
would survive a legal challenge to its validity or provide meaningful or
significant protection to the Company. Some competitors of the Company have
announced the filing with the PTO of patent applications relating to fixing
and assessing the year 2000 problem. The Company expects that the risk of
infringement claims against the Company might increase because its competitors
might successfully obtain patents for software products and processes or
because new and overlapping processes and methodologies used in such services
will become more pervasive, increasing the likelihood of infringement. There
can be no assurance that third parties will not assert infringement claims
against the Company in the future, that the assertion of such claims will not
result in litigation or that the Company would prevail in such litigation or
be able to obtain a license for the use of any infringed intellectual property
from a third party on commercially reasonable terms, if at all. Furthermore,
litigation, regardless of its outcome, could result in substantial cost to the
Company and divert management's attention from the Company's operations. Any
infringement claim or litigation against the Company could, therefore, have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company maintains trademarks and service marks to identify its various
service offerings, products and software. Although the Company has registered
one trademark and one service mark with the PTO and has several trademark and
service mark applications pending in the United States and foreign
jurisdictions, not all of the applications have been granted and, even if
granted, there can be no assurance that a particular trademark or service mark
will survive a legal challenge to its validity or provide meaningful or
significant protection to the Company. In some cases, entities other than the
Company are using certain trademarks and service marks, either in
jurisdictions in which the Company has not filed an application or in which
the Company is using a mark in a different manner than a third party. There
may be some risk of infringement claims against the Company in the event that
a service or product of the Company is too similar to that of another entity
that is using a similar mark.
DEPENDENCE ON THIRD-PARTY TECHNOLOGY
The Company's proprietary software is currently designed, and may in the
future be designed, to work on or in conjunction with certain third-party
hardware and/or software products. If any of these current or future third-
party vendors were to discontinue making their products available to the
Company or to licensees of the Company's software or to increase materially
the cost to the Company or its licensees to acquire, license or purchase the
third-party vendors' products, or if a material problem were to arise in
connection with the ability of the Company to design its software to properly
use or operate with third-party hardware and/or software products, the Company
would be required to redesign its software to function with or on alternative
third-party
12
<PAGE>
products or attempt to develop internally a replacement for the third-party
products. In such an event, interruptions in the availability or functioning
of the Company's software and delays in the introduction of new products and
services may occur until equivalent technology is obtained. There can be no
assurance that an alternative source of suitable technology would be available
or that the Company would be able to develop an alternative product in
sufficient time or at a reasonable cost. The failure of the Company to obtain
or develop alternative technologies or products on a timely basis and at a
reasonable cost could have a material adverse effect on the Company's
business, financial condition and results of operations.
RAPID TECHNOLOGICAL CHANGE
The market for the Company's products and services is characterized by
rapidly changing technology, evolving industry standards and new product
introductions and enhancements that may render existing products obsolete. As
a result, the Company's market position could erode rapidly due to unforeseen
changes in the features and functionality of competing products. The Company's
future success will depend in part upon its ability to enhance its existing
products and services and to develop and introduce new products and services
to meet changing client requirements. The process of developing products and
services such as those offered by the Company is extremely complex and is
expected to become increasingly complex and expensive in the future with the
introduction of new platforms and technologies. There can be no assurance that
the Company will successfully complete the development of new products in a
timely fashion or that the Company's current or future products will satisfy
the needs of its target market.
DEPENDENCE ON KEY MANAGEMENT PERSONNEL
The Company's business depends on a small number of key managerial
personnel. The loss of any of these key individuals could have a material
adverse effect on the Company's operations. In particular, the Company's
operations, particularly its research and development efforts, are dependent
on Dr. Dominic K. Chan, the Company's Chairman and Chief Executive Officer.
Dr. Chan is not subject to an employment agreement with the Company. See
"Management--Employment Agreements."
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS
Although the Company's international revenue represented only 9.4% of total
revenue during 1996, the Company has subsidiaries in Spain and India and
distributors in Canada, Italy and Japan, and intends to expand its
international sales activities as part of its business strategy. To date,
substantially all of the Company's international revenue has been attributable
to revenue generated by the Company's majority-owned Spanish subsidiary,
Persist, S.A. In order to expand international sales, the Company must
establish additional foreign operations, hire additional personnel and
establish relationships with additional value added integrators and
distributors. This will require significant management attention and financial
resources and could have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, there can be no
assurance that the Company will be able to address international market demand
for the Company's products and services. The Company's international sales are
primarily denominated in U.S. dollars. An increase in the value of the U.S.
dollar relative to foreign currencies could make the Company's products more
expensive and, therefore, potentially less competitive in those markets. In
addition, the Company's international business may be subject to a variety of
risks, including difficulties in collecting international accounts receivable
or obtaining U.S. export licenses, potentially longer payment cycles,
increased costs associated with maintaining international marketing efforts,
the introduction of non-tariff barriers and higher duty rates and difficulties
in enforcement of contractual obligations and intellectual property rights.
There can be no assurance that such factors will not have a material adverse
effect on the Company's future international sales and, consequently, on the
Company's business, financial condition or results of operations.
DEPENDENCE ON INDIA OFFSHORE SOFTWARE DEVELOPMENT CENTER
The Company has recently established an offshore software development center
in Bangalore, India that is intended to provide the Company with a cost
advantage as well as the ability to provide 24-hour coverage for its
13
<PAGE>
outsourcing services clients. To provide its service delivery model, the
Company must maintain communications between its offices, the offices of its
clients in the U.S. and the Bangalore offshore software development facility.
Any loss of the Company's ability to transmit voice and data through satellite
communications to India could have a material adverse effect on the Company's
business, financial condition and results of operations. In the past, India
has experienced significant inflation, low growth in gross domestic product
and shortages of foreign exchange. India also has experienced civil unrest and
terrorism and, in the past, has been involved in conflict with neighboring
countries. No assurance can be given that the Company will not be adversely
affected by changes in inflation, interest rates, taxation, social stability
or other political, economic or diplomatic developments in or affecting India
in the future. In addition, the Indian government has exercised and continues
to exercise significant influence over many aspects of the Indian economy, and
Indian government actions concerning the economy could have material adverse
effect on private sector entities, including the Company. During recent years,
India's government has provided significant tax incentives and relaxed certain
regulatory restrictions in order to encourage foreign investment in specified
sectors of the economy, including the software development industry. Certain
of those benefits that directly affect the Company include, among others, tax
holidays, liberalized import and export duties and preferential rules on
foreign investment and repatriation. Notwithstanding these benefits, however,
India's central and state governments remain significantly involved in the
Indian economy. The elimination of any of the benefits realized by the Company
from its Indian operations could have a material adverse effect on the
Company's business financial condition and results of operations.
IMMIGRATION ISSUES
The Company believes that its success in part has resulted from its ability
to attract and retain persons with technical and project management skills
from other countries. As of May 31, 1997, approximately four of the Company's
U.S.-based employees were working for the Company in the H-1B, non-immigrant
work permitted visa classification. There is a limit on the number of new H-1B
petitions that the Immigration and Naturalization Service may approve in any
government fiscal year, and in years in which this limit is reached, the
Company may be unable to obtain H-1B visas necessary to bring critical foreign
employees to the U.S. Compliance with existing U.S. immigration laws, or
changes in such laws making it more difficult to hire foreign nationals or
limiting the ability of the Company to retain H-1B employees in the U.S.,
could require the Company to incur additional unexpected labor costs and
expenses. Any such restrictions or limitations on the Company's hiring
practices could have a material adverse effect on the Company's business,
financial condition and results of operations.
DEPENDENCE ON GOVERNMENT CONTRACTS
One of the Company's strategies is to sell its products and services
directly or indirectly to state, federal and foreign government agencies. Any
failure to obtain a contract award, or a delay on the part of a government
agency in making the award or of ordering products and services under an
awarded contract, could have a material adverse effect on the financial
performance of the Company within a given period. Other risks involved in
government sales are the larger discounts (and thus lower margins) typically
involved in government sales, the dependence of the Company on the ability of
the prime contractor to obtain the award, the unpredictability of funding for
various government programs, the ability of the government agency to
unilaterally terminate the prime contract, and the dependence on the
creditworthiness of the prime contractor (some of which are relatively small
organizations without substantial funds). The Company anticipates that
government sales may constitute a significant but fluctuating portion of its
revenue in the future.
CONTROL BY DIRECTORS AND OFFICERS
Upon completion of this offering, the Company's officers and directors, and
their affiliates, will beneficially own approximately 51.4% of the Company's
outstanding Common Stock. These stockholders, if acting together, would have
the ability to elect the Company's directors and may have the ability to
determine the outcome of corporate actions requiring stockholder approval,
irrespective of how other stockholders of the Company may vote. This
concentration of ownership may have the effect of delaying or preventing a
change in control of the Company. See "Management" and "Principal and Selling
Stockholders."
14
<PAGE>
BROAD DISCRETION AS TO USE OF PROCEEDS
The Company intends to use a portion of the net proceeds from this offering
to repay outstanding subordinated indebtedness. The remaining net proceeds
will be used, as determined by management in its sole discretion, for research
and development, working capital and general corporate purposes, as well as
for the possible acquisition of additional businesses and technologies that
are complementary to the current or future business of the Company. However,
the Company has not determined the specific allocation of the remaining net
proceeds among the various uses described above. Accordingly, investors in
this offering will rely upon the judgment of the Company's management with
respect to the use of proceeds, with only limited information concerning
management's specific intentions. See "Use of Proceeds."
NO PUBLIC MARKET
Prior to this offering, there has been no public market for the Common
Stock, and there can be no assurance that an active trading market will
develop or be sustained after this offering or that the market price of the
Common Stock will not decline below the initial public offering price. The
initial public offering price has been determined by negotiations among the
Company and the Representatives of the Underwriters. See "Underwriting" for a
discussion of the factors considered in determining the initial public
offering price. Investors should be aware that market prices for securities of
software companies such as the Company are highly volatile.
DIVIDENDS
No cash dividends have been paid on the Common Stock to date and the Company
does not anticipate paying dividends in the foreseeable future. See "Dividend
Policy."
DILUTION
Purchasers of shares of Common Stock in this offering will suffer an
immediate and substantial dilution in the net tangible book value of the
Common Stock from the initial public offering price. See "Dilution."
SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS
Sales of substantial amounts of shares of Common Stock in the public market
following this offering could adversely affect the market price of the Common
Stock. On the date of this Prospectus, in addition to the 3,500,000 shares
offered hereby, approximately 174,252 shares of Common Stock, which are not
subject to 180-day lock-up agreements (the "Lock-Up Agreements") with the
Representatives of the Underwriters, will be eligible for immediate sale in
the public market pursuant to Rule 144(k) under the Securities Act of 1933, as
amended (the "Securities Act"). Approximately 139,387 additional shares of
Common Stock, which are not subject to the Lock-Up Agreements, will be
eligible for sale in the public market in accordance with Rule 144 or Rule 701
under the Securities Act beginning 90 days after the date of this Prospectus.
Upon expiration of the Lock-Up Agreements 180 days after the date of this
Prospectus (and assuming no exercise of outstanding options), approximately
9,008,665 additional shares of Common Stock will be available for sale in the
public market, subject to the provisions of Rule 144 under the Securities Act.
Promptly following the consummation of this offering, the Company intends to
register an aggregate of 400,000 shares of Common Stock issuable under its
1997 Director Stock Option Plan and 1997 Employee Stock Purchase Plan. In
addition, the Company intends to register approximately 4,962,957 shares of
Common Stock issuable under its 1992 Long-Term Incentive Plan and 1997 Stock
Incentive Plan following the 90th day after the date of this Prospectus.
Holders of approximately 10,107,071 shares of Common Stock (including
1,068,406 shares of Common Stock that may be acquired pursuant to the exercise
of vested options held by them and exercisable within 60 days of June 30,
1997) have agreed, pursuant to the Lock-Up Agreements, not to sell, offer,
contract or grant any option to sell, pledge, transfer, establish an open put
equivalent position or otherwise dispose of such shares for 180 days after the
date of the final Prospectus. The Company is unable to predict the effect that
sales made under Rule 144, or otherwise, may have on the then prevailing
market price of the Common Stock. The holders of approximately 5,459,112
shares of Common Stock are entitled to certain piggyback and demand
registration rights with respect to such
15
<PAGE>
shares. By exercising their registration rights, such holders could cause a
large number of shares to be registered and sold in the public market. Sales
pursuant to Rule 144 or other exemptions from registration, or pursuant to
registration rights, may have an adverse effect on the market price for the
Common Stock and could impair the Company's ability to raise capital through
an offering of its equity securities. See "Description of Capital Stock,"
"Shares Eligible for Future Sale" and "Underwriting."
POTENTIAL ADVERSE EFFECTS OF ANTI-TAKEOVER PROVISIONS; POSSIBLE ISSUANCE OF
PREFERRED STOCK
The Company's Amended and Restated Articles of Organization and Amended and
Restated By-laws contain provisions that may make it more difficult for a
third party to acquire, or discourage acquisition bids for, the Company. For
instance, the Company's Amended and Restated By-laws provide that special
meetings of stockholders may be called only by the President, the Board of
Directors or the holders of at least 80% of the voting securities of the
Company. In addition, the Massachusetts General Laws provide that stockholders
may take action without a meeting only by the unanimous written consent of all
stockholders. The Company's Board of Directors is also divided into three
classes, as nearly equal in size as possible, with staggered three-year terms.
Upon completion of this offering, the Company will be subject to an anti-
takeover provision of the Massachusetts General Laws which prohibits, subject
to certain exceptions, a holder of 5% or more of the outstanding voting stock
of the Company from engaging in certain activities with the Company, including
a merger, stock or asset sale. The foregoing provisions could limit the price
that certain investors might be willing to pay in the future for shares of the
Company's Common Stock. In addition, shares of the Company's Preferred Stock
may be issued in the future without further stockholder approval and upon such
terms and conditions, and having such rights, privileges and preferences, as
the Board of Directors may determine. The rights of the holders of Common
Stock will be subject to, and may be adversely affected by, the rights of any
holders of Preferred Stock that may be issued in the future. The issuance of
Preferred Stock, while providing desirable flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
making it more difficult for a third party to acquire, or discouraging a third
party from acquiring, a majority of the outstanding voting stock of the
Company. The Company has no present plans to issue any shares of Preferred
Stock. See "Description of Capital Stock."
16
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from the sale of shares of Common Stock
offered by the Company hereby are estimated to be $40,789,000, after deducting
the underwriting discount and estimated offering expenses. The Company will
not receive any of the net proceeds from the sale of shares by the Selling
Stockholders. "See Principal and Selling Stockholders."
The Company intends to use approximately $1,080,000 of the net proceeds from
this offering to repay in full the outstanding indebtedness, and the related
prepayment premiums, outstanding under a certain Secured Subordinated Note due
June 30, 2002 (the "MCRC Note") issued to Massachusetts Capital Resource
Company and bearing interest at a rate of 10% per annum. The Company used the
proceeds from the MCRC Note for working capital purposes.
The Company plans to use the balance of the net proceeds from this offering
for research and development, working capital and other general corporate
purposes. The Company may also use a portion of the net proceeds of this
offering to fund acquisitions of complementary businesses, products or
technologies, although there are currently no commitments or agreements with
respect to any such acquisitions.
Pending use of the net proceeds, the Company intends to invest the net
proceeds from this offering in short-term, investment-grade, interest-bearing
instruments. Other than the portion of the proceeds to be used to repay
outstanding indebtedness, the Company does not believe it can accurately
estimate the amounts to be used for each purpose at this time. See "Risk
Factors--Broad Discretion as to Use of Proceeds."
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its shares of
Common Stock. The Company currently intends to retain all of its earnings, if
any, to finance future growth and therefore does not anticipate paying cash
dividends in the foreseeable future. Under the terms of the Company's credit
agreements there are certain restrictions on the Company's ability to declare
and pay dividends. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources" and
Notes 6 and 7 of Notes to the Company's Consolidated Financial Statements.
17
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of March
31, 1997 on an actual, pro forma and pro forma as adjusted basis. The
information set forth in the table below should be read in conjunction with
the Company's Consolidated Financial Statements and Notes thereto appearing
elsewhere in this Prospectus. See "Use of Proceeds."
<TABLE>
<CAPTION>
MARCH 31, 1997
----------------------------------------------------------
PRO FORMA
ACTUAL PRO FORMA(1) AS ADJUSTED(1)(2)
--------------- ---------------- ---------------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C>
Capital lease obligations..... $ 170 $ 170 $ 170
Long-term debt, net of current
portion...................... 1,306 1,306 363
--------------- --------------- ---------------
Total long-term debt...... 1,476 1,476 533
--------------- --------------- ---------------
Redeemable convertible
preferred stock, no par
value;
Series A--1,903,525 shares
authorized, issued and
outstanding actual; none
issued and outstanding pro
forma and pro forma as
adjusted.................... 6,094 -- --
Series B--1,818,182 shares
authorized, issued and
outstanding actual; none
issued and outstanding pro
forma and pro forma as
adjusted.................... 6,158 -- --
Redeemable common stock
right........................ 294 -- --
--------------- --------------- ---------------
Total redeemable stock.... 12,546 -- --
--------------- --------------- ---------------
Stockholders' equity
(deficit):
Common stock, $.01 par value;
50,000,000 shares authorized
pro forma and pro forma as
adjusted; 9,979,023 shares
issued and outstanding pro
forma; 12,779,023 shares
issued and outstanding pro
forma as adjusted (3)....... -- 100 128
Class A common stock, no par
value; 13,295,000 shares
authorized; 6,156,114 shares
issued and outstanding
actual; no shares issued and
outstanding pro forma and
pro forma as adjusted....... 2,209 -- --
Class B common stock, no par
value; 275,000 shares
authorized; 101,196 shares
issued and outstanding
actual; no shares issued and
outstanding pro forma and
pro forma as adjusted....... 164 -- --
Additional paid-in capital... -- 14,819 55,580
Accumulated deficit.......... (5,446) (5,446) (5,583)
Note receivable from
stockholder................. (58) (58) (58)
Cumulative translation
adjustment.................. (29) (29) (29)
--------------- --------------- ---------------
Total stockholders' equity
(deficit)................ (3,160) 9,386 50,038
--------------- --------------- ---------------
Total capitalization.... $ 10,862 $ 10,862 $ 50,571
=============== =============== ===============
</TABLE>
- --------
(1) Gives effect to (i) the filing of an amendment to the Company's Articles
of Organization in May 1997 redesignating the Company's Class A Common
Stock as Common Stock, $.01 par value, and increasing the number of
authorized shares of Common Stock to 50,000,000, (ii) the lapse of the
Redeemable Common Stock Right and the conversion of all outstanding shares
of the Company's Class B Common Stock and Convertible Preferred Stock into
an aggregate of 3,822,903 shares of Common Stock upon the closing of this
offering, and (iii) the filing of an amendment to the Company's Articles
of Organization upon the closing of this offering to eliminate the
Company's Class B Common Stock and existing series of Convertible
Preferred Stock and to authorize 5,000,000 shares of undesignated
Preferred Stock.
(2) Reflects the issuance and sale by the Company of 2,800,000 shares of
Common Stock offered hereby and the application of a portion of the net
proceeds therefrom to repay certain indebtedness, after deducting the
underwriting discount and estimated offering expenses.
(3) Excludes an aggregate of 3,056,238 shares of Common Stock reserved under
the Company's 1992 Long-Term Incentive Plan, all of which shares were
subject to outstanding options as of March 31, 1997 at a weighted average
exercise price of $2.26 per share. Also excludes an aggregate of 2,350,000
shares of Common Stock, which includes 469,500 shares that were subject to
outstanding options at June 30, 1997 at an exercise price of $10.00 per
share, reserved under the Company's 1997 Stock Incentive Plan, 1997
Director Stock Option Plan and 1997 Employee Stock Purchase Plan, which
plans were adopted by the Board of Directors and approved by the
stockholders of the Company in May 1997. Also excludes 312,500 shares of
Common Stock issuable upon the exercise of outstanding warrants as of
March 31, 1997 at an exercise price of $1.60 per share. See "Management--
Executive Compensation" and Notes 10 through 14 of Notes to the Company's
Consolidated Financial Statements.
18
<PAGE>
DILUTION
The pro forma net tangible book value of the Company as of March 31, 1997
was $8,960,000, or $0.90 per share of Common Stock. Pro forma net tangible
book value per share is determined by dividing the Company's tangible net
worth (tangible assets less liabilities) by the number of shares of Common
Stock outstanding, after giving effect to the mandatory conversion of the
Company's Class B Common Stock and Convertible Preferred Stock and the lapse
of the Redeemable Common Stock Right upon the completion of this offering.
After giving effect to the sale of the shares of Common Stock offered by the
Company hereby and after deducting the underwriting discount and estimated
offering expenses, the pro forma net tangible book value of the Company as of
March 31, 1997 would have been $49,612,000, or $3.88 per share. This
represents an immediate increase in such pro forma net tangible book value of
$2.98 per share to existing stockholders and an immediate dilution of $12.12
per share to new investors purchasing shares in this offering. The following
table illustrates the per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share....................... $16.00
Pro forma net tangible book value per share as of March 31,
1997....................................................... $0.90
Increase per share attributable to this offering............ 2.98
-----
Pro forma net tangible book value per share after this
offering..................................................... 3.88
------
Dilution per share to new investors........................... $12.12
======
</TABLE>
The following table summarizes, on a pro forma basis as of March 31, 1997,
the total number of shares of Common Stock purchased from the Company, the
total consideration paid and the average consideration paid per share by the
existing stockholders and by the new investors (before deducting the
underwriting discount and estimated offering expenses):
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------ -------------------
AVERAGE
PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders(1).. 9,979,023 78.1% $14,388,000 24.3% $1.44
New investors............. 2,800,000 21.9 44,800,000 75.7 16.00
---------- ----- ----------- -----
Total................... 12,779,023 100.0% $59,188,000 100.0%
========== ===== =========== =====
</TABLE>
- --------
(1) Sales by the Selling Stockholders in this offering will reduce the number
of shares held by existing stockholders to 9,279,023, or 72.6% of the
total number of shares of Common Stock outstanding after this offering (or
8,754,023 shares and 68.5% if the Underwriters' over-allotment option is
exercised in full), and will increase the number of shares held by new
investors to 3,500,000, or 27.4% of the total number of shares of Common
Stock outstanding after this offering (or 4,025,000 shares and 31.5% if
the Underwriters' over-allotment option is exercised in full).
19
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below for the three years
ended December 31, 1996, and as of December 31, 1995 and 1996, are derived
from the Company's Consolidated Financial Statements, which appear elsewhere
in this Prospectus and which have been audited by Price Waterhouse LLP,
independent accountants. The selected financial data set forth below as of
December 31, 1994 are derived from the Company's audited financial statements,
which are not included in this Prospectus. The selected financial data as of
and for the years ended December 31, 1992 and 1993 are derived from the
Company's unaudited financial statements, which are not included in this
Prospectus. The selected consolidated financial data for the three months
ended March 31, 1996 and 1997, and as of March 31, 1997, are derived from the
Company's unaudited consolidated financial statements which appear elsewhere
in this Prospectus. In the opinion of management, the unaudited financial
statements have been prepared on a basis consistent with the Consolidated
Financial Statements which appear elsewhere in this Prospectus and include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair statement of the financial position and results of operations for these
unaudited periods. The operating results for the three months ended March 31,
1997 are not necessarily indicative of the results to be expected for the full
year ending December 31, 1997. The data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Company's Consolidated Financial
Statements, including the Notes thereto, included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------------------- ----------------
1992 1993 1994 1995 1996 1996 1997
------ ------ ------ ------- -------- -------- ------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenue:
Outsourcing services... $ 746 $1,798 $7,130 $16,400 $ 10,190 $ 2,244 $2,519
License................ -- -- -- -- 6,526 -- 4,144
Other services......... 117 433 742 2,105 2,519 404 1,196
------ ------ ------ ------- -------- -------- ------
Total revenue (1)..... 863 2,231 7,872 18,505 19,235 2,648 7,859
------ ------ ------ ------- -------- -------- ------
Cost of revenue:
Outsourcing services... 517 841 4,700 9,602 8,488 2,234 2,045
License................ -- -- -- -- 162 -- 127
Other services......... 103 306 319 2,421 2,931 506 1,289
------ ------ ------ ------- -------- -------- ------
Total cost of
revenue.............. 620 1,147 5,019 12,023 11,581 2,740 3,461
------ ------ ------ ------- -------- -------- ------
Gross profit (loss).... 243 1,084 2,853 6,482 7,654 (92) 4,398
------ ------ ------ ------- -------- -------- ------
Operating expenses:
Sales and marketing.... 76 265 366 2,129 3,116 654 1,383
Research and
development........... 7 196 560 1,703 6,033 1,360 1,634
General and
administrative........ 274 428 1,283 2,357 3,249 748 925
------ ------ ------ ------- -------- -------- ------
Total operating
expenses............. 357 889 2,209 6,189 12,398 2,762 3,942
------ ------ ------ ------- -------- -------- ------
Income (loss) from
operations............ (114) 195 644 293 (4,744) (2,854) 456
Interest income
(expense), net........ 2 -- (63) (203) (296) (38) 27
------ ------ ------ ------- -------- -------- ------
Income (loss) before
income taxes, minority
interest and equity in
loss of less than
majority-owned
company............... (112) 195 581 90 (5,040) (2,892) 483
Provision (benefit) for
estimated income
taxes................. -- 7 179 (8) (143) (142) 48
------ ------ ------ ------- -------- -------- ------
Income (loss) before
minority interest and
equity in loss of less
than majority-owned
company............... (112) 188 402 98 (4,897) (2,750) 435
Minority interest in
consolidated
subsidiary............ -- -- -- (43) (24) 38 (29)
Equity in loss of less
than majority-owned
company............... -- -- (97) -- -- -- --
------ ------ ------ ------- -------- -------- ------
Net income (loss)...... $ (112) $ 188 $ 305 $ 55 $ (4,921) $ (2,712) $ 406
====== ====== ====== ======= ======== ======== ======
Pro forma net income
(loss) per share (2).. $ (0.46) $ 0.03
======== ======
Weighted average shares
used to compute pro
forma net income
(loss) per share(2)... 10,695 12,711
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------
MARCH 31,
1992 1993 1994 1995 1996 1997
---- ------ ------ ------ ------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents....... $-- $ 2 $ 339 $ 264 $ 7,388 $ 5,022
Working capital (deficit)....... (19) 338 1,267 2,218 8,218 8,406
Total assets.................... 540 1,075 2,924 7,179 17,725 15,712
Long-term debt, net of current
portion........................ 224 491 777 1,792 1,538 1,476
Redeemable stock................ -- -- -- -- 12,287 12,546
Stockholders' equity (deficit).. 202 498 867 1,802 (3,302) (3,160)
</TABLE>
- -------
(1) Revenue (in thousands) from related parties in the years ended December
31, 1992, 1993, 1994, 1995 and 1996 and the three months ended March 31,
1996 and 1997 was $745, $824, $4,317, $10,124, $6,443, $1,179 and $975,
respectively. See the Company's Consolidated Financial Statements.
(2) See Note 2 of Notes to the Company's Consolidated Financial Statements for
an explanation of the determination of pro forma net income (loss) per
share.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion contains certain forward-looking statements. Actual
results could differ materially. See "Risk Factors."
OVERVIEW
Peritus was founded in 1991 to address the growing market for managing and
maintaining the installed base of software in organizations. The Company
focused its efforts on the delivery of software maintenance outsourcing
services until 1995, when it began to devote significant resources to the
development of software tools addressing the problems associated with mass
changes to application systems and their associated databases, particularly
the year 2000 problem. In 1996, the Company began licensing its
AutoEnhancer/2000 software, which was designed to address the year 2000
problem, to value added integrators and directly to end users. In 1996, the
Company expanded its research and development efforts through the acquisition
of Vista Technologies Incorporated, a developer of computer-aided engineering
software ("Vista").
The Company derives its revenue from software maintenance outsourcing
services, software and methodology licensing and other services sold directly
to end users or indirectly via value added integrators and distributors, and
its clients include primarily Fortune 1000 companies and similarly sized
business and government organizations worldwide. The Company's products and
services are marketed through its direct sales force, both domestically and in
Spain, through value added integrators operating worldwide and through
international distributors in Canada, Italy and Japan.
Revenue Recognition Policies
The Company's outsourcing services are generally offered under multi-year,
fixed-price, fixed-time frame contracts. In connection with the delivery of
its outsourcing services, the Company assesses a client's IT costs and agrees
to provide services at a price generally below the internal costs of the
client. Revenue under these contracts is recognized using the percentage-of-
completion method and is based on the ratio that labor-hours incurred to date
bear to estimated total labor-hours at completion, provided that collection of
the related receivable is probable. Because the labor-hours associated with
the Company's outsourcing services are typically higher in the early phases of
the contract, revenue is also typically higher in such phases and declines
over the term of the contract. Under the percentage-of-completion method, the
Company updates on a quarterly basis its completion estimates of each contract
to reflect changes in projected completion costs or dates. The cumulative
impact of any revision in estimates is reflected in each quarterly financial
reporting period in which the change in the estimate becomes known. When the
revised estimates indicate a loss on the contract, such loss is provided for
currently in its entirety. As the Company bears the risk of cost overruns and
inflation associated with multi-year, fixed-price, fixed-time frame contracts,
the Company's operating results may be adversely affected by inaccurate
estimates of contract completion costs and dates. These contracts may be
revised by the Company and the client when a significant change in the scope
or cost of a project arises that neither the Company nor the client had
anticipated. These contracts are terminable at will by either party upon
written notice in accordance with the terms of the contract, at which time
payment for services rendered to date is due.
The Company licenses its software products and methodologies directly and
indirectly (via distributors) to end users and to value added integrators for
their use in serving their clients. License fees charged to end users are
fixed, with the amount of the fee based on the estimated total lines of code
to be processed. Revenue from end-user licenses is recognized when software
and methodologies have been delivered to the end user, all significant
contractual obligations have been met and collection of the related receivable
is probable. License fees charged to value added integrators and distributors
are generally royalties based on lines of code processed or to be processed.
Revenue derived from these usage-based licenses is recognized when licensed
software has been delivered, the fee is fixed or determinable, all significant
contractual obligations have been met and collection of the related receivable
is probable.
21
<PAGE>
Other services provided by the Company include technology transfer
engagements (including insourcing engagements expected to begin in 1997),
product training, value added integrator and distributor sales training,
consulting services and software product maintenance. Other services also
include direct delivery contracts, in which the Company provides full year
2000 renovations and pilot year 2000 renovations for clients using the
Company's AutoEnhancer/2000 software. Pilot projects are generally priced to
the client at the Company's estimated cost of providing such services. Revenue
from direct delivery contracts is recognized over the duration of such
contracts as work is performed and defined milestones are attained. Any
estimated losses on direct delivery contracts are recorded in their entirety
in the period in which they become known. Revenue from technology transfer
engagements, product and sales training and consulting services is billed on a
time-and-materials basis and is recognized as the services are provided. With
respect to the Company's proposed insourcing services, the Company intends to
charge a royalty for client productivity gains resulting from such services,
the revenue from which will be recognized as such gains are realized by the
client. Revenue from software product maintenance contracts on the Company's
licensed products, including client support bundled with the initial license
fee, is deferred and recognized ratably over the contractual periods during
which the services are provided.
Client Concentration
During the past several years, the Company's revenue has been dependent on a
few major clients. During the three months ended March 31, 1997, revenue from
three clients accounted for 26.1%, 14.0% and 10.6% of the Company's total
revenue, respectively. During 1996, revenue from three clients accounted for
29.0%, 14.6% and 12.1% of the Company's total revenue. During 1995, revenue
from three clients accounted for 50.3%, 12.9% and 11.0% of the Company's total
revenue, and in 1994 revenue from two clients accounted for 51.7% and 29.3% of
the Company's total revenue. The largest client in each of 1996, 1995 and 1994
was a related party of the Company. See Note 8 of Notes to the Company's
Consolidated Financial Statements. The Company's ten largest clients in the
three months ended March 31, 1997 and each of 1996, 1995 and 1994 accounted
for approximately 82.2%, 77.9%, 90.5% and 92.1% of the Company's total
revenue, respectively. The Company anticipates that this concentration of
clients as a percentage of the Company's total revenue will diminish in the
future but that the Company will continue to depend to a significant extent
upon revenue from a small number of clients. See "Risk Factors--Concentration
of Clients and Credit Risk; Related Party Transactions."
Capitalized Software Costs
In accordance with Statement of Financial Accounting Standards ("SFAS") 86,
Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed, the Company is required to capitalize software development costs
incurred after the establishment of the technological feasibility of a
product. Costs incurred prior to the establishment of technological
feasibility are charged to research and development expense. As releases of
the Company's products over the three years ended December 31, 1996 have
generally occurred soon after technological feasibility has been established,
the costs subject to capitalization have not been material and thus have not
been capitalized. In January 1996, the Company acquired Vista for total
consideration of $815,000 in a transaction accounted for under the purchase
method of accounting. Approximately $150,000 of the acquisition price was
allocated to software technology and is being amortized over three years to
cost of revenue. See Note 2 of Notes to the Company's Consolidated Financial
Statements.
Spanish Subsidiary
In September 1994, the Company, along with two other investors, established
Persist, S.A. ("Persist") to provide software maintenance services in Spain
and Portugal. The Company's initial equity position in Persist was 40.0%. In
1995, Persist signed two outsourcing agreements and increased staff to deliver
these contracts. Also in 1995, the Company acquired a majority interest in
Persist and, accordingly, began to consolidate the financial statements of
Persist with those of the Company. Persist continues to provide outsourcing
services to clients and has also begun to license the AutoEnhancer/2000
software in Spain and Portugal. See Note 3 of Notes to the Company's
Consolidated Financial Statements.
22
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of
total revenue of certain line items included in the Company's consolidated
statement of operations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
-------------------------- ---------------------
1994 1995 1996 1996 1997
------- ------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Revenue:
Outsourcing services....... 90.6% 88.6% 53.0% 84.7% 32.1%
License.................... -- -- 33.9 -- 52.7
Other services............. 9.4 11.4 13.1 15.3 15.2
------- ------- -------- ---------- --------
Total revenue (1)........ 100.0 100.0 100.0 100.0 100.0
------- ------- -------- ---------- --------
Cost of revenue:
Outsourcing services....... 59.7 51.9 44.1 84.4 26.0
License.................... -- -- 0.8 -- 1.6
Other services............. 4.1 13.1 15.3 19.1 16.4
------- ------- -------- ---------- --------
Total cost of revenue.... 63.8 65.0 60.2 103.5 44.0
------- ------- -------- ---------- --------
Gross profit (loss).......... 36.2 35.0 39.8 (3.5) 56.0
------- ------- -------- ---------- --------
Operating expenses:
Sales and marketing........ 4.6 11.5 16.2 24.7 17.6
Research and development... 7.1 9.2 31.4 51.4 20.8
General and administra-
tive...................... 16.3 12.7 16.9 28.2 11.8
------- ------- -------- ---------- --------
Total operating ex-
penses.................. 28.0 33.4 64.5 104.3 50.2
------- ------- -------- ---------- --------
Income (loss) from
operations................ 8.2 1.6 (24.7) (107.8) 5.8
Interest income (expense),
net......................... (0.8) (1.1) (1.5) (1.4) 0.3
------- ------- -------- ---------- --------
Income (loss) before income
taxes, minority interest
and equity in loss of less
than majority-owned
company................... 7.4 0.5 (26.2) (109.2) 6.1
Provision (benefit) for
estimated income taxes...... 2.3 -- (0.7) (5.4) 0.6
------- ------- -------- ---------- --------
Income (loss) before
minority interest and
equity in loss of less
than majority-owned
company................... 5.1 0.5 (25.5) (103.8) 5.5
Minority interest in
consolidated subsidiary..... -- (0.2) (0.1) 1.4 (0.4)
Equity in loss of less than
majority-owned company...... (1.2) -- -- -- --
------- ------- -------- ---------- --------
Net income (loss).......... 3.9% 0.3% (25.6)% (102.4)% 5.1%
======= ======= ======== ========== ========
</TABLE>
- --------
(1) Revenue from related parties in the years ended December 31, 1994, 1995
and 1996 and the three months ended March 31, 1996 and 1997 represented
54.8%, 54.7%, 33.5%, 44.5% and 12.4% of total revenue, respectively.
THREE MONTHS ENDED MARCH 31, 1997 COMPARED TO THREE MONTHS ENDED MARCH 31,
1996
REVENUE
Total revenue increased 196.8% to $7,859,000 in the three months ended March
31, 1997 from $2,648,000 in the three months ended March 31, 1996. This
increase was primarily due to the initial licensing of the Company's
AutoEnhancer/2000 software, as well as from increases in other services
revenue and, to a lesser
23
<PAGE>
extent, outsourcing services revenue. International revenue increased 273.5%
to $732,000 in the three months ended March 31, 1997 from $196,000 in the
three months ended March 31, 1996. As a percentage of total revenue,
international revenue increased to 9.3% in the three months ended March 31,
1997 from 7.4% in the three months ended March 31, 1996. Substantially all of
the Company's international revenue for the three months ended March 31, 1997
and 1996 was attributable to revenue generated by Persist.
Outsourcing Services. Outsourcing services revenue increased 12.3% to
$2,519,000 in the three months ended March 31, 1997 from $2,244,000 in the
three months ended March 31, 1996. As a percentage of total revenue,
outsourcing services revenue decreased to 32.0% in the three months ended
March 31, 1997 from 84.7% in the three months ended March 31, 1996. The
increase in outsourcing services revenue in absolute dollars was primarily
attributable to the addition of two new outsourcing contracts in late 1996 and
was partially offset by the recognition of lesser amounts of revenue under the
percentage-of-completion method on existing contracts that were in their later
phases. The decrease in outsourcing services revenue as a percentage of total
revenue reflects the contribution of license revenue to total revenue during
the three months ended March 31, 1997. Outsourcing services remain a major
component of the solutions offered by the Company, and the Company anticipates
that such services will continue to account for a significant portion of total
revenue for the foreseeable future.
License. License revenue was $4,144,000 in the three months ended March 31,
1997, or 52.7% of total revenue. The Company recognized no license revenue in
the three months ended March 31, 1996. The Company's license revenue in the
three months ended March 31, 1997 was primarily attributable to the delivery
of licensed software to two end users and to license fees from value added
integrators.
Other Services. Other services revenue increased 196.0% to $1,196,000 in the
three months ended March 31, 1997 from $404,000 in the three months ended
March 31, 1996. As a percentage of total revenue, other services revenue was
15.2% in the three months ended March 31, 1997 compared to 15.3% in the three
months ended March 31, 1996. The increase in other services revenue in
absolute dollars was primarily attributable to an increase in consulting,
training and client support services relating to the Company's year 2000
products and services. This increase was partially offset by a decrease in
direct delivery services for one significant pilot year 2000 renovation.
COST OF REVENUE
Cost of Outsourcing Services Revenue. Cost of outsourcing services revenue
consists primarily of salaries, benefits and overhead costs associated with
delivering outsourcing services to clients. The cost of outsourcing services
revenue decreased 8.5% to $2,045,000 in the three months ended March 31, 1997
from $2,234,000 in the three months ended March 31, 1996. Cost of outsourcing
services revenue decreased as a percentage of outsourcing services revenue to
81.2% in the three months ended March 31, 1997 from 99.6% in the three months
ended March 31, 1996. The decrease in the cost of outsourcing services revenue
as a percentage of outsourcing services revenue was due primarily to the re-
deployment in late 1996 of underutilized resources to research and development
and support activities, partially offset by the addition of resources
necessary to provide services under the two new outsourcing contracts.
Cost of License Revenue. Cost of license revenue consists primarily of
salaries, benefits and related overhead costs associated with materials
packaging and freight. Cost of license revenue was $127,000 in the three
months ended March 31, 1997, or 3.1% of license revenue. There was no cost of
license revenue in the three months ended March 31, 1996. These costs were
attributable to the licensing of the Company's AutoEnhancer/2000 software.
Cost of Other Services Revenue. Cost of other services revenue consists
primarily of salaries, benefits and related overhead costs associated with
delivering other services to clients. Cost of other services revenue increased
154.7% to $1,289,000 in the three months ended March 31, 1997 from $506,000 in
the three months ended March 31, 1996. Cost of other services revenue as a
percentage of other services revenue decreased to
24
<PAGE>
107.8% in the three months ended March 31, 1997 from 125.2% in the three
months ended March 31, 1996. Costs exceeded revenue in the three months ended
March 31, 1996 primarily as a result of expected cost overruns on one
significant pilot engagement, which subsequently became a significant product
license. Costs exceeded revenue in the three months ended March 31, 1997 due
to increased staffing in the Company's client support, training and consulting
organizations in anticipation of future revenue primarily related to the
introduction of the Company's year 2000 products and services.
OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related overhead costs for Company personnel; sales
referral fees to third parties; advertising programs; and other promotional
activities. Sales and marketing expenses increased 111.5% to $1,383,000 in the
three months ended March 31, 1997 from $654,000 in the three months ended
March 31, 1996. As a percentage of total revenue, sales and marketing expenses
decreased to 17.6% in the three months ended March 31, 1997 from 24.7% in the
three months ended March 31, 1996. The increase in expenses in absolute
dollars was primarily attributable to increased staffing, commissions,
including an increase in sales referral fees to third parties, and promotional
activities in conjunction with the launch of the Company's AutoEnhancer/2000
software. The Company intends to increase the amount of expenditures for sales
and marketing in 1997, both domestically and internationally. There can be no
assurance that these expenditures will result in increased revenue.
Research and Development. Research and development expenses consist
primarily of salaries, benefits and related overhead costs for engineering and
technical personnel and outside engineering consulting services associated
with developing new products and enhancing existing products. Research and
development expenses increased 20.1% to $1,634,000 in the three months ended
March 31, 1997 from $1,360,000 in the three months ended March 31, 1996. As a
percentage of total revenue, research and development expenses decreased to
20.8% in the three months ended March 31, 1997 from 51.4% in the three months
ended March 31, 1996. The increase in research and development expenses in
absolute dollars was primarily attributable to increased staffing for the
product development efforts for the Company's year 2000 products and services
and mass change technologies, including an increase in staffing effected
through new hires and internal transfers. The Company intends to employ
additional research and development staff and therefore anticipates that
research and development expenses will increase in absolute dollars in 1997.
General and Administrative. General and administrative expenses consist
primarily of salaries and related costs for the finance and accounting, human
resources, legal services, information systems and other administrative
departments of the Company, as well as legal and accounting expenses and the
amortization of goodwill associated with the Vista acquisition. General and
administrative expenses increased 23.7% to $925,000 in the three months ended
March 31, 1997 from $748,000 in the three months ended March 31, 1996. As a
percentage of total revenue, general and administrative expenses decreased to
11.8% in the three months ended March 31, 1997 from 28.3% in the three months
ended March 31, 1996. The increase in general and administrative expenses in
absolute dollars was primarily due to additions to the Company's
administrative staff to support growth, higher professional fees and increases
in other general corporate expenses. The Company anticipates that general and
administrative expenses will increase in absolute dollars in 1997 in part due
to increased costs associated with becoming a publicly held company.
Interest Income (Expense), Net. Interest income (expense), net is primarily
composed of interest income from cash balances and interest expense on debt.
Interest income, net of $27,000 in the three months ended March 31, 1997
compares to interest expense, net of $38,000 in the three months ended March
31, 1996. This change was primarily attributable to decreased interest expense
on lesser borrowings by the Company as well as increased interest income from
increased cash balances.
Provision (Benefit) for Income Taxes. The Company recorded an income tax
provision of $48,000 in the three months ended March 31, 1997, versus a
benefit of $142,000 in the three months ended March 31, 1996.
25
<PAGE>
The provision was the result of an increase in taxable income, which was
partially offset by the Company's expected utilization in 1997 of previously
generated net operating loss carryforwards. The usage of these net operating
loss carryforwards may be limited due to a change in Company ownership that
resulted from sales of the Company's Convertible Preferred Stock.
Minority Interest in Consolidated Subsidiary. The minority interest in
consolidated subsidiary represents the equity interest in the operating
results of Persist, the Company's majority-owned Spanish subsidiary, held by
stockholders of Persist other than the Company. The minority interest in
consolidated subsidiary increased to income of $29,000 in the three months
ended March 31, 1997 from a loss of $38,000 in the three months ended March
31, 1996. This change was the result of the increased profitability of
Persist. At March 31, 1997, the Company held a 63.7% equity interest in
Persist compared to a 69.5% equity interest at March 31, 1996.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUE
Total revenue increased 3.9% to $19,235,000 in 1996 from $18,505,000 in
1995. This increase was primarily due to the initial licensing of the
Company's AutoEnhancer/2000 software in 1996, as well as from an increase in
other services revenue, which was offset by a significant decrease in
outsourcing services revenue. International revenue increased 66.8% to
$1,800,000 in 1996 from $1,079,000 in 1995. As a percentage of total revenue,
international revenue increased to 9.4% in 1996 from 5.8% in 1995.
Substantially all of the Company's international revenue during 1995 and 1996
was attributable to revenue generated by Persist.
Outsourcing Services. Outsourcing services revenue decreased 37.9% to
$10,190,000 in 1996 from $16,400,000 in 1995. As a percentage of total
revenue, outsourcing services revenue decreased to 53.0% in 1996 from 88.6% in
1995. The decrease in outsourcing services revenue was primarily attributable
to the recognition of lesser amounts of revenue under the percentage-of-
completion method on two significant contracts that were in their later
phases. In addition, as the Company began to focus more of its efforts in 1996
on the licensing of its AutoEnhancer/2000 software, the Company did not add a
sufficient number of new outsourcing contracts to offset this decline in
outsourcing services revenue.
License. License revenue was $6,526,000 in 1996, or 33.9% of total revenue.
License revenue was generated in 1996 from the introduction of the Company's
AutoEnhancer/2000 software and was primarily attributable to three licenses,
one of which was with a related party.
Other Services. Other services revenue increased 19.7% to $2,519,000 in 1996
from $2,105,000 in 1995. As a percentage of total revenue, other services
revenue increased to 13.1% in 1996 from 11.4% in 1995. The increase in other
services revenue was primarily attributable to an increase in technology
transfer revenue as well as the introduction of consulting and product
training services for the Company's AutoEnhancer/2000 software. These
increases were partially offset by a decrease in direct delivery services for
one significant pilot year 2000 renovation.
COST OF REVENUE
Cost of Outsourcing Services Revenue. Cost of outsourcing services revenue
decreased 11.6% to $8,488,000 in 1996 from $9,602,000 in 1995. Cost of
outsourcing services revenue increased as a percentage of outsourcing services
revenue to 83.3% in 1996 from 58.5% in 1995. Although cost of outsourcing
services revenue declined in absolute dollars from 1995 to 1996, the decline
did not keep pace with the decreases in outsourcing services revenue. The
increase in cost of outsourcing services revenue as a percentage of
outsourcing services revenue was due primarily to the underutilization of
personnel resulting from the lack of significant new outsourcing contracts in
1996, and, to a lesser extent, to cost overruns associated with a significant
contract. In the third and fourth quarters of 1996, the Company re-deployed
resources dedicated to outsourcing services from the delivery of those
services to client support, consulting support and research and development.
26
<PAGE>
Cost of License Revenue. Cost of license revenue was $162,000 in 1996, or
2.5% of license revenue. There was no cost of license revenue in 1995. These
costs were attributable to the introduction of the Company's AutoEnhancer/2000
software.
Cost of Other Services Revenue. Cost of other services revenue increased
21.1% to $2,931,000 in 1996 from $2,421,000 in 1995. Cost of other services
revenue also increased as a percentage of other services revenue to 116.4% in
1996 from 115.0% in 1995. Costs exceeded revenue in both years as a result of
expected cost overruns for one significant pilot direct delivery client, which
subsequently became a product licensee, as well as the increase in staffing of
both client support and product training in anticipation of future revenue.
OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses increased 46.4% to
$3,116,000 in 1996 from $2,129,000 in 1995. As a percentage of total revenue,
sales and marketing expenses increased to 16.2% in 1996 from 11.5% in 1995.
The increase in sales and marketing expenses during 1996 was primarily
attributable to increased staffing, commissions, including an increase of
approximately $350,000 in sales referral fees to third parties, and
promotional activities in conjunction with the launch of the Company's
AutoEnhancer/2000 software, as well as increased staffing to build third-party
channels for the Company's products and services.
Research and Development. Research and development expenses increased 254.3%
to $6,033,000 in 1996 from $1,703,000 in 1995. As a percentage of total
revenue, research and development expenses increased to 31.4% in 1996 from
9.2% in 1995. The increase in research and development expenses was primarily
attributable to significant product development efforts relating to the
Company's year 2000 products and services and mass change technologies,
including an increase in staffing effected through new hires, the acquisition
of Vista in January 1996 and internal transfers. At December 31, 1996, there
were 59 full-time employees in research and development compared to 17 at
December 31, 1995.
General and Administrative. General and administrative expenses increased
37.8% to $3,249,000 in 1996 from $2,357,000 in 1995. As a percentage of total
revenue, general and administrative expenses increased to 16.9% in 1996 from
12.7% in 1995. The increase in general and administrative expenses was
primarily due to additions to the Company's administrative staff to support
growth, higher professional fees and increases in other general corporate
expenses.
Interest Income (Expense), Net. Interest expense, net, increased 45.8% to
$296,000 in 1996 from $203,000 for 1995. The increase was primarily
attributable to increased average borrowings by the Company.
Provision (Benefit) for Income Taxes. The Company's benefit for estimated
income taxes increased to $143,000 in 1996 from $8,000 in 1995. The increase
was the result of an increase in gross deferred tax assets, caused primarily
by additional net operating loss carryforwards and tax credit carryforwards,
which resulted in the reversal of the net deferred tax liability recorded as
of December 31, 1995.
Minority Interest in Consolidated Subsidiary. The minority interest in
consolidated subsidiary decreased 44.2% to $24,000 in 1996 from $43,000 in
1995. The decrease was the result of the decreased profitability of Persist,
partially offset by a decrease in the Company's equity interest in Persist. At
December 31, 1996, the Company held a 63.7% equity interest in Persist
compared to a 69.5% equity interest at December 31, 1995.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
REVENUE
Total revenue increased 135.1% to $18,505,000 in 1995 from $7,872,000 in
1994. This increase in revenue was primarily due to increased outsourcing
services revenue as well as an increase in other services revenue related to
one direct delivery client. International revenue increased 180.3% to
$1,079,000 in 1995 from $385,000 in 1994. As a percentage of total revenue,
international revenue increased to 5.8% in 1995 from 4.8% in 1994.
Substantially all of the Company's international revenue in 1995 was
attributable to revenue generated by the Company's Spanish subsidiary.
27
<PAGE>
Outsourcing Services. Outsourcing services revenue increased 130.0% to
$16,400,000 in 1995 from $7,130,000 in 1994. As a percentage of total revenue,
outsourcing services revenue decreased to 88.6% in 1995 from 90.6% in 1994.
The increase in outsourcing services revenue in absolute dollars was primarily
attributable to the addition of two significant outsourcing contracts that
commenced in the fourth quarter of 1994.
Other Services. Other services revenue increased 183.7% to $2,105,000 in
1995 from $742,000 in 1994. As a percentage of total revenue, other services
revenue increased to 11.4% in 1995 from 9.4% in 1994. The increase was
primarily attributable to the addition of a significant year 2000 pilot direct
delivery contract.
COST OF REVENUE
Cost of Outsourcing Services Revenue. Cost of outsourcing services revenue
increased 104.3% to $9,602,000 in 1995 from $4,700,000 in 1994. Cost of
outsourcing services revenue decreased as a percentage of outsourcing services
revenue to 58.5% in 1995 from 65.9% in 1994. The increase in costs was
primarily attributable to increased staffing to meet the demands of two new
outsourcing contracts. As part of one of these contracts, the Company agreed
to hire 58 of the client's employees in September 1994 to help deliver
services under this contract. The decrease in costs as a percentage of
outsourcing services revenue was primarily attributable to increased technical
staff productivity, which was partially offset by cost overruns on one
contract.
Cost of Other Services Revenue. Cost of other services revenue increased
658.9% to $2,421,000 in 1995 from $319,000 in 1994. Cost of other services
revenue increased as a percentage of other services revenue to 115.0% in 1995
from 43.0% in 1994. The increase in costs was primarily attributable to
increased staffing necessary to service a new year 2000 pilot direct delivery
contract entered into in the first quarter of 1995 and the expected cost
overruns associated with such contract.
OPERATING EXPENSES
Sales and Marketing. Sales and marketing expenses increased 481.7% to
$2,129,000 in 1995 from $366,000 in 1994. As a percentage of total revenue,
sales and marketing expenses increased to 11.5% in 1995 from 4.7% in 1994. The
increase in sales and marketing expenses was primarily attributable to
increased staffing, commissions and promotional activities to support the
Company's rapid growth.
Research and Development. Research and development expenses increased 204.1%
to $1,703,000 in 1995 from $560,000 in 1994. As a percentage of total revenue,
research and development expenses increased to 9.2% in 1995 from 7.1% in 1994.
The increase in research and development expenses was primarily attributable
to an increase in staffing in 1995.
General and Administrative. General and administrative expenses increased
83.7% to $2,357,000 in 1995 from $1,283,000 in 1994. As a percentage of total
revenue, general and administrative expenses decreased to 12.7% in 1995 from
16.3% in 1994. The increase in general and administrative expenses in absolute
dollars was primarily the result of additions to the Company's finance,
administrative and support staff as well as increases in professional fees and
other general corporate expenses to support the Company's growth.
Interest Income (Expense), Net. Interest expense, net increased 222.2% to
$203,000 in 1995 from $63,000 in 1994. The increase was primarily attributable
to increased average borrowings by the Company.
Provision (Benefit) for Income Taxes. The Company's benefit for estimated
income taxes increased to $8,000 in 1995 from a tax provision of $179,000 in
1994. The change was a result of lower income before provision for income
taxes in 1995, along with an increase in gross deferred tax assets, caused
primarily by an increase in tax credit carryforwards.
Equity in Loss of Less Than Majority-Owned Company; Minority Interest in
Consolidated Subsidiary. In 1994, the equity in loss of less than majority-
owned company was $97,000. This amount represented the Company's 40.0% share
of net losses realized by Persist. In 1995, the Company obtained a majority
ownership interest in Persist, requiring the Company to consolidate the entire
results of operations of Persist with the results of the Company.
Consequently, the share of net income of Persist attributable to its minority
stockholders, which was $43,000 in 1995, was included under the heading
"Minority Interest in Consolidated Subsidiary."
28
<PAGE>
QUARTERLY RESULTS
The following tables set forth a summary of the Company's unaudited
quarterly consolidated operating results for each of the five quarters in the
period ended March 31, 1997. This information has been derived from unaudited
interim consolidated financial statements that, in the opinion of management,
have been prepared on a basis consistent with the Consolidated Financial
Statements contained elsewhere in this Prospectus and include all adjustments,
consisting of only normal recurring adjustments, necessary for a fair
statement of such information when read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto. The operating results for
any quarter are not necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31,
1996 1996 1996 1996 1997
-------- --------- --------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenue:
Outsourcing services........... $ 2,244 $ 2,514 $2,611 $2,821 $2,519
License........................ -- 45 2,424 4,057 4,144
Other services................. 404 701 610 804 1,196
------- ------- ------ ------ ------
Total revenue (1).............. 2,648 3,260 5,645 7,682 7,859
------- ------- ------ ------ ------
Cost of revenue:
Outsourcing services........... 2,234 2,199 1,977 2,077 2,045
License........................ -- -- 40 122 127
Other services................. 506 672 816 938 1,289
------- ------- ------ ------ ------
Total cost of revenue.......... 2,740 2,871 2,833 3,137 3,461
------- ------- ------ ------ ------
Gross profit (loss)............. (92) 389 2,812 4,545 4,398
------- ------- ------ ------ ------
Operating expenses:
Sales and marketing............ 654 729 668 1,065 1,383
Research and development....... 1,360 1,401 1,506 1,766 1,634
General and administrative..... 748 707 763 1,031 925
------- ------- ------ ------ ------
Total expenses................. 2,762 2,837 2,937 3,862 3,942
------- ------- ------ ------ ------
Income (loss) from operations.. (2,854) (2,448) (125) 683 456
Interest expense, net........... (38) (61) (77) (120) 27
------- ------- ------ ------ ------
Income (loss) before income
taxes and minority interest... (2,892) (2,509) (202) 563 483
Provision (benefit) for esti-
mated income taxes............. (142) (62) (1) 62 48
------- ------- ------ ------ ------
Income (loss) before minority
interest...................... (2,750) (2,447) (201) 501 435
Minority interest in consoli-
dated subsidiary............... 38 (18) (5) (39) (29)
------- ------- ------ ------ ------
Net income (loss).............. $(2,712) $(2,465) $ (206) $ 462 $ 406
======= ======= ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31,
1996 1996 1996 1996 1997
-------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
Revenue:
Outsourcing services........... 84.7% 77.1% 46.3% 36.7% 32.1%
License........................ -- 1.4 42.9 52.8 52.7
Other services................. 15.3 21.5 10.8 10.5 15.2
------ ----- ----- ----- -----
Total revenue (1).............. 100.0 100.0 100.0 100.0 100.0
------ ----- ----- ----- -----
Cost of revenue:
Outsourcing services........... 84.4 67.5 35.0 27.0 26.0
License........................ -- -- 0.7 1.6 1.6
Other services................. 19.1 20.6 14.5 12.2 16.4
------ ----- ----- ----- -----
Total cost of revenue.......... 103.5 88.1 50.2 40.8 44.0
------ ----- ----- ----- -----
Gross profit (loss)............. (3.5) 11.9 49.8 59.2 56.0
------ ----- ----- ----- -----
Operating expenses:
Sales and marketing............ 24.7 22.4 11.8 13.9 17.6
Research and development....... 51.4 43.0 26.7 23.0 20.8
General and administrative..... 28.2 21.6 13.5 13.4 11.8
------ ----- ----- ----- -----
Total expenses................. 104.3 87.0 52.0 50.3 50.2
------ ----- ----- ----- -----
Income (loss) from operations.. (107.8) (75.1) (2.2) 8.9 5.8
Interest expense, net........... (1.4) (1.9) (1.4) (1.6) 0.3
------ ----- ----- ----- -----
Income (loss) before income
taxes and minority interest... (109.2) (77.0) (3.6) 7.3 6.1
Provision (benefit) for esti-
mated income taxes............. (5.4) (1.9) -- 0.8 0.6
------ ----- ----- ----- -----
Income (loss) before minority
interest...................... (103.8) (75.1) (3.6) 6.5 5.5
Minority interest in consoli-
dated subsidiary............... 1.4 (0.5) -- (0.5) (0.4)
------ ----- ----- ----- -----
Net income (loss).............. (102.4)% (75.6)% (3.6)% 6.0% 5.1%
====== ===== ===== ===== =====
</TABLE>
- --------
(1) Revenue (in thousands) from related parties in each of the five quarters
in the period ended March 31, 1997 was $1,179, $1,327, $2,753, $1,184 and
$975, respectively, which represents 44.5%, 40.7%, 48.8%, 15.4% and 12.4%
of total revenue, respectively. See the Company's Consolidated Financial
Statements.
29
<PAGE>
The Company's quarterly revenue, expenses and operating results have varied
significantly in the past and are likely to vary significantly from quarter to
quarter in the future. A significant portion of the Company's revenue in any
quarter is typically derived from a limited number of large client
transactions. In addition, the sales cycle associated with these transactions
is lengthy and is subject to a number of uncertainties, including clients'
budgetary constraints, the timing of clients' budget cycles and clients'
internal approval processes. Accordingly, the timing of significant
transactions is unpredictable and, as a result, the Company's revenue and
results of operations for any particular period are subject to significant
variability. The complexity of certain projects and the requirements of
generally accepted accounting principles can also result in a deferral of
revenue recognition, in whole or in part, on a particular contract during a
quarter, even though the contract has been executed or payment has actually
been received by the Company. Quarterly fluctuations may also result from
other factors such as new product and service introductions or announcements
of new products and services by the Company's competitors, changes in the
Company's or its competitors' pricing policies, changes in the mix of
distribution channels through which the Company's products and services are
sold, the timing and nature of sales and marketing expenses, changes in
operating expenses, the financial stability of major clients, changes in the
demand for software maintenance products and services, foreign currency
exchange rates and general economic conditions. See "Certain Transactions--
Potential Fluctuations in Quarterly Performance."
LIQUIDITY AND CAPITAL RESOURCES
The Company has experienced significant growth since 1992, with its revenue
growing from $863,000 in 1992 to $19,235,000 in 1996. During this period, the
Company financed its operations and capital expenditures primarily with the
proceeds from sales of the Company's Convertible Preferred Stock and Common
Stock, borrowings, advance payments for services from clients and internally
generated cash flows. The Company's cash balances were $5,022,000, $7,388,000,
$264,000 and $339,000 at March 31, 1997 and December 31, 1996, 1995 and 1994,
respectively. The Company's working capital was $8,406,000, $8,218,000,
$2,218,000 and $1,267,000 at March 31, 1997 and December 31, 1996, 1995 and
1994, respectively.
The Company's operating activities used cash of $1,851,000, $2,342,000 and
$1,097,000 during the three months ended March 31, 1997 and the years ended
December 31, 1996 and 1995, respectively, and provided $41,000 during the year
ended December 31, 1994. The Company's use of cash during the three months
ended March 31, 1997 was primarily caused by a decrease in deferred revenue of
$2,356,000 and a reduction of other accrued expenses and current liabilities
of $485,000. These decreases were partially offset by net income of $406,000,
plus non-cash depreciation and amortization expense of $262,000. The Company's
use of cash in 1996 was primarily caused by operating losses of $4,921,000,
net of $854,000 of non-cash depreciation and amortization expense, and a net
increase in accounts receivable and unbilled revenue totaling $3,090,000.
These uses of cash during 1996 were offset somewhat by an increase in deferred
revenue of $3,262,000 and an increase in other accrued expenses and current
liabilities of $949,000. The use of cash in 1995 was principally caused by an
increase in accounts receivable and in net costs and earnings in excess of
billings on uncompleted contracts of $2,480,000, which was partially offset by
net income of $55,000, plus non-cash depreciation and amortization expense of
$443,000 and an increase in operating liabilities of $958,000. The cash
provided by operations during 1994 was attributable to net income of $305,000,
plus non-cash depreciation and amortization expense of $228,000, an increase
in operating liabilities of $519,000 and an increase in deferred taxes of
$179,000. These increases were partially offset by an increase in accounts
receivable and in net costs and earnings in excess of billings on uncompleted
contracts totaling $1,295,000.
The Company used cash of $448,000, $1,059,000, $972,000 and $125,000 for
investing activities during the three months ended March 31, 1997 and the
years ended December 31, 1996, 1995 and 1994, respectively. Investing
activities have consisted principally of the acquisition of property and
equipment, most notably computer equipment and software to support the growing
employee base and corporate infrastructure. Although the Company has no
significant commitments for capital expenditures in 1997, the Company expects
to continue
30
<PAGE>
to purchase property and equipment to further develop its infrastructure. The
Company's cash flows from investing activities in 1996 also included net cash
of $174,000 provided by the acquisition of Vista.
The Company's financing activities used cash of $60,000 during the three
months ended March 31, 1997 and provided cash of $10,555,000, $1,994,000 and
$421,000, during the years ended December 31, 1996, 1995 and 1994,
respectively. In March and October 1996, the Company raised aggregate net
proceeds of $11,684,000 in private placements of the Company's Convertible
Preferred Stock and Common Stock. Net proceeds from the sales of such shares
were used for the Company's general working capital needs, to make scheduled
debt payments and for treasury stock acquisitions. In 1995 and 1994, financing
activities consisted primarily of borrowings from banks and other lending
institutions.
In May 1995, the Company issued a secured subordinated note payable for
approximately $924,000 with a face value of $1,000,000 and interest payable at
10% per annum. The note is subordinate to any bank debt and is collateralized
by a second security interest in all of the assets of the Company. In
addition, the note carries a prepayment premium and contains various
restrictive covenants including, but not limited to, minimum earnings and
limitations on certain interest coverage, debt and equity ratios. The note
also included warrants with an ascribed value of approximately $76,000 for the
purchase of up to 312,500 shares of Common Stock for $1.60 per share. The
warrants expire on June 30, 2000. The Company intends to use a portion of the
net proceeds of this offering to repay in full the note. See "Certain
Transactions" and "Use of Proceeds."
In September 1996, the Company obtained a revolving line of credit facility
from a bank which bears interest at the bank's prime rate plus 0.5% (9.0% at
March 31, 1997). The maximum borrowing under this line of credit is $3,500,000
and is limited to 75% of certain receivables plus 50% of costs and estimated
earnings in excess of billings on uncompleted contracts, as defined by the
line of credit agreement. The line of credit, which was extended on June 20,
1997, expires and all borrowings are payable in full on June 30, 1998. In
addition to this line of credit, the Company also entered into an equipment
financing agreement in September 1996. Under this agreement, the bank agreed
to provide up to $1,500,000 for the purchase of certain equipment (as defined
by the agreement) through June 30, 1997. Ratable principal and interest
payments are payable during the period July 1, 1997 through June 1, 2000, and
bear interest at the bank's prime rate plus 1% (9.5% at March 31, 1997). Both
of these agreements require the Company to comply with certain financial
covenants and are secured by all of the assets of the Company. As of March 31,
1997, there were no borrowings outstanding under the revolving credit facility
and $562,000 was outstanding, and $825,000 remained available, under the
equipment financing agreement.
To date, the Company has not invested in derivative securities or any other
financial instruments that involve a high level of complexity or risk. Cash
has been and the Company contemplates that it will continue to be invested in
interest-bearing, investment grade securities.
The Company believes that the net proceeds from the sale of Common Stock
offered by this Prospectus, together with cash generated from operations and
existing cash balances and advances available under its credit line agreements
will be adequate to finance its capital requirements for at least the next
twelve months. To the extent that such amounts are insufficient to finance the
Company's capital requirements, the Company will be required to raise
additional funds through equity or debt financing. No assurance can be given
that such financing will be available on terms acceptable to the Company, and,
if available, such financing may result in further dilution to the Company's
stockholders and higher interest expense.
31
<PAGE>
ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued SFAS 128,
Earnings per Share. SFAS 128 specifies modifications to the calculation of
earnings per share from those currently utilized by the Company. Under SFAS
128, "basic" earnings per share will be calculated based upon the weighted
average number of common shares actually outstanding, and "diluted" earnings
per share will be calculated based upon the weighted average number of common
shares and dilutive potential common shares. SFAS 128 is effective in the
Company's fourth quarter of 1997 and will be adopted at that time. The
adoption of SFAS 128 will have no effect on the reporting of the Company's
results of operations, as the Company has not been required to report
historical earnings per share. In addition, the adoption of SFAS 128 will have
no effect on the Company's financial position or cash flows.
32
<PAGE>
BUSINESS
OVERVIEW
The Company provides software products and services that enable
organizations to improve the productivity, quality and effectiveness of their
IT systems maintenance or software evolution functions. The Company's
solution, which employs software tools, methodologies and processes, is
designed to automate the typically labor-intensive processes involved in
conducting mass change and other software maintenance tasks. In 1996, the
Company released its first commercially available product, its
AutoEnhancer/2000 software, which is aimed at the industry's most pervasive
mass change challenge, the year 2000 problem. The Company also provides on a
fixed-fee basis software maintenance outsourcing services that employ the
Company's proprietary software tools, methodologies and processes to generate
productivity gains through the automation of the software evolution process.
The Company has entered into agreements with a number of leading value added
integrators and distributors, including Bull, a related party, CIBER, Inc.,
Computer Sciences Corp., IBM Global Services and Keane, Inc., which license
the Company's software tool for use in serving their clients. In addition, the
Company licenses its AutoEnhancer/2000 software directly to end users, which
include Met Life and Merrill Lynch. Representative outsourcing clients of the
Company include Advanced Micro Devices, Inc., Computervision, MicroAge
Computer Center, Inc., NYNEX and Stratus. In June 1997, the Company entered
into a joint marketing agreement with VIASOFT to form a joint marketing
arrangement that would combine complementary product and services offerings in
a "best practice" suite of year 2000 solutions.
INDUSTRY BACKGROUND
With the globalization of markets and increased competitive pressures to
reduce operating costs, shorten time to market, improve product quality and
increase customer responsiveness, large organizations throughout the world
have become increasingly dependent on IT to organize and manage their
businesses and serve their customers. Many of these organizations utilize
large mainframe computer systems, client/server systems or a combination
thereof for the information processing requirements of their enterprises.
These IT systems contain the core knowledge and processes that support
mission-critical operations, and maintaining the investment in these IT
systems is a requirement for organizations worldwide.
A key challenge facing organizations has been to modify, update and adapt
their IT systems and evolve their software to respond to a changing and more
competitive business environment. This challenge has increased with the
broadening complexity of IT and the continued evolution of mainframe systems,
as well as the advent of distributed, client/server computing and the
proliferation of third-party enterprise software applications. At the same
time, the pace of change in business environments has accelerated, requiring
organizations to continually evolve their IT systems and environments to adapt
to changing business conditions and processes. This software evolution process
is typically time-consuming, labor-intensive and expensive, and consists not
only of fixing bugs and maintaining the current level of software performance
and functionality, but also making enhancements, implementing mass changes to
the code and migrating applications to new computing platforms.
According to its January 1993 ADM Research Note, Gartner Group, Inc.
estimated that, within the established worldwide IT infrastructure, up to 200
billion lines of COBOL software code have been written to support
applications, many of which are mission-critical. In addition, between 60% to
80% of the average annual IT application development budget is spent on the
maintenance of legacy systems. Although the maintenance function within IT
departments has received little management attention historically, the
impending year 2000 problem, with an estimated cost of between $300 and $600
billion to fix, represents the most significant IT maintenance challenge to
date.
One of the most crucial software evolution challenges currently facing IT
departments is the cost-effective implementation of mass changes to
application systems and their associated databases. A mass change software
modification initiative is the process of effecting a change to the way a
basic variable is interpreted and acted
33
<PAGE>
upon by a computer program and associated databases in which the variable may
appear or be used thousands, or even millions, of times. The primary goal of a
mass change initiative is to allow organizations to evolve their applications
to accommodate changes in business practices or conditions by modifying
frequently occurring variables without altering or impacting the underlying
logic or function of the program. In large mainframe computing environments, a
typical mass change initiative may involve sorting through hundreds of
millions of lines of code to locate and then correct the targeted variables.
Mass change problems have become more acute for businesses with the increase
in the complexity and volume of computer data, coupled with the use of
disparate IT platforms, operating systems and languages.
Examples of mass change problems include the year 2000 problem, which is the
inability of certain computer systems to properly interpret dates for the year
2000 and beyond; the European Union's expected conversion to the euro
currency; the anticipated increase in the number of digits in Japan's
telephone numbers; the increase in the number of characters in Australia's
medical account classification codes; and the extension of the number of
digits or other characters in zip codes, product codes for manufactured goods
and account numbers for service providers. Additional mass change needs are
being driven by internationalization and localization requirements, weights
and measures standardization, identity-code changes, mergers and acquisitions
and privatization of government agencies.
Presently, the most pervasive mass change problem is the year 2000 problem,
which will affect IT systems in organizations worldwide. To make mission-
critical applications "year 2000 compliant," organizations will be required
over the next several years to devote considerable IT resources, including
investment in software tools and processes, personnel, time and other
resources, to undertake large-scale mass change initiatives.
A typical year 2000 renovation project includes: an ASSESSMENT PHASE, where
an enterprise performs an inventory of its code, analyzes the impact and
exposure of the year 2000 problem on its business and plans the renovation of
the affected code; a CORRECTION PHASE, which entails the implementation of
source code renovation, including the identification of all date-sensitive
variables, correction of the code, and generation of bridges and data
converters so the corrected code will still function with non-compliant code,
and verification of the corrected code; and a TESTING PHASE, which ensures the
integrity of a year 2000 renovation by performing unit and systems tests prior
to re-deploying the code into production. To date, most large organizations
that have begun to address the year 2000 problem have focused on the initial
assessment phase, and relatively few have begun the more critical correction
and testing phases. The Company's AutoEnhancer/2000 software focuses on the
correction phase of a year 2000 renovation project with links to third-party
assessment tools on the front of the process and third-party testing tools on
the back.
To respond to the foregoing challenges in software evolution, many large
organizations are seeking to improve the software evolution process. With the
lack of internal resources to incorporate new and developing technologies,
select and train personnel and develop efficient methodologies to improve IT
applications, many large organizations are seeking ways to outsource their IT
requirements, particularly on a fixed-price, fixed-time frame basis in order
to minimize the risks and costs associated with such large-scale technology
requirements. In addition, industry analysts acknowledge that there is a
growing shortage of IT professionals, which is being exacerbated by the year
2000 problem. These trends have resulted in increased demand for automated
software tools that supplement traditional, mostly manual, maintenance methods
that are often tedious, time-consuming and error-prone.
Historically, software development tools have been targeted to address the
front end of the software development cycle--the analysis, design and coding
of an application--rather than on the maintenance or evolution of the
application. Existing tools and processes to address the software evolution
and mass change needs of organizations typically provide limited
functionality, lack a high degree of automation and are not designed to
address the full scope of the maintenance process. In addition, many existing
solutions do not emphasize productivity and do not address the broad range of
requirements needed to manage the software evolution process across
heterogeneous computing environments.
34
<PAGE>
With software evolution becoming an increasing burden in the operation of
mission-critical systems, organizations are actively seeking solutions that:
(i) provide comprehensive software evolution capabilities to accommodate
continually changing business needs; (ii) automate and streamline the software
evolution function; (iii) provide a comprehensive solution to mass change
initiatives, including the year 2000 problem; (iv) are compatible with
multiple platforms, operating systems and programming languages; and (v)
provide measurable productivity gains.
PERITUS SOLUTIONS
Peritus offers comprehensive products and services that enable organizations
to improve the productivity, effectiveness and quality of the software
evolution process. The Company's solutions employ a combination of tools,
processes, skilled professionals and methodologies. The Company's underlying
technology consists of its Peritus Intermediate Language ("PIL") and
proprietary tools that can be implemented to address mass change or other
software maintenance challenges.
MASS CHANGE SOLUTIONS
Proven Technology for Mass Change. The Company's Mass Change Engine, which
is based on PIL and other proprietary technologies, converts source code from
a variety of programming languages into PIL in order to perform analysis,
correction and testing on the code during mass change maintenance initiatives.
The Mass Change Engine is designed to automate the labor-intensive code
maintenance function, thereby increasing productivity, and can be customized
to provide function-specific mass change capabilities. The Mass Change Engine
operates across multiple platforms, languages and operating systems.
Comprehensive Year 2000 Renovation Tool. The Company's year 2000 products
and services provide a comprehensive renovation solution for organizations
seeking to address the year 2000 problem. The Company's AutoEnhancer/2000
software, which is based on its Mass Change Engine, is also designed to
provide flexibility in addressing the critical identification, correction and
verification components of a year 2000 renovation. The AutoEnhancer/2000
software is designed to be interoperable with third-party assessment,
extraction and testing tools.
SERVICE OFFERING COMPONENTS
Comprehensive Software Evolution Services. The Company's service offerings
are designed to address software evolution needs through tools and processes
that provide productivity gains by automating and improving the software
evolution process. These services are generally offered on a fixed-fee basis,
and the client can realize the resulting productivity gains in the form of
reductions in internal IT costs, increases in throughput, improved turn-around
time and/or improved software quality. The Company's current service offerings
include outsourcing, in which Peritus assumes responsibility for the evolution
of a client's software, and technology transfer services, in which Peritus
provides its methodologies and tools to clients in-house, enabling them to
implement enhanced, repeatable processes for software evolution.
Team-Based Process Methodologies. The Company employs team-based
methodologies in its service offerings. Teams typically consist of both
Company and client employees, with a Company project manager supervising the
process. In the delivery of its services, the Company combines concepts from
disciplines such as scientific inquiry, operations research and psychology
with engineering "best practices" (such as formal inspections, cross
functional teams and quality initiatives) to create a workflow paradigm that
optimizes a team's ability to leverage its combined talent, knowledge and
experience.
Advanced Technology Platform. The Company has developed its core
technologies through the use of advanced mathematical algorithms and
techniques. To achieve productivity gains, the Company utilizes proprietary
tools that better enable maintenance teams to rapidly locate and fix bugs and
provide software enhancements. These tools include a software maintenance
assistance tool designed to automate the process of logical code analysis, a
business rules extraction tool and a groupware tool designed to facilitate
workflow coordination.
35
<PAGE>
STRATEGY
The Company's objective is to establish leadership in providing tools,
processes and services that significantly increase productivity and quality in
software evolution. The Company's strategy includes the following key
elements:
Establish Leadership in Software Evolution Technology. The Company intends
to continue to develop its core technologies by enhancing its Peritus
Intermediate Language and related technologies in the areas of mass change,
business rules extraction, verification, testing and code analysis. The
Company is currently developing specific versions of its Mass Change Engine to
address mass change market opportunities in addition to the year 2000 problem.
Leverage Year 2000 Opportunities. The Company has focused a significant
portion of its recent research and development expenditures on enhancing
current products and technologies designed to address year 2000 market
opportunities. The Company intends to continue marketing its year 2000
products and services through both direct and indirect channels. The Company
believes that the year 2000 problem has heightened industry concerns regarding
software maintenance. The Company anticipates that these concerns will serve
as a catalyst in helping organizations to view software maintenance as a
dynamic, evolutionary process capable of addressing mass change problems and
enabling organizations to improve the productivity, effectiveness and quality
of their software maintenance. In addition, the Company intends to leverage
the relationships developed through its year 2000 products and services into
long-term outsourcing engagements and future mass change sales opportunities.
Develop Multiple Distribution Channels. The Company currently markets its
products through a combination of direct and indirect channels. The Company
believes that indirect channels are an important part of its distribution
strategy and plans to continue to develop these channels. Currently, the
Company has agreements with 22 value added integrators and distributors that
license its AutoEnhancer/2000 software. The Company's value added integrators
operate on a worldwide basis, and its distributors are currently located in
the United States, Canada, Italy and Japan. During 1997, the Company expects
to enter into additional value added integrator and distribution agreements,
including agreements with additional government systems integrators to
penetrate state, federal and foreign government agencies. The Company also
intends to work with several complementary software and services providers to
create a "best practice" suite of year 2000 solutions. In June 1997, the
Company entered into a joint marketing agreement with VIASOFT to form a joint
marketing arrangement that would combine complementary product and service
offerings. The Company also intends to continue to expand its direct sales
organization.
Leverage Existing Client Base. The Company has established strong long-term
client relationships, which often involve multiple contracts over several
years. The Company intends to leverage existing client relationships by cross-
selling other products and services to its clients. For example, the Company
believes that clients that purchase year 2000 products and services will
likely have other mass change and software evolution needs, which the Company
intends to target.
Continue to Expand Service Offerings. The Company intends to expand its
service offerings by introducing insourcing services to organizations
interested in retaining the maintenance function in-house and by continuing to
offer outsourcing and technology transfer services. Through its resources in
the United States, Spain and India, the Company has developed "virtual"
outsourcing teams that provide outsourcing coverage and support 24 hours a
day. The Company intends to increase productivity and capacity among its
virtual outsourcing teams by hiring additional overseas personnel during 1997.
Pursue Strategic Opportunities. Although the Company's growth to date has
occurred principally through internally developed products and services, the
Company is pursuing additional strategic alliances with value added
integrators to enhance the scope of the products and services offered to end
users. In addition, the Company believes that the opportunity exists to expand
its products and services through the acquisition of complementary businesses
and technologies. Although the Company currently has no commitments or
agreements with respect to any such acquisition, management intends to analyze
potential acquisitions and to pursue those opportunities that complement or
supplement its business strategy.
36
<PAGE>
TECHNOLOGY
The Company's core technologies consist of its Peritus Intermediate
Language, its Mass Change Engine, other computer-based tools and formal
mathematical techniques.
The Peritus Intermediate Language. The Company has developed its Peritus
Intermediate Language to support accurate diagnosis of why a program functions
incorrectly. PIL is based on the mathematical theory that all computations can
be expressed in a small number of abstract instructions into which existing
computer languages can be translated. PIL consists of 13 abstract
instructions, and currently the COBOL, RPG, C and PL/1 programming languages
have been translated by the Company into PIL. When data enter a computer
program, their paths can be traced by the values assigned to them by the
instructions in that program. In contrast, PIL can be used to trace the paths
of all data that fall into mathematically describable classes. As a result, if
the data are in a certain state when a program completes or aborts, it is
possible, using PIL, to determine the initial conditions of these data before
the program was executed. In addition, the use of PIL allows tools to be built
that can verify that a program is logically correct by specifying pre and post
conditions of classes of data rather than relying on the traditional method of
testing, which is based on trial and error using selected data points.
Mass Change Engine. The Company's Mass Change Engine is designed to address
mass changes to IT systems (such as expansion of data fields or changes in
product or part identifiers) by accepting as input the identified data
structure and desired rules of transformation. The Mass Change Engine then
examines the entire set of computer programs to trace all related data and
instructions, computes the necessary changes that are the result of that
simple change requirement and makes corresponding adjustments in all programs
and data so that only the desired change occurs without impacting the
underlying logic. These tasks are accomplished through the use of an adaptive
seed generator based on neural network technology, the creation of a
repository of relationships between the data and instructions using PIL and
the use of propagations that determine the relationship between variables and
seeds using a set of identification rules and information embedded in the
repository. The Company's Mass Change Engine can be adapted to address
specific mass change needs. The Company's AutoEnhancer/2000 software is an
example of an extension of the Mass Change Engine.
Other Computer-Based Tools. The Company's software maintenance tools have
been specifically designed to address the needs of the software maintenance
practitioner and are used primarily by the Company's outsourcing teams. The
Company anticipates that certain of its tools may be released as commercial
products in the future. The Company's current computer-based tools include:
. Peritus Code Analyzer ("PCA")--PCA is a software maintenance assistance
tool designed to automate the process of logical code analysis. The tool
is used to discover and correct defects, implement enhancements, verify
properties of software (such as database integrity or security
properties), migrate from one language to another and update systems or
programs and data for specific enhancements (such as those required by
the year 2000 problem).
. Business Rules Extraction--The Company's business rules extraction tool
analyzes complex data structures and computer instructions within an
information system and determines and distills the business rules that
are embedded throughout the system. The extraction of business rules
decreases the effort involved in porting, migrating, reengineering,
simplifying and evolving software.
. Peritus Control System ("PCS")--PCS is a workflow and productivity-
enhancing groupware tool designed to support the Peritus model for
workflow coordination and accumulation of maintenance-related knowledge
and experience.
Formal Mathematical Techniques. Peritus has developed a discipline that
makes the analysis of software a more reliable activity based on the technique
of logical code analysis. Logical code analysis facilitates the understanding
of unfamiliar code and the isolation of the code specifically related to the
maintenance task and executes the required changes without impacting the
underlying logic. The Company's formal mathematical techniques are an integral
component of its core technologies and serve as the basis for the automation
capabilities of those technologies.
37
<PAGE>
PRODUCTS AND SERVICES
The Company's products and services are designed to deliver increased
productivity through tools, processes, skilled professionals and
methodologies. The Company initially provides clients with process and
methodology before introducing its products and technologies, thus laying the
foundation for the successful use of the Company's products. The Company's
current product offering includes its AutoEnhancer/2000 software, and its
current and proposed service offerings include software maintenance
outsourcing, technology transfer and insourcing services.
AutoEnhancer/2000 Software
The Company's AutoEnhancer/2000 software is a comprehensive solution
designed to address the correction phase of a year 2000 renovation. This
software tool currently processes COBOL, PL/1 and RPG computer languages. It
contains a user-friendly graphical user interface ("GUI") and can be easily
modified to interoperate with third-party assessment and testing tools. In
1996, the Company began licensing a COBOL version of this product to end users
and value added integrators. During 1996 and the three months ended March 31,
1997, revenue from the licensing of the AutoEnhancer/2000 software represented
33.9% and 52.7% of the Company's total revenue, respectively, and the Company
expects that such license revenue will continue to represent a significant
percentage of its total revenue for the foreseeable future. As of April 30,
1997, the AutoEnhancer/2000 software was installed in more than 45
installations.
Through a series of integrated and automated functions, the Company's
AutoEnhancer/2000 software identifies date-sensitive variables and corrects
the source code using date-field expansion or windowing techniques. In
addition, the tool generates bridges, wrappers, and data conversion programs
that enable the modified code to interface with remaining non-renovated
programs and data. The modifications are then verified through the use of
logical code analysis techniques to facilitate the extensive testing
requirements.
In order to increase the accurate identification of lines of affected
software code, the AutoEnhancer/2000 software traces and propagates variables
that a user has identified as date-sensitive to identify interrelated
variables. The AutoEnhancer/2000 software also uses a pattern matching program
that identifies variables that were named by a user in such a manner as to
suggest that they may be date-sensitive variables. This pattern matching
program uses "neural net" concepts, logical principles, user input and user
feedback to attempt to learn and adjust the patterns searched so as to improve
accuracy in determining which variations to encompass as variables of
interest. Quantifying the speed at which the Company's AutoEnhancer/2000
software (or other conversion tools) performs data conversion or the accuracy
at which the software identifies lines of affected software code is not easily
accomplished as results vary based on a large number of variables, including:
(i) the user-determined qualitative degree of accuracy of identification and
correction of errors; (ii) the nature and type of the identification and
correction methods; (iii) the computer languages used in the code being
corrected; (iv) whether the computer code contains a mixture of various
languages or involves proprietary aspects specific to the client; and (v) the
specific coding practices used by programmers in creating programs and
generating computer code. Among software tools designed for data correction of
the year 2000 problem, there is no mutually agreed upon standard benchmark of
comparison with regard to speed and accuracy.
38
<PAGE>
The following table highlights the various steps in which the
AutoEnhancer/2000 software addresses the correction phase of a year 2000
renovation:
AUTOENHANCER/2000 SOFTWARE
<TABLE>
<CAPTION>
FUNCTION FEATURES BENEFITS
- -------------------------------------------------------------------------------------------
<S> <C> <C>
SEGMENTATION . Load source code into program . EBCDIC to ASCII encoded accurately
. Perform pre-renovation compile and recoverably
. Establish source code boundary . Strict source code control
. Identify print and display outputs environment established
. Perform dataset name unification . Source code completeness verified
. Source code compliability
validated
. Data synonyms established
- -------------------------------------------------------------------------------------------
IDENTIFICATION . Convert source code into PIL . Logic of code unraveled for
. Perform record name unification automated analysis
. Select bridging strategies . Record synonyms established
. Find the date-sensitive items . Bridging strategies specified
through propagation . Date-sensitive variables and
. Resolve ambiguous identification constants identified
conditions . Procedure-division uses of date-
. Facilitate identification sensitive items identified
completeness using Adaptive Seed . Accuracy and completeness of
Generator identification verified
- -------------------------------------------------------------------------------------------
CORRECTION . Create and apply correction . Source code corrected
transactions
. Create and apply harmonization . Redefines realigned
transactions . All identified uses of date-
. Resolve correction warnings sensitive items corrected
- -------------------------------------------------------------------------------------------
BRIDGE . Generate bridge programs by . Interoperability of renovated and
building wrappers, filters and unrenovated code established
converters
- -------------------------------------------------------------------------------------------
ADAPTATION . Identify Job Control Language . Date-sensitive JCL identified and
(JCL) date-sensitive issues corrections suggested
. Identify record size changes
. Create JCL correction plan
- -------------------------------------------------------------------------------------------
VERIFICATION . Reconcile planned and implemented . Intended and actual changes
corrections reconciled
. Perform post-renovation compile and . Verification to ensure that
compare to pre-renovation compile changes do not impact compiler
results results
- -------------------------------------------------------------------------------------------
PACKAGING . Package renovated source code and . Source code returned to facilitate
generated source code for return replacement and testing
to client
</TABLE>
- --------------------------------------------------------------------------------
39
<PAGE>
Peritus offers extensive training and support to its software licensees. The
licensee's renovation engineers participate in both formal and on-the-job
training supported by the Company's expert renovation engineers. This training
and support facilitates successful implementation and deployment of
AutoEnhancer/2000 software in the licensee's environment. The Company also
provides licensees with client technical support as well as on-site or remote
consulting.
The Company licenses its AutoEnhancer/2000 software directly and indirectly
(via distributors) to end users and to value added integrators for their use
in addressing the year 2000 needs of their clients. License fees to end users
are fixed, with the amount of the fee based on the estimated total lines of
code to be processed, and license fees to value added integrators and
distributors are generally royalties based on lines of code processed or to be
processed.
Outsourcing Services
The Company offers customized software maintenance outsourcing services to
clients. In an outsourcing project, the Company assumes responsibility for the
evolution of a client's software, including bug fixing, enhancements,
applications migration and porting. The Company's outsourcing services address
the maintenance needs of application software, system software, embedded
software and software products and are designed to provide productivity gains
regardless of platform, operating system, language or software function. In
the delivery of its outsourcing services, the Company uses a number of
proprietary technologies. Compared to traditional software maintenance
methods, the Company's technologies allow faster de-bugging by identifying and
excluding irrelevant variables and by tracing the cause of errors from the
known output resulting from such errors. In addition, the Company may from
time to time directly provide year 2000 renovation services for its clients.
Outsourcing services are performed at both Company and client locations with
a team of Company employees, or a team comprising Company and client
employees. Formal training, support and continuous improvement are part of
every outsourcing service offering. The Company's self-directed outsourcing
teams understand and exploit organizational dynamics, workflow management and
proprietary technology to enhance the productivity, responsiveness and quality
of the software evolution process. Individual team members develop a deep and
broad understanding of many programming languages and applications, as well as
maintenance technologies and de-bugging methodologies.
In connection with the delivery of its outsourcing services, the Company
assesses the IT costs of a client and in general agrees to provide IT services
at a price targeted at 30% below the client's IT costs that are identified
during a detailed upfront assessment. This savings is often realized in the
first year. In addition, the Company's outsourcing services are designed to:
. Re-deploy key resources to mission-critical applications
. Enhance control of the maintenance function
. Improve turnaround time and quality of response
. Reduce dependency on specific individuals and specific domain knowledge
A typical outsourcing engagement represents a multi-million dollar, multi-
year, fixed-price contract that specifies service rather than staffing levels.
Technology Transfer Services
The Company offers technology transfer services to assist organizations that
seek to increase the productivity of their software evolution activities while
keeping their software maintenance activities in-house. This technology
transfer program transfers the organizational model and workflow methodology
of the Company's software maintenance outsourcing solutions to enable clients
to implement enhanced, repeatable processes for software evolution.
40
<PAGE>
With respect to technology transfer services, the Company targets an
increase in client productivity of 25% within six months. Productivity gains
are measured against pre-determined metrics that are established during a
detailed upfront assessment of the client's applications and workflow. A
typical technology transfer engagement consists of training multiple teams of
client personnel in the Company's methodology. Engagements have a duration of
four to six months with approximately 14 days of on-site delivery and
coaching.
During 1997, the Company plans to introduce insourcing services, which will
combine the Company's technology transfer services with on-site management of
the Peritus-trained client teams. In an insourcing engagement, the Company
will participate with the client management to ensure that the teams
accurately implement the Company's approach and perform at expected
productivity levels. Typical insourcing engagements are expected to have two
revenue components: a fee for services and a royalty tied to the client's
productivity gains.
SALES AND MARKETING
The Company offers its products and services to clients through both direct
and indirect channels, which include relationships with value added
integrators that use the Company's technology as an integral part of their
overall solutions, as well as domestic and international distributors. As of
May 31, 1997, the Company had 18 full-time employees in sales and marketing.
Direct Sales
The Company sells and supports its products and services directly through
its sales force located in Billerica, Massachusetts; Trumbull, Connecticut;
Schaumburg, Illinois; Denver, Colorado; Ontario, Canada and Barcelona, Spain.
The Company plans a significant expansion of its sales force through regional
offices in the Northeast, Mid-Atlantic, West and Midwest regions of the United
States.
Indirect Sales
The Company currently has agreements with 22 value added integrators and
distributors. The Company's value added integrators include large systems
integrators, IT consulting organizations and other providers of IT services
and solutions that use the Company's AutoEnhancer/2000 software to perform
year 2000 renovation projects for their clients. The Company regularly offers
sales training to its value added integrators. The Company's distributors are
located in the United States, Canada, Italy and Japan and are authorized by
Peritus to sublicense the Company's products and/or services to end users or
system integrators in their respective territories. In June 1997, the Company
entered into a joint marketing agreement with VIASOFT to form a joint
marketing arrangement that would combine complementary product and service
offerings in a "best practice" suite of year 2000 solutions. See "Risk
Factors--Dependence on Third-Party Channels; Potential for Channel Conflict."
Below is a list of the Company's value added integrators and distributors
with which the Company has agreements as of June 15, 1997:
Analyst International Corporation Integris, a Bull Company
ACTC Technologies, Inc. I-NET, Inc.
Bell Communications Research, Inc. Japan Third Party Co., Ltd.
BFL Software Limited Keane, Inc.
CIBER, Inc. LGS Group, Inc.
Complete Business Solutions, Inc. MCSI Technologies, Inc.
Computer Sciences Corp. Netsiel S.p.A.
Comtex Information Systems, Inc. PKS Systems Integration, Inc.
Coritel, S.L. PRT Corp. of America
Datamatics Ltd. Stratagem, Inc.
IBM Global Services Vital Computer Service
International, Inc.
41
<PAGE>
Marketing
The Company's marketing organization works closely with the sales
organization in the development of Company marketing literature, market
research to assist in strategic planning and tactical decision making, trade
show programs and exhibit planning, advertising and public relations support.
In 1997, the Company began "Powered by Peritus," a new marketing and
advertising campaign. It comprises several programs, including a direct mail
initiative aimed at potential year 2000 end-user licensees, new channel
candidates and outsourcing prospects. The Company is also conducting a
significant advertising campaign for its year 2000 products.
CLIENTS
The Company offers its products and services to end users in a number of
industries. Below is a partial list of the Company's clients, each of which has
accounted for at least $200,000 of revenue since January 1, 1995:
Advanced Micro Devices, Inc. Metropolitan Life Insurance Company
Bell Communications Research, Inc. MicroAge Computer Center, Inc.
Bull HN Information Systems Inc. Microcom, Inc.
Computervision Corporation NYNEX
The First National Bank of Boston Prudential Life Insurance
Jostens Learning Corporation Stratus Computer, Inc.
Merrill Lynch, Pierce, Fenner
& Smith Incorporated
To date, the Company's revenue has been dependent on a few major clients,
including Bull, Stratus, Computervision, Met Life, IBM and Merrill Lynch.
During the three months ended March 31, 1997, Merrill Lynch, Met Life and IBM
represented approximately 26.1%, 14.0% and 10.6% of the Company's total
revenue, respectively. During 1996, Bull, Merrill Lynch and Stratus represented
approximately 29.0%, 14.6% and 12.1% of the Company's total revenue,
respectively. During 1995, Bull, Stratus and Computervision represented
approximately 50.3%, 12.9% and 11.0% of the Company's total revenue,
respectively. During 1994, Bull and Computervision represented approximately
51.7% and 29.3% of the Company's total revenue, respectively. In addition, the
Company's ten largest clients represented approximately 82.2%, 77.9%, 90.5% and
92.1% of the Company's total revenue in the three months ended March 31, 1997
and the years ended December 31, 1996, 1995 and 1994, respectively. See "Risk
Factors--Concentration of Clients and Credit Risk."
The Company has entered into agreements to provide software consulting
services and software maintenance services with each of Computervision, Stratus
and Bull. These agreements expire, subject to extension, on December 31, 2000,
February 16, 1999 and February 3, 1998, respectively.
The Company has also entered into a license agreement with Bull that expires
on December 31, 2001. This agreement grants to Bull certain use rights,
sublicensing rights and the right to make certain derivative works with regard
to proprietary software programs of the Company. In the event that the Company
fails to fulfill any of its obligations under the Bull license agreement for a
period of 90 days, Bull has the option, upon notice to the Company, to elect in
lieu of termination to assume performance of the Company's obligations and to
have access to source code of the Company's licensed software to perform such
assumed obligations. See "Certain Transactions."
The Company and Merrill Lynch have entered into a master license agreement
granting to Merrill Lynch the right to use certain proprietary software of the
Company on a non-exclusive, perpetual use basis to address year 2000 issues.
The Company has also entered into a license agreement with Met Life that
provides for the purchase by Met Life of several non-exclusive, worldwide
licenses of certain of the Company's proprietary software. The Met Life
agreement is terminable by Met Life upon 90 days' written notice. Such
termination may result in a partial refund of sums paid to the Company under
the agreement.
While each client engagement differs, the following examples illustrate the
types of business needs the Company has addressed:
42
<PAGE>
Merrill Lynch--AutoEnhancer/2000 Licensee. Merrill Lynch, a global financial
services concern, evaluated the Company's AutoEnhancer/2000 software in 1996
as part of its process of developing a comprehensive solution to its year 2000
renovation efforts. Along with a number of other vendors, Peritus was invited
to conduct two pilot programs, which were designed to demonstrate the tool's
ability to automate the identification and correction tasks of a year 2000
conversion. In December 1996, Merrill Lynch entered into a direct end-user
license for the AutoEnhancer/2000 software to support its data expansion
renovation efforts. Merrill Lynch notified the Company that the tool was among
those selected based upon the accuracy of its identification function and the
level of automation provided. Merrill Lynch has established a renovation
center in New York that provides divisions with remote access to perform the
renovations, and Peritus has trained more than 35 of Merrill Lynch's
renovation engineers.
Computer Sciences Corp.--AutoEnhancer/2000 Value Added Integrator. Computer
Sciences Corp. ("CSC"), an international provider of IT services, provides a
dedicated national practice that addresses the year 2000 problem. CSC's
Catalyst 2000(R) service includes a renovation center designed to process
large amounts of code through the correction phase. To achieve the desired
throughput, the CSC renovation center sought tools that would automate the
process. After evaluating several tools and technologies, CSC chose the
Company's AutoEnhancer/2000 software for its center and signed a strategic
agreement that provided for a usage-based license. Since the initiation of the
agreement, Peritus has trained CSC renovation engineers to work with the
Peritus technology in this renovation center. See "Certain Transactions."
NYNEX--Outsourcing Engagement. In mid-1995, NYNEX began exploring ways to
reduce costs and improve the process of maintaining its IT applications.
Peritus was invited to bid on an outsourcing engagement that involved the
maintenance of a budget and planning application. After a competitive process,
NYNEX awarded the contract to Peritus for a number of reasons, including the
fixed-price nature of the bid and the commitment to improved productivity. In
April 1996, NYNEX extended the contract to include additional applications.
CLIENT TECHNICAL SUPPORT
In connection with the licensing of its products, the Company provides its
clients with technical support and advice, including problem resolution,
installation assistance, error corrections and product enhancements released
during maintenance. The Company believes that a high level of service and
support is critical to its success and represents an important competitive
advantage. Furthermore, the Company believes that a close and active service
and support relationship is important to client satisfaction and provides the
Company with important information regarding evolving client requirements. The
Company provides each of its significant clients with a dedicated client
technical support representative whose primary responsibility is to resolve
questions and concerns and act as a liaison between the client and the
Company. In addition, the Company provides toll-free telephone support, as
well as access to electronic bulletin boards and other forms of electronic
communication to provide clients with the latest information regarding the
Company's products and services. Client technical support fees related to the
Company's year 2000 products are typically 15% of license fees and are capped
at $200,000 annually per direct licensee. As of May 31, 1997, the Company's
client technical support organization consisted of 12 full-time employees.
RESEARCH AND PRODUCT DEVELOPMENT
The Company believes that its future success depends in large part on its
ability to maintain and enhance its current product line, develop new
products, maintain technological competitiveness and meet an expanding range
of client requirements. The Company plans to continue to enhance its products
and develop new products, including the development of new versions of its
mass change software and the commercialization of its internally used
outsourcing tools and methodologies.
As of May 31, 1997, the Company's research and development organization
consisted of 56 full-time employees, 15 of whom were located at the Company's
facility in Schaumburg, Illinois and 41 of whom were
43
<PAGE>
located at the Company's Billerica, Massachusetts headquarters. In January
1997, the Company began research and development activities in Bangalore,
India. The Company's research and development expenses were $6,033,000,
$1,703,000 and $560,000, or 31.4%, 9.2% and 7.1% of total revenue, for the
years ended December 31, 1996, 1995 and 1994, respectively.
The Company has generally relied on internal efforts and resources to
develop its software and methodologies. However, in some limited cases, the
Company has contracted with various firms, certain of which are located in
India and Canada, to develop materials, processes, software or portions of
software for and on behalf of the Company. In January 1996, the Company
acquired Vista to gain additional technologies in user interface and software
behavior modeling.
COMPETITION
The market for the Company's software products and services, including its
solutions for the year 2000 problem, is intensely competitive and
characterized by rapid changes in technology and user needs and the frequent
introduction of new products. The Company's competitors include year 2000
software vendors, year 2000 service providers and outsourcing service
providers.
Vendors of year 2000 software products generally focus on a particular phase
of a year 2000 renovation, such as assessment, correction or testing. The
Company's AutoEnhancer/2000 software primarily addresses the correction phase
of a year 2000 renovation. The Company believes that the principal competitive
factors affecting competition in the year 2000 software market include product
functionality, degree of automation, speed of throughput, product performance
and reliability, ability to respond to changing client needs, ease of use,
training, quality of support and price. The Company's principal and potential
competitors in the market for year 2000 software include Computer Associates
International, Inc., Compuware Corporation, Micro Focus Group Public Limited
Company, Platinum Technology, Inc., SEEC, Inc. and VIASOFT.
The Company provides year 2000 services primarily through its relationships
with value added integrators. Peritus believes that these value added
integrators compete on the basis of service, the expertise and experience of
the service personnel, the ability of such personnel to provide solutions to
application problems and price. Principal competitors in this market include
AMDAHL, Cap Gemini America, Computer Horizons Corp. and Information Management
Resources, Inc. Many smaller local and regional organizations also compete in
the year 2000 services market.
The Company also faces competition in the provision of its software
maintenance outsourcing services. The Company believes that the principal
competitive factors in the market for outsourcing services include price, the
ability to provide productivity guarantees, strong client relationships,
comprehensive delivery methodologies, responsiveness to client needs, depth of
technical skills and reputation. The Company's principal competitors in this
market include not only in-house IT departments and systems integrators such
as the Big Six accounting firms but also outsourcing service providers such as
Computer Sciences Corp., Electronic Data Systems Corporation, IBM Global
Services, Keane, Inc. and PKS.
A number of the Company's competitors are more established, benefit from
greater name recognition and have substantially greater financial, technical
and marketing resources than the Company and certain of the Company's value
added integrators and distributors. Moreover, other than the need for
technical expertise, there are no significant proprietary or other barriers to
entry in the year 2000 industry. There can be no assurance that the Company's
products and services or the solutions offered by the Company's value added
integrators and distributors will compete effectively with those of their
respective competitors. The Company's value added integrators and distributors
may also offer or develop products and services that compete with the
Company's products and services. There can be no assurance that those clients
will not give higher priority to the sales of these or other competitive
products and services.
44
<PAGE>
INTELLECTUAL PROPERTY
The Company relies on a combination of copyright, trade secret, patent,
service mark, and trademark laws and license agreements to protect its
proprietary rights in technology. In addition, the Company currently requires
its employees and consultants to enter into nondisclosure and assignment of
invention agreements to limit use of, access to and distribution of its
proprietary information.
The Company's business includes the maintenance, evolution, repair and
development of software applications, system software and other deliverables,
including written specifications and documentation in connection with specific
client engagements. Ownership of software and associated deliverables created
for clients is generally retained by or assigned to the client, and the
Company does not retain an interest in such software or deliverables. The
source code for the Company's proprietary software is generally protected as
trade secrets and as unpublished copyrighted works. However, the Company has
entered into source code escrow agreements with a limited number of its
licensees requiring release of source code in certain circumstances. Such
source code escrow agreements usually limit the use and disclosure of such
source code in the event that it is released.
In addition, the Company has entered into license agreements with a limited
number of clients that allow these clients access to and use of the Company's
AutoEnhancer/2000 software source code for certain purposes. Access to the
source code may increase the likelihood of misappropriation or misuse by third
parties.
The Company's business also includes licensing of the Company's proprietary
software, methodologies and related services to end users, as well as to value
added integrators and distributors authorized to provide services to third
parties. In general, such licensing of the Company's proprietary software,
methodologies and related services to a licensee is a limited term, limited
use, non-exclusive license that contains restrictions on copying, disclosure,
usage, decompiling and transferability. In particular cases, however, a
license agreement may have certain provisions that are exclusive in some
manner. Within these licensing agreements the Company seeks to avoid
disclosure of its trade secrets, including, but not limited to, generally
requiring those persons with access to the Company's proprietary information
to execute confidentiality agreements restricting use of and access to the
Company's confidential information.
The Company generally relies on internal efforts in order to develop its
software and methodologies. However, in some limited cases the Company has
contracted with various firms, certain of which are located in India and
Canada, to develop software or portions of software for and on behalf of the
Company. Software development by a contractor for the Company is done pursuant
to agreements that generally assign all rights to the Company and contain
nondisclosure provisions. Such software developed by a contractor may be
merged with software that the Company has developed using its internal
employees. In January 1996, the Company acquired Vista and was assigned all of
Vista's intellectual property rights, consisting mainly of unregistered
copyrights.
The Company has filed two patent applications with the United States Patent
and Trademark Office pertaining to technologies, processes and methodologies
used by the Company's software. Neither of these patents has been granted and
there can be no assurance that a patent will be issued pursuant to either of
these applications or that, if granted, such patent would survive a legal
challenge to its validity or provide meaningful or significant protection to
the Company. Some competitors of the Company have announced the filing with
the United States Patent and Trademark Office of patent applications relating
to fixing and assessing the year 2000 problem. The Company expects that the
risk of infringement claims against the Company might increase because its
competitors might successfully obtain patents for software products and
processes or because as the number of competitors providing software and
software related services addressing year 2000 problem increases, new and
overlapping processes and methodologies used in such services will become more
pervasive, increasing the likelihood of infringement.
There can be no assurance that the Company's means of protecting its
proprietary rights in the United States or abroad will be adequate. The laws
of some foreign countries may not protect the Company's proprietary rights
45
<PAGE>
as fully or in the same manner as do the laws of the United States. Also,
despite the steps taken by the Company to protect its proprietary rights, it
may be possible for unauthorized third parties to copy aspects of the
Company's products, reverse engineer, develop similar technology
independently, or obtain and use information that the Company regards as
proprietary. Furthermore, there can be no assurance that others will not
develop technologies similar or superior to the Company's technology or design
around the proprietary rights owned by the Company. However, the Company
believes that, because of the rapid pace of technological change in the
software industry, patent, trade secret and copyright protection is less
significant to the Company's competitive position than factors such as the
knowledge, ability and experience of its personnel, new product development,
frequent product enhancements, name recognition and ongoing product
maintenance support with regard to developing, establishing and maintaining a
technology leadership position.
EMPLOYEES
As of May 31, 1997, the Company employed 263 full-time employees, including
56 in research and development, 18 in sales and marketing, 165 in professional
services and support and 24 in finance, administration and corporate support.
The success of the Company depends on its continued ability to attract and
retain highly skilled and qualified personnel. Competition for such personnel
is intense in the computer software industry, particularly for software
developers, service consultants, and sales and marketing personnel. There can
be no assurance that the Company will be able to attract and retain qualified
personnel in the future.
The Company's employees are not represented by any labor unions. The Company
considers its relations with its employees to be good.
FACILITIES
The Company is headquartered in Billerica, Massachusetts, where it leases
approximately 45,000 square feet under a lease expiring in January 1999. In
addition, the Company leases office space of approximately 8,000 square feet
in Trumbull, Connecticut, which it currently uses to provide some outsourcing
and software evolution services and approximately 23,000 square feet in
Westboro, Massachusetts, where the Company also provides outsourcing and
software evolution services. These leases expire in January 1999 and December
1999, respectively.
The Company also maintains a research and development facility in
Schaumburg, Illinois, of approximately 5,000 square feet, the lease for which
expires in September 1998. The Company leases additional facilities and
offices in Phoenix, Arizona; Denver, Colorado; Ontario, Canada and Bangalore,
India. The Company's majority-owned subsidiary, Persist, leases facilities in
Barcelona, Spain. The Company believes its facilities are in good condition.
The Company expects that additional space will be required as it expands its
business. It believes it will be able to obtain suitable space as needed.
LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
46
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company as of May 31, 1997 are
as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Dominic K. Chan......... 48 Chairman of the Board of Directors and Chief Executive
Officer
Douglas A. Catalano..... 46 President, Chief Operating Officer and Director
Allen K. Deary.......... 38 Vice President, Finance, Chief Financial Officer, Clerk and
Director
Adarsh K. Arora......... 44 Vice President, Research and Development
Andrea C. Campbell...... 45 Vice President, Outsourcing Operations
Leonard Miller.......... 57 Vice President, Strategic Programs
Robert D. Savoia........ 54 Vice President, Business Development and Marketing
John E. MacPhee......... 36 Director of Finance and Treasurer
Arthur Carr(1).......... 65 Director
John Giordano(2)........ 40 Director
W. Michael
Humphreys(1)........... 45 Director
Axel Leblois(2)......... 48 Director
Henry F. McCance(1)..... 54 Director
Roland Pampel(2)........ 62 Director
</TABLE>
- --------
(1) Member of Compensation Committee.
(2) Member of Audit Committee.
Dr. Chan co-founded Peritus in 1991 and served as its President and a
director from inception to December 1996. Since December 1996, Dr. Chan has
served as the Company's Chief Executive Officer and Chairman of the Board of
Directors. Prior to co-founding the Company, Dr. Chan held the position of
Executive Vice President of Research and Development for Bull, a manufacturer
of computer products. He holds a patent for a voice and data integration
device. Dr. Chan received a B.S. in Mathematics from Wake Forest University
and an M.S. and a Ph.D. in Mathematics from the University of Wisconsin.
Mr. Catalano joined Peritus in December 1996 as President and Chief
Operating Officer and as a director. From November 1982 to December 1996, Mr.
Catalano held various positions at Computer Sciences Corp., a company which
provides systems integration services, where he most recently served as
President of CSC Consulting, Inc. ("CSC"). Mr. Catalano holds a B.S. in
Finance from Northeastern University.
Mr. Deary co-founded Peritus in 1991, and has served as its Vice President,
Finance and Chief Financial Officer and as a director since inception. Mr.
Deary previously served as Director, Product Life Cycle Process at Bull, where
his primary focus was to develop and implement worldwide cross-functional
product teams. Mr. Deary received his B.S. in Accounting from Northeastern
University.
Dr. Arora joined Peritus in January 1996 as Vice President, Research and
Development. Prior to joining Peritus, he co-founded and served as President
and Chief Executive Officer from January 1986 to January 1996 of Vista
Technologies Incorporated, a manufacturer of high-end computer aided
engineering and computer aided software engineering products. Dr. Arora
received a B.S. in Mathematics at Lucknow University in India, and an M.S. and
a Ph.D. in Computer Science at Northwestern University.
47
<PAGE>
Ms. Campbell co-founded Peritus and served as Vice President, Consulting and
Technology Transfer Services from September 1992 to June 1996. Since June
1996, Ms. Campbell has served as Vice President, Outsourcing Operations. Ms.
Campbell was previously employed as Human Resources Director at Bull Worldwide
Information Services, Inc., a manufacturer of computer products, from March
1990 to August 1992. Ms. Campbell received her B.A. from Kalamazoo College and
her M.A. in Psychology from Western Michigan University.
Mr. Miller joined Peritus in September 1996 as Vice President, Strategic
Programs. Mr. Miller was previously employed from January 1964 to August 1996
at Metropolitan Life Insurance Company, most recently as its Chief Information
Officer of Individual Business. He received a B.A. in Business Management from
Boston University.
Mr. Savoia joined Peritus in January 1997 as Vice President, Business
Development and Marketing. Prior to joining Peritus, he served as Vice
President and Managing Partner of CSC from 1989 to December 1996. During his
eight years at CSC, he was a member of the Operating and Executive Committees,
Vice President of Business Development, and was the partner in charge of the
New York consulting practice. Mr. Savoia received a B.S. in Management Science
from Northeastern University.
Mr. MacPhee joined Peritus in July 1996 as Director of Finance and as
Treasurer. Prior to joining Peritus, Mr. MacPhee served as Corporate
Controller at Bachman Information Systems, Inc., a manufacturer of computer
aided software engineering products, from April 1986 to June 1996. He received
a B.A. in Management and Accounting from the University of Massachusetts,
Amherst.
Mr. Carr has served on the Board of Directors of the Company since November
1995. Mr. Carr has been a private investor since December 1993. From 1991 to
November 1993, Mr. Carr served as Chairman, President and Chief Executive
Officer of Bytex Corporation, a manufacturer of data communications equipment.
He is a director of Bay Networks, Inc., a manufacturer of computer network
systems.
Mr. Giordano has served on the Board of Directors of the Company since March
1997. Mr. Giordano has been employed at Bull since 1978, most recently as Vice
President, Chief Financial Officer and Treasurer since February 1997. He
received a B.S. in Business Administration from Boston College.
Mr. Humphreys has served on the Board of Directors of the Company since
March 1996. Mr. Humphreys has been a partner of Matrix Partners, a private
venture capital firm, since 1982. Prior to his association with Matrix
Partners, he was a general partner of Hellman, Ferri Investment Associates, a
private venture capital partnership. Mr. Humphreys is a director of GeoTel
Communications Corporation, a developer of telecommunications software, as
well as several privately held companies. He received a B.S. from the
University of Oregon and an M.B.A. from the Harvard Graduate School of
Business Administration.
Mr. Leblois has served on the Board of Directors of the Company since
February 1995. Since January 1996, Mr. Leblois has served as the Chairman of
World Times Inc., a publishing company. From May 1991 to December 1995, he
served as President and Chief Executive Officer of Bull. Mr. Leblois is a
director of Wang Laboratories, Inc., a software and services provider, and
Boston Private Bank & Trust Company, a private banking and asset management
firm. He received a BAC in Science and Politics from IEP Paris, an M.B.A. from
the European Institute of Business Administration and a License de Philosophie
from the University of Paris.
Mr. McCance has served on the Board of Directors of the Company since March
1996. Mr. McCance has been a general partner of Greylock, a private venture
capital firm, since 1973. He is Chairman of the Board, President and Secretary
of Greylock Management Corporation, the service organization to the Greylock
venture capital partnerships. Mr. McCance is a director of Shiva Corporation,
a manufacturer of remote access products, and of several privately held
companies. He received a B.A. in Economics from Yale University and an M.B.A.
from the Harvard Graduate School of Business Administration.
48
<PAGE>
Mr. Pampel has served on the Board of Directors of the Company since
November 1995. Mr. Pampel is recently retired. From March 1994 to January
1997, Mr. Pampel held the positions of President, Chief Executive Officer and
director of Microcom, Inc. ("Microcom"), a manufacturer of computer equipment.
Prior to joining Microcom, Mr. Pampel was President and Chief Executive
Officer of Nicolet Instrument Inc., a manufacturer of medical instruments,
from October 1991 to September 1993. He currently serves on the Board of
Directors of Microcom, Infinium Software, Inc., a provider of client-server
business software applications, and Cayenne Software, Inc., a provider of
computer-aided software engineering products. Mr. Pampel holds a B.S. in
Electrical Engineering from the University of Connecticut.
Following this offering, the Board of Directors will be divided into three
classes, each of whose members will serve for a staggered three-year term. The
Board will consist of three Class I Directors (Messrs. Catalano, Giordano and
McCance), three Class II Directors (Messrs. Deary, Humphreys and Pampel) and
three Class III Directors (Messrs. Carr, Chan and Leblois). At each annual
meeting of stockholders, a class of directors will be elected for a three-year
term to succeed the directors or director of the same class whose terms are
then expiring. The terms of the Class I Directors, Class II Directors and
Class III Directors expire upon the election and qualification of successor
directors at the annual meeting of stockholders held during the calendar years
1998, 1999 and 2000, respectively.
On May 29, 1992, the Company entered into an agreement (the "1992 Bull
Agreement") with Bull, a principal stockholder of the Company, in which the
Company issued Bull 575,000 shares of Common Stock in exchange for the
transfer and assignment by Bull of certain items of equipment and other
personal property. Under the 1992 Bull Agreement, the Company agrees to use
its best efforts to elect one representative of Bull to the Board of Directors
for so long as Bull holds 50% of the shares of Common Stock purchased under
the 1992 Bull Agreement, and that in the event no representative of Bull is
elected to the Board of Directors, Bull has a right of representation at
meetings of the Board for so long as Bull holds 25% of the shares of Common
Stock purchased under the 1992 Bull Agreement. To date, Bull has not sold any
of the shares of Common Stock acquired by it under the 1992 Bull Agreement,
and, after giving effect to this offering and assuming the Underwriters' over-
allotment option is exercised in full, Bull will still hold over 50% of the
shares of Common Stock acquired by it under such agreement. Pursuant to the
1992 Bull Agreement, the Company is also obligated to hold meetings of its
Board of Directors at least four times per year. John Giordano, the Vice
President, Chief Financial Officer and Treasurer of Bull, currently serves as
Bull's representative on the Board of Directors. See "Principal and Selling
Stockholders" and "Certain Transactions."
Each officer serves at the discretion of the Board of Directors. There are
no family relationships among any of the directors and executive officers of
the Company.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has a Compensation Committee composed of Messrs.
Carr, Humphreys and McCance, which makes recommendations concerning salaries
and incentive compensation for employees of and consultants to the Company and
administers and grants stock options pursuant to the Company's stock option
plans, and an Audit Committee composed of Messrs. Giordano, Leblois and
Pampel, which reviews the results and scope of the audit and other services
provided by the Company's independent public accountant.
DIRECTOR COMPENSATION
All of the directors are reimbursed for expenses incurred in connection with
their attendance at Board and committee meetings. See "--Executive
Compensation--1997 Director Stock Option Plan."
49
<PAGE>
EXECUTIVE COMPENSATION
The following table sets forth the total compensation paid or accrued for the
year ended December 31, 1996 for the Company's Chief Executive Officer and its
three other most highly compensated executive officers in 1996 (the Chief
Executive Officer and such other executive officers are hereinafter referred to
as the "Named Executive Officers"):
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
------------------
ANNUAL COMPENSATION AWARDS
-------------------- ------------------
NAME AND SECURITIES ALL OTHER
PRINCIPAL POSITION(1) SALARY BONUS UNDERLYING OPTIONS COMPENSATION(2)
--------------------- ---------- --------- ------------------ ---------------
<S> <C> <C> <C> <C>
Dominic K. Chan ........ $ 202,613 $ 40,000 -- $3,131
Chairman of the Board
and
Chief Executive Officer
Allen K. Deary.......... 147,903 40,000 14,200 3,002
Vice President, Finance
and
Chief Financial Officer
Adarsh Arora............ 120,891 40,000 51,192 1,395
Vice President,
Research
and Development
Andrea C. Campbell...... 111,499 40,000 17,085 2,112
Vice President,
Outsourcing Operations
</TABLE>
- --------
(1) Douglas A. Catalano joined the Company as President and Chief Operating
Officer in December 1996. See "--Employment Agreements."
(2) Consists of the Company's matching contributions to the Company's 401(k)
Plans.
50
<PAGE>
The following table sets forth grants of stock options to each of the Named
Executive Officers during the year ended December 31, 1996. No stock
appreciation rights ("SARs") were granted during the year ended December 31,
1996.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------
POTENTIAL
REALIZABLE VALUE
NUMBER OF PERCENT OF TOTAL AT ASSUMED
SECURITIES OPTIONS ANNUAL RATES OF
UNDERLYING GRANTED TO EXERCISE OR STOCK PRICE
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION APPRECIATION FOR
NAME GRANTED FISCAL YEAR PER SHARE(1) DATE OPTION TERM(2)
---- ---------- ---------------- ------------ ---------- -----------------
5% 10%
-- ---
<S> <C> <C> <C> <C> <C> <C>
Dominic K. Chan......... -- -- -- -- -- --
Allen K. Deary.......... 14,200 0.9% $2.80 11/22/2006 $ 25,005 $ 63,367
Adarsh Arora............ 51,192 3.3 2.80 11/22/2006 90,144 228,443
Andrea C. Campbell...... 2,885 0.2 2.80 10/17/2006 5,080 12,874
14,200 0.9 2.80 11/22/2006 25,005 63,367
</TABLE>
- --------
(1) All options were granted pursuant to the Company's Long-Term Incentive
Plan at fair market value as determined by the Board of Directors of the
Company on the date of the grant.
(2) Amounts reported in these columns represent amounts that may be realized
upon exercise of the options immediately prior to the expiration of their
term assuming the specified compound rates of appreciation (5% and 10%) on
the market value of the Common Stock on the date of option grant over the
term of the options. These numbers are calculated based on rules
promulgated by the Securities and Exchange Commission and do not reflect
the Company's estimate of future stock price growth. Actual gains, if any,
on stock option exercises and Common Stock holdings are dependent on the
timing of such exercise and the future performance of the Common Stock.
There can be no assurance that the rates of appreciation assumed in this
table can be achieved or that the amounts reflected will be received by
the individuals.
The following table sets forth certain information regarding stock options
exercised during 1996 and stock options held by each of the Named Executive
Officers on December 31, 1996.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTIONS VALUES
<TABLE>
<CAPTION>
NUMBER OF SHARES
NUMBER OF UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
SHARES OPTIONS AT FISCAL IN-THE-MONEY OPTIONS
ACQUIRED YEAR-END AT FISCAL YEAR-END
ON VALUE ------------------------- ----------------------------
NAME EXERCISE REALIZED(1) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE(1)
---- --------- ----------- ------------------------- ----------------------------
<S> <C> <C> <C> <C>
Dominic K. Chan......... -- -- 18,750/-- $46,875/$ --
Allen K. Deary.......... -- -- 286,983/24,802 894,530/14,522
Adarsh Arora............ -- -- --/51,192 --/25,596
Andrea C. Campbell...... 5,000 $16,006 165,673/75,979 518,969/182,645
</TABLE>
- --------
(1) Represents the difference between the exercise price and the fair market
value of the Common Stock on the date of exercise or at fiscal year end,
as the case may be, as determined by the Board of Directors of the
Company.
STOCK PLANS
1997 Director Stock Option Plan
The Company's 1997 Director Stock Option Plan (the "Director Plan") was
adopted by the Board of Directors and approved by the stockholders of the
Company in May 1997. Under the terms of the Director Plan, directors of the
Company who are not employees of the Company or any subsidiary of the Company
are eligible
51
<PAGE>
to receive nonstatutory options to purchase shares of Common Stock. A total of
200,000 shares of Common Stock may be issued upon exercise of options granted
under the Director Plan.
Pursuant to the Director Plan, each non-employee director at the time of the
effective date of this offering (each, an "IPO Director") will receive an
option to purchase 15,000 shares of Common Stock at a price per share
equivalent to the initial public offering price. In addition, each IPO
Director will receive an option to purchase 3,000 shares of Common Stock at
the annual meeting of stockholders to be held in 1998, and at each annual
meeting of stockholders thereafter, at an exercise price per share equal to
the closing price of a share of Common Stock on the date of grant. Each
director, other than the IPO Directors, will receive an option to purchase
15,000 shares of Common Stock on the date of his or her initial election to
the Board of Directors and an option to purchase 3,000 shares of Common Stock
on the date of each annual meeting of stockholders after his or her election.
The exercise price per share of such options will be the closing price of a
share of Common Stock on the date of the grant. All options granted under the
Director Plan vest at a rate of one-third of the shares per year over a period
of three years from the date of grant so long as the optionee remains a
director of the Company.
1992 Long-Term Incentive Plan and 1997 Stock Incentive Plan
The Company's Long-Term Incentive Plan (the "Long-Term Incentive Plan") was
adopted by the Board of Directors and approved by the stockholders of the
Company on January 24, 1992. Amendments to the Long-Term Incentive Plan
increased the number of authorized shares under the Plan to 4,409,820 shares
of Common Stock as of February 1997. As of June 30, 1997, options to purchase
3,012,957 shares of Common Stock at a weighted average exercise price of $2.28
per share were outstanding under the Long-Term Incentive Plan. No additional
option grants will be granted under the Long-Term Incentive Plan after May 28,
1997.
The Company's 1997 Stock Incentive Plan (the "Incentive Plan") was adopted
by the Board of Directors and approved by the stockholders of the Company in
May 1997. The Incentive Plan is intended to replace the Company's Long-Term
Incentive Plan. Up to 1,950,000 shares of Common Stock (subject to adjustment
in the event of stock splits and other similar events) may be issued pursuant
to awards granted under the Incentive Plan. As of June 30, 1997, options to
purchase 469,500 shares of Common Stock at an exercise price of $10.00 per
share were outstanding under the Incentive Plan.
The Incentive Plan provides for the grant of incentive stock options
intended to qualify under Section 422 of the Internal Revenue Code of 1986, as
amended (the "Code"), nonstatutory stock options, restricted stock awards and
other stock-based awards, including the grant of shares based upon certain
conditions, the grant of securities convertible into Common Stock and the
grant of stock appreciation rights (collectively, "Awards").
Officers, employees, directors, consultants and advisors of the Company and
its subsidiaries are eligible to be granted Awards under the Incentive Plan.
Under present law, however, incentive stock options may only be granted to
employees. The maximum number of shares with respect to which an Award may be
granted to any participant under the Incentive Plan may not exceed 1,000,000
shares per calendar year.
Optionees may receive the right to purchase a specified number of shares of
Common Stock at a specified option price and subject to such other terms and
conditions as are specified in connection with the option grant. Options may
be granted at an exercise price which may be less than, equal to or greater
than the fair market value of the Common Stock on the date of grant. Under
present law, incentive stock options and options intended to qualify as
performance-based compensation under Section 162(m) of the Code may not be
granted at an exercise price less than the fair market value of the Common
Stock on the date of grant (or less than 110% of the fair market value in the
case of incentive stock options granted to optionees holding more than 10% of
the voting power of the Company). The Incentive Plan permits the Board to
determine the manner of payment of the exercise price of options, including
through payment by cash, check or in connection with a "cashless exercise"
through a broker, by surrender to the Company of shares of Common Stock, by
delivery to the Company of a promissory note, or by any combination of the
permitted forms of payment.
52
<PAGE>
As of May 31, 1997, approximately 269 persons were eligible to receive
Awards under the Incentive Plan, including the Company's eight executive
officers and six non-employee directors. The granting of Awards under the
Incentive Plan is discretionary.
The Incentive Plan is administered by the Board of Directors. The Board has
the authority to adopt, amend and repeal the administrative rules, guidelines
and practices relating to the Incentive Plan and to interpret the provisions
thereof. Pursuant to the terms of the Incentive Plan, the Board of Directors
may delegate authority under the Incentive Plan to one or more committees of
the Board, and subject to certain limitations, to one or more executive
officers of the Company. The Board has authorized the Compensation Committee
to administer the Incentive Plan, including the granting of options to
executive officers. Subject to any applicable limitations contained in the
Incentive Plan, the Board of Directors, the Compensation Committee, or any
other committee or executive officer to whom the Board delegates authority, as
the case may be, selects the recipients of Awards, may amend, modify or
terminate any outstanding Award and determines (i) the number of shares of
Common Stock covered by options and the dates upon which such options become
exercisable, (ii) the exercise price of options, (iii) the duration of
options, and (iv) the number of shares of Common Stock subject to any
restricted stock or other stock-based Awards and the terms and conditions of
such Awards, including conditions for repurchase, issue price and repurchase
price.
In the event of a merger, liquidation or other Acquisition Event (as defined
in the Incentive Plan), the Board of Directors is authorized to provide for
outstanding options or other stock-based Awards to be assumed or substituted
for, to accelerate the Awards to make them fully exercisable prior to
consummation of the Acquisition Event.
No Award may be made under the Incentive Plan after May 2007, but Awards
previously granted may extend beyond that date. The Board of Directors may at
any time amend, suspend or terminate the Incentive Plan, except that no Award
designated as subject to Section 162(m) of the Code by the Board of Directors
after the date of such amendment shall become exercisable, realizable or
vested (to the extent such amendment was required to grant such Award) unless
and until such amendment is approved by the Company's stockholders.
1997 Employee Stock Purchase Plan
The Company's 1997 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors and approved by the stockholders of the
Company in May 1997. The Purchase Plan authorizes the issuance of up to a
total of 200,000 shares of Common Stock to participating employees.
All employees of the Company, including directors of the Company who are
employees, and all employees of any participating subsidiaries, whose
customary employment is more than 20 hours per week are eligible to
participate in the Purchase Plan. Employees who would immediately after the
grant own 5% or more of the total combined voting power or value of the stock
of the Company or any subsidiary are not eligible to participate. As of May
31, 1997, approximately 260 of the Company's employees would have been
eligible to participate in the Purchase Plan.
On the first day of a designated payroll deduction period (the "Offering
Period"), the Company will grant to each eligible employee who has elected to
participate in the Purchase Plan an option to purchase shares of Common Stock
as follows: the employee may authorize an amount (a whole percentage from 1%
to 10% of such employee's base pay) to be deducted by the Company from such
pay during the Offering Period. On the last day of the Offering Period, the
employee is deemed to have exercised the option, at the option exercise price,
to the extent of accumulated payroll deductions. Under the terms of the
Purchase Plan, the option price is an amount equal to 85% of the average
market price (as defined) per share of the Common Stock on either the first
day or the last day of the Offering Period, whichever is lower. In no event
may an employee purchase in any one Offering Period a number of shares which
exceeds the number of shares determined by dividing $12,500 by the average
market price of a share of Common Stock on the commencement date of the
Offering Period. The Purchase Plan provides for four consecutive six-month
Offering Periods beginning with the six-month period extending from October 1,
1997 through March 31, 1998.
53
<PAGE>
If an employee is not a participant on the last day of the Offering Period,
such employee is not entitled to exercise any option, and the amount of such
employee's accumulated payroll deductions will be refunded. An employee's
rights under the Purchase Plan terminate upon voluntary withdrawal from the
Purchase Plan at any time, or when such employee ceases employment for any
reason, except that upon termination of employment because of death, the
employee's beneficiary has certain rights to elect to exercise the option to
purchase the shares which the accumulated payroll deductions in the
participant's account would purchase at the date of death.
Because participation in the Purchase Plan is voluntary, the Company cannot
now determine the number of shares of Common Stock to be purchased by any
particular current executive officer, by all current executive officers as a
group or by non-executive employees as a group.
EMPLOYMENT AGREEMENTS
The Company entered into an employment agreement with Mr. Catalano on
December 30, 1996, pursuant to which Mr. Catalano will serve as President and
Chief Operating Officer of the Company. Although the employment agreement has
no set term, it is terminable (i) by the Company or Mr. Catalano without cause
upon 45 days' prior notice, (ii) by either party pursuant to a breach of the
employment agreement by the other party and failure to remedy the breach by
such party after 30 days' prior notice, or (iii) immediately by the Company
with cause (as defined). The agreement provides that Mr. Catalano is entitled
to receive a base salary of $250,000 in 1997 and is eligible to receive a
bonus in an amount to be determined by the Board of Directors, an appropriate
committee or a designee thereof. Mr. Catalano's base salary will be reviewed
annually thereafter. The Company granted Mr. Catalano, and Mr. Catalano
subsequently exercised, an option to purchase 151,515 shares of Common Stock
at an exercise price of $3.30 per share. The Company also granted Mr. Catalano
an incentive stock option to purchase an additional 149,212 shares of Common
Stock (the "ISO"), which was exercised as to 27,999 shares on the date of
grant, and a nonstatutory stock option to purchase an additional 630,788
shares of Common Stock (the "NSO"), both at an exercise price of $3.30 per
share. The ISO and NSO will become exercisable as to 30,303 and 157,697 shares
of common stock, respectively, on December 30, 1997. The ISO and NSO will then
both vest as to the remaining shares in 12 equal portions, the first of which
will become exercisable on the last day of the first calendar quarter of 1998,
and the remaining of which will become exercisable on the last day of each
succeeding calendar quarter. Mr. Catalano's options will be fully vested as of
the fourth anniversary of the employment agreement. If his employment is
terminated by the Company without cause (as defined), Mr. Catalano will be
entitled to receive severance compensation for 52 weeks thereafter in an
amount equal to the base salary which would otherwise be payable to Mr.
Catalano during that period. In addition, upon any such termination, the ISO
and NSO options will become exercisable as to that number of shares which
would have become exercisable if Mr. Catalano's employment had terminated one
year after the actual date of termination. Throughout the term of this
employment agreement, the Chairman of the Board of the Company agrees to
nominate Mr. Catalano as a candidate for election to the Board of Directors of
the Company. The Agreement also contains a non-solicitation covenant and a
non-competition covenant pursuant to which Mr. Catalano is prohibited, during
the term of his employment, from engaging in any business activity that would
compete directly or indirectly with the products or services of the kind or
type developed by the Company. The non-competition covenant extends for a one-
year period after termination, but is limited during this period to prohibit
Mr. Catalano from engaging in business activities competitive with the
Company's products or services related to the Company's year 2000 business
activities.
In January 1997, the Company and Mr. Savoia entered into an employment
agreement providing for the employment of Mr. Savoia as a Vice President of
the Company. Although the employment agreement has no set term, it is
terminable (i) by the Company or Mr. Savoia without cause upon 45 days' prior
notice, (ii) by either party pursuant to a breach of the employment agreement
by the other party and failure to remedy the breach by such party upon 30
days' prior notice, or (iii) immediately by the Company with cause (as
defined). The agreement provides for an annual base salary of $200,000 as well
as annual incentive compensation in an amount determined by the Board of
Directors of the Company, an appropriate committee or a designee thereof. If
his employment is terminated by the Company without cause (as defined), Mr.
Savoia will be entitled to receive
54
<PAGE>
severance compensation for 52 weeks in an amount equal to the base salary
otherwise payable to Mr. Savoia during such period. In addition, upon any such
termination any options to purchase shares of Common Stock granted to Mr.
Savoia within six months of January 27, 1997 will become exercisable as to
that number of shares which would have become exercisable if Mr. Savoia's
employment had terminated one year after the actual date of termination. This
employment agreement also contains a non-solicitation covenant and a non-
competition covenant pursuant to which Mr. Savoia, during the term of his
employment, is prohibited from engaging in any business activity that would
compete directly or indirectly with products or services of the kind or type
developed by the Company. The non-competition covenant extends for a one-year
period after termination, but is limited during this period to prohibit Mr.
Savoia from engaging in business activities competitive with the Company's
products or services related to the Company's year 2000 business activities.
On August 15, 1996, the Company entered into a letter agreement with Leonard
Miller providing for the employment of Mr. Miller in accordance with the terms
of the letter agreement. Pursuant to the letter agreement, the term of Mr.
Miller's employment extends from September 1, 1996 through August 31, 2000.
The letter agreement provides for an annual base salary of $200,000 as well as
an annual bonus to be determined in accordance with the Company's policies. In
connection with the commencement of his employment, the Company granted Mr.
Miller an option to purchase 200,000 shares of Common Stock at an exercise
price of $2.80 per share. The option was exercisable with respect to 50,000
shares on the date of commencement of Mr. Miller's employment and is
exercisable as to an additional 50,000 shares on each of August 31, 1997, 1998
and 1999. In the event that Mr. Miller's employment by the Company is
terminated without cause, any of the 200,000 shares subject to this option
that remain unvested as of the date of termination will vest immediately upon
termination. In addition, upon termination without cause Mr. Miller shall
receive severance compensation paid biweekly for a period of one year
thereafter in an amount equal to one year's base salary at the time of the
letter agreement. In the event that the Company is liquidated, all of Mr.
Miller's unvested options will vest immediately prior to liquidation.
In connection with the issuance and sale of shares of the Company's Series A
Convertible Preferred Stock and Common Stock, the Company entered into a Non-
Competition Agreement with Dominic K. Chan which commenced on March 15, 1996
and terminates on the first anniversary of the date on which Mr. Chan's
employment with the Company terminates. The Non-Competition Agreement provides
for severance payments to Mr. Chan in quarterly installments over a one-year
period following termination, in an aggregate amount not to exceed the amount
paid to Mr. Chan by the Company in combined salary and bonus for the 12-month
period immediately preceding the date of termination. The Company's obligation
to pay such severance is conditional upon Mr. Chan's continued compliance with
the terms of the Non-Competition Agreement. The Non-Competition Agreement
prohibits Mr. Chan, during the term thereof, from engaging in any business
activity that is directly or indirectly competitive in the United States with
any of the products or services being developed or otherwise provided by the
Company at the date of his termination.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The current members of the Company's Compensation Committee are Messrs.
Carr, Humphreys and McCance. No executive officer of the Company has served as
a director or member of the compensation committee (or other committee serving
an equivalent function) of any other entity, whose executive officers served
as a director of or member of the Compensation Committee of the Company.
55
<PAGE>
CERTAIN TRANSACTIONS
On May 29, 1992, the Company entered into an agreement (the "1992 Bull
Agreement") with Bull, a principal stockholder of the Company, in which the
Company issued Bull 575,000 shares of Common Stock in exchange for the
transfer and assignment by Bull of certain items of equipment and other
personal property. Under the 1992 Bull Agreement, the Company agrees to use
its best efforts to elect one representative of Bull to the Board of Directors
for so long as Bull holds 50% of the shares of Common Stock purchased under
the 1992 Bull Agreement, and that in the event no representative of Bull is
elected to the Board of Directors, Bull has a right of representation at
meetings of the Board for so long as Bull holds 25% of the shares of Common
Stock purchased under the 1992 Bull Agreement. To date, Bull has not sold any
of the shares of Common Stock acquired by it under the 1992 Bull Agreement,
and, after giving effect to this offering and assuming the Underwriters' over-
allotment option is exercised in full, Bull will still hold over 50% of the
shares of Common Stock acquired by it under such agreement. Pursuant to the
1992 Bull Agreement, the Company is also obligated to hold meetings of its
Board of Directors at least four times per year. John Giordano, the Vice
President, Chief Financial Officer and Treasurer of Bull, currently serves as
Bull's representative on the Board of Directors. Other than the Board seat,
right of representation and meeting requirements described above, the
Company's obligations under the 1992 Bull Agreement will terminate upon
consummation of this offering. See "Principal and Selling Stockholders."
Pursuant to a follow-on agreement dated September 1, 1994, the Company
granted Bull, among other things, an option to purchase up to 15% of the
authorized shares of Common Stock of the Company before December 31, 1995 at a
price not to exceed $1.48 per share. On October 31, 1995, Bull exercised this
option and acquired 512,500 shares of Common Stock at a price of $1.48 per
share. The September 1, 1994 agreement was amended and restated in its
entirety by an Agreement of Amendment between the Company and Bull, dated
March 15, 1996, pursuant to which Bull received certain rights of
participation and the right to request that the Company assign its rights and
obligations under a certain Master Services Agreement between the Company and
Bull, to a third party in the event that a direct competitor of Bull or of any
of its affiliates acquired a controlling interest in all or substantially all
of the assets of the Company. The Agreement of Amendment terminates upon the
consummation of this offering. Prior to co-founding the Company, Dominic K.
Chan, the Company's Chairman of the Board and Chief Executive Officer, was
employed by Bull, most recently in the position of Executive Vice President of
Research and Development, and Allen K. Deary, the Company's Vice President,
Finance and Chief Financial Officer, was employed by Bull as its Director of
Product Life Cycle Process. Axel Leblois, a director of the Company, was
President and Chief Operating Officer of Bull from May 1991 to December 1995.
See "Management--Executive Officers and Directors."
On February 3, 1992, the Company entered into a Master Software Services
Agreement with Bull pursuant to which the Company agreed to provide
maintenance and professional services to Bull in accordance with certain
Statements of Work entered into between the parties. The Company derived
revenue of $4,069,741, $9,313,118 and $4,079,375 from the agreement in 1994,
1995 and 1996, respectively. On July 29, 1996, the Company licensed its
AutoEnhancer/2000 software to Bull, by and through Bull's Integris division,
pursuant to a License Agreement, as amended September 27, 1996, pursuant to
which Bull acts as both a value added integrator and distributor. With regard
to Bull's use of the Company's software, the License Agreement, as amended,
provides for various scheduled payments during 1996 and 1997 which result in a
fully paid-up royalty of $1,500,000. Additional royalties are due to the
Company from Bull upon any sublicensing by Bull pursuant to the License
Agreement. See Note 8 of Notes to the Company's Consolidated Financial
Statements.
In connection with the establishment by the Company of certain credit
facilities in the aggregate amount of $942,000 with Danvers Savings Bank on
August 16, 1993, April 28, 1994 and August 5, 1994, Dominic K. Chan gave an
unlimited guaranty of all of the Company's obligations to Danvers Savings
Bank. Mr. Chan's guaranty was secured by a pledge of Mr. Chan's life insurance
policy in the amount of $200,000. On September 13, 1996, in connection with
the establishment of credit facilities with Fleet National Bank, the Company
repaid all outstanding principal and interest on the Danvers Savings Bank
Loans, and Danvers Savings Bank released Mr. Chan's guaranty.
56
<PAGE>
On November 18, 1994, the Company entered into a DOS Engineering Development
Agreement with Microcom, Inc. ("Microcom") pursuant to which the Company
provides certain software enhancement and maintenance services to Microcom.
The Company derived revenue of $110,891, $402,354 and $136,755 from the
Agreement in 1994, 1995 and 1996, respectively. Roland Pampel, a director of
the Company, held the positions of President, Chief Executive Officer and
director of Microcom from March 1994 to January 1997.
On January 3, 1995, the Company entered into a General Computer Consulting
Services Agreement, with Met Life pursuant to which the Company provided
certain software conversion services to Met Life. In connection with the
General Computer Consulting Services Agreement, the Company entered into two
Authorization Letters with Met Life, dated January 3, 1995 and November 27,
1995, respectively. On October 1, 1996, the Company entered into a License
Agreement with Met Life providing for the grant of non-exclusive licenses to
use certain proprietary software products developed by the Company, as
specified in certain subsequent purchase orders entered into between the
Company and Met Life. Leonard Miller, the Company's Vice President, Strategic
Programs, was previously employed at Met Life from January 1964 to August
1996, most recently in the position of Chief Information Officer of Individual
Business. The Company derived revenue of $162,000, $1,716,901 and $1,501,434
from Met Life in 1994, 1995 and 1996, respectively.
Under a Note and Warrant Purchase Agreement dated May 30, 1995 (the "Warrant
Agreement"), the Massachusetts Capital Resource Company ("MCRC") loaned
$1,000,000 to the Company, evidenced by a Secured Subordinated Note (the "MCRC
Note"). The aggregate indebtedness under the MCRC Note was $1,000,000 on April
30, 1997, and the interest rate on the MCRC Note is 10% per annum. The MCRC
Note matures on June 30, 2002, subject to the Company's option to prepay
subject to certain prepayment premiums, in whole or in part, the principal
amount of the MCRC Note and the accrued interest thereunder at any time after
July 1, 1996. Beginning on September 30, 1998, and on the last day of
December, March, June and September in each year thereafter, up to and
including June 30, 2002, the Company is required to redeem, without premium,
$62,500 in principal amount of the MCRC Note, together with interest thereon.
The Company's obligations under the MCRC Note are secured by equipment,
inventory and certain other intangible personal property of the Company
pursuant to a Security Agreement of the same date between the Company and
MCRC. The Security Agreement terminates upon repayment of the MCRC Note in
full. The Company currently intends to use a portion of the proceeds of this
offering to repay in full the MCRC Note. See "Use of Proceeds."
Upon execution of the Warrant Agreement, MCRC received a warrant (the
"Warrant") to purchase 312,500 shares of Common Stock, as adjusted for stock
splits, distributions and other dilutive actions taken by the Company, at an
exercise price of $1.60 per share. The Warrant may be exercised until the
later of (i) June 30, 2002 or (ii) repayment of the MCRC Note. MCRC currently
does not intend to exercise the Warrant prior to the commencement of this
offering. On May 30, 1995, the Company also entered into a Voting Agreement
with Dominic K. Chan and MCRC (the "MCRC Voting Agreement") pursuant to which
MCRC agrees to vote as directed by Mr. Chan with respect to the election of
members of the Board of Directors of the Company. The MCRC Voting Agreement
will terminate upon the consummation of this offering.
The Company issued an unsecured promissory note, dated September 1991, in
the amount of $62,000 payable to Vista Technologies Incorporated ("Vista"), an
entity of which Adarsh K. Arora, the Company's Vice President, Research and
Development, was the principal owner. The note incurred interest at 7% per
annum. In July 1995, the Company repaid all outstanding principal and interest
on the note.
On January 29, 1996, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") with Vista and its stockholders, including its
President and Chief Executive Officer and principal stockholder, Adarsh K.
Arora, pursuant to which Vista merged with and into the Company. Upon
consummation of the merger, each share of capital stock of Vista was converted
into 0.5437 shares of Common Stock of the Company (the "Conversion Ratio").
Mr. Arora, as the duly appointed representative of the Vista stockholders, and
Mr. Chan, the Company's President and Chief Executive Officer at the time of
the merger, determined the Conversion Ratio and other terms of the Merger
Agreement. In determining the terms of the Merger Agreement, the Company
conducted its own analysis of Vista, including a review of the financial
condition of Vista and the
57
<PAGE>
strategic value of Vista to the Company. At the time of the Merger Agreement,
Mr. Arora was unaffiliated with the Company. In connection with the Merger
Agreement, the Company employed certain employees of Vista, including Mr.
Arora.
On March 15, 1996, the Company issued an aggregate of 1,903,525 shares of
Series A Convertible Preferred Stock (described below) to nine purchasers at a
price of $2.80 per share. Of these shares, Matrix Partners IV, L.P. and Matrix
IV Entrepreneurs Fund, L.P., of which W. Michael Humphreys, a director of the
Company, is a general partner, purchased 795,761 and 41,882 shares,
respectively; Greylock Equity Limited Partnership, of which Henry F. McCance,
a director of the Company, is a general partner, purchased 837,643 shares;
Arthur Carr, a director of the Company, purchased 18,300 shares; MCRC
purchased 196,083 shares; Thomas Deary and Therese Deary, the parents of Allen
K. Deary, purchased 1,830 shares; Michael Deary and Lauri Deary, the brother
and sister-in-law of Allen K. Deary, purchased 3,660 shares; and James Carroll
and Mary Carroll, the father-in-law and mother-in-law of Allen K. Deary,
purchased 1,830 shares. On the same date, the Company issued 71,775 shares of
Common Stock to MCRC for consideration in the amount of $200,970. In
connection with the sale of Series A Convertible Preferred Stock, the Company
entered into a Voting Agreement (the "Voting Agreement") with Matrix Partners
IV, L.P., Matrix IV Entrepreneurs Fund, L.P., Greylock Equity Limited
Partnership and MCRC providing, among other things, that one representative of
Matrix Partners IV, L.P. and one representative of Greylock Equity Limited
Partnership would be elected by the holders of the Series A Convertible
Preferred Stock to the Board of Directors of the Company. The Voting Agreement
will terminate upon the consummation of this offering. In addition, the
Company entered into a Stock Restriction Agreement with Dominic K. Chan and
his wife, Marsha C. Chan (together, the "Chans"), Bull, Matrix Partners IV,
L.P., Matrix IV Entrepreneurs Fund, L.P., Greylock Equity Limited Partnership
and MCRC (together, the "Investors") providing, among other things, that the
Chans would execute a lock-up agreement in the event of an underwritten public
offering of Common Stock and grant a right of first refusal in favor of the
Company and a right of participation in favor of the Investors with respect to
any sale of shares of Common Stock held by the Chans. The Stock Restriction
Agreement will terminate upon consummation of this offering. Also in
connection with this financing, on March 15, 1996, the Company repurchased
159,588 shares of Common Stock at a price of $2.80 per share from certain
stockholders of the Company and sold 71,775 shares of Common Stock to certain
purchasers of the Series A Convertible Preferred Stock for consideration of
$200,970. Also in connection with this financing, Dominic K. Chan sold 625,000
shares of the Company's Common Stock to certain purchasers of the Series A
Convertible Preferred Stock, and the Company granted certain redemption rights
in connection with the shares of Common Stock sold by the Company and Dr.
Chan. In conjunction with any redemption of the Series A Convertible Preferred
Stock by the Company, holders of the Series A Convertible Preferred Stock must
surrender for redemption, at a redemption price equal to $2.80 per share,
0.366 shares of the Common Stock acquired by such holders in this financing.
See Note 10 of Notes to the Company's Consolidated Financial Statements.
In the event of any liquidation, dissolution or winding up of the Company,
the holders of Series A Convertible Preferred Stock are entitled to receive,
on a pro-rata basis, $3.825 per share, plus all accrued and unpaid dividends.
In addition to voting with the holders of Common Stock, the holders of Series
A Convertible Preferred Stock, voting separately as a class, are entitled to
elect two members of the Board of Directors of the Company, and the Company
may not, without the consent of at least two-thirds of the outstanding Series
A Convertible Preferred Stock, increase the size of the Board of Directors in
excess of nine members. The holders of Series A Convertible Preferred Stock
are entitled to receive cumulative annual dividends in the amount of $0.3825
per share, plus 10% of previously accrued and unpaid dividends, whether or not
such dividends are declared by the Board of Directors. These dividends are
payable upon liquidation, dissolution or winding up of the Company, or upon
redemption of the Series A Convertible Preferred Stock. In addition, the
holders of Series A Convertible Preferred Stock have a right of redemption
exercisable on March 15 of each of the years 2001, 2002 and 2003, pursuant to
which the Company is required to redeem 33 1/3%, 50% and 100% of the Series A
Convertible Preferred Stock at a redemption price equal to $2.80 per share,
plus accrued and unpaid dividends through the redemption date. All shares of
Series A Convertible Preferred Stock will convert into shares of Common Stock
upon the closing of this offering.
58
<PAGE>
On March 15, 1996, the Company entered into a Stock Option Agreement with
the Chans granting the Company the right to purchase, upon the death of
Dominic K. Chan, a certain percentage of the shares of Common Stock held by
the Chans as set forth in the Stock Option Agreement. The Stock Option
Agreement will terminate upon the consummation of this offering.
Pursuant to a Registration Rights Agreement, dated March 15, 1996, between
the Company and certain persons and entities (the "Rightsholders"), including
Matrix IV Partners, L.P., Matrix IV Entrepreneurs Fund, L.P., Greylock Equity
Limited Partnership, Bull, Arthur Carr, Virginia L. Carr, Thomas Deary and
Therese Deary, Michael Deary and Lauri Deary and MCRC, the Rightsholders are
entitled to certain rights with respect to registration under the Securities
Act of 1933, as amended, of certain shares of Common Stock, including shares
of Common Stock that may be acquired pursuant to the conversion of Convertible
Preferred Stock or the exercise of warrants. For a description of such rights,
see "Shares Eligible for Future Sale."
On May 1, 1996, the Company entered into a License and Alliance Agreement
with CSC providing for the grant of a non-exclusive license to CSC to use the
Company's AutoEnhancer/2000 software and related services, and for the
collaboration of the Company and CSC in connection with providing year 2000
services to CSC's clients. The Company derived revenue of $190,000 in 1996
under the License and Alliance Agreement. The initial term of the License and
Alliance Agreement terminated May 1, 1997. On March 15 and June 25, 1997, the
Company executed Amendments to the License and Alliance Agreement--Agreement
for the Purchase of a Special Inventory Package providing for the grant of a
$2,500,000 usage-based license payable by CSC during 1997. Prior to joining
the Company as President and Chief Operating Officer and as a director, Mr.
Catalano was employed by CSC from November 1982 to December 1996, and most
recently served as its President. Mr. Savoia served as Vice President and
Managing Partner of CSC from 1989 to December 1996 before joining the Company
in the position of Vice President, Business Development and Marketing.
On October 28, 1996, the Company issued an aggregate of 1,818,182 shares of
Series B Convertible Preferred Stock to 25 purchasers at a price of $3.30 per
share, including the sale of 8,000 shares to Axel Leblois, 10,000 shares to
Arthur Carr and 10,000 shares to Virginia L. Carr, the wife of Arthur Carr.
The Company entered into an Amendment No. 1 to the Stock Restriction Agreement
and an Amendment No. 1 to the Registration Rights Agreement to provide that
the purchasers of the Series B Convertible Preferred Stock would become
parties to such agreements. Messrs. Leblois and Carr are directors of the
Company.
For a description of certain employment and other arrangements between the
Company and its executive officers, see "Management--Executive Compensation--
Employment Agreements."
The Company has adopted a policy providing that all material transactions
between the Company and its officers, directors and other affiliates must (i)
be approved by a majority of the members of the Company's Board of Directors
and by a majority of the disinterested members of the Company's Board of
Directors and (ii) be on terms no less favorable to the Company than could be
obtained from unaffiliated third parties.
59
<PAGE>
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Common Stock of the Company as of June 30, 1997, and as
adjusted to reflect the sale of the shares of Common Stock offered hereby, by
(i) each of the directors of the Company, (ii) each of the Named Executive
Officers, (iii) each person or entity known to the Company to own beneficially
more than 5% of the Company's Common Stock, (iv) all directors and executive
officers as a group and (v) each of the other Selling Stockholders. Except as
indicated below, none of these entities has a relationship with the Company
or, to the knowledge of the Company, any Underwriters of this offering or
their respective affiliates. Unless otherwise indicated, each person or entity
named in the table has sole voting power and investment power (or shares such
power with his or her spouse) with respect to all shares of capital stock
listed as owned by such person or entity.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED PRIOR TO NUMBER OF BENEFICIAL OWNERSHIP
OFFERING(1) SHARES AFTER OFFERING(1)(2)
-------------------- BEING --------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE OFFERED(3) NUMBER PERCENTAGE
- ------------------------ --------- ---------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C>
Dominic K. Chan(4)....... 3,013,763 30.0% 300,000 2,713,763 21.1%
c/o Peritus Software
Services, Inc.
304 Concord Road
Billerica, MA 01821-3485
Greylock Equity Limited
Partnership(5)........... 1,144,258 11.4% -- 1,144,258 8.9%
One Federal Street
Boston, MA 02110
Henry F. McCance(5)...... 1,144,258 11.4% -- 1,144,258 8.9%
c/o Greylock Equity
Limited Partnership
One Federal Street
Boston, MA 02110
Matrix Partners IV,
L.P.(6)................. 1,144,258 11.4% -- 1,144,258 8.9%
Bay Colony Corp. Center
1000 Winter Street
Suite 4500
Waltham, MA 02154
W. Michael Humphreys(7).. 1,144,258 11.4% -- 1,144,258 8.9%
c/o Matrix Partners IV,
L.P.
Bay Colony Corp. Center
1000 Winter Street
Suite 4500
Waltham, MA 02154
Bull HN Information
Systems Inc.(8)......... 1,087,500 10.9% 360,000 727,500 5.7%
300 Concord Road
Billerica, MA 01821
John Giordano(8)......... 1,087,500 10.9% 360,000 727,500 5.7%
c/o Bull HN Information
Systems Inc.
300 Concord Road
Billerica, MA 01821
Y2K Partners, Ltd.(9).... 606,061 6.0% -- 606,061 4.7%
c/o EFO Holdings, Inc.
1111 West Mockingbird
Lane
Suite 1400
Dallas, TX 75247
Douglas A. Catalano...... 179,515 1.8% -- 179,515 1.4%
Arthur Carr(10).......... 30,625 * -- 30,625 *
Axel Leblois(11)......... 11,125 * -- 11,125 *
Roland Pampel(12)........ 80,212 * -- 80,212 *
Allen K. Deary(13)....... 386,247 3.8% 20,000 366,247 2.8%
Adarsh K. Arora.......... 148,808 1.5% -- 148,808 1.2%
Andrea C. Campbell(14)... 250,986 2.5% 20,000 230,986 1.8%
All executive officers
and directors, as
a group (14
persons)(15)............ 7,577,297 71.7% 700,000 6,877,297 51.4%
</TABLE>
- --------
60
<PAGE>
* Less than 1% of outstanding Common Stock.
(1) The number of shares beneficially owned by each stockholder is determined
under rules promulgated by the Securities and Exchange Commission, and
the information is not necessarily indicative of beneficial ownership for
any other purpose. Under such rules, beneficial ownership includes any
shares as to which the individual has sole or shared voting power or
investment power and also any shares which the individual has the right
to acquire within 60 days of June 30, 1997 through the exercise of any
stock option, warrant or other right. The inclusion herein of such
shares, however, does not constitute an admission that the named
stockholder is a direct or indirect beneficial owner of such shares.
(2) Assumes no exercise of the Underwriters' over-allotment option.
(3) In the event that the over-allotment option is exercised in full, Dominic
K. Chan, Bull, Allen K. Deary, Andrea C. Campbell and Adarsh K. Arora
will offer to sell 200,000, 265,000, 30,000, 10,000 and 20,000 shares of
Common Stock, respectively, to the Underwriters. As a result of such
exercise, Dominic K. Chan, Bull, Allen K. Deary, Andrea C. Campbell and
Adarsh K. Arora will beneficially own 2,513,763, 462,500, 336,247,
220,986 and 128,808 shares of Common Stock, or 19.6%, 3.6%, 2.6%, 1.7%
and 1.0% of the outstanding shares, respectively, after this offering.
(4) Includes 18,750 shares of Common Stock subject to outstanding stock
options which are exercisable within 60 days of June 30, 1997; 2,795,013
shares of Common Stock held jointly with his wife, Marsha C. Chan; and
200,000 shares of Common Stock held in the name of the Chan Family
Irrevocable Trust of which Julian Chan, Marsha C. Chan and Theodore
Tedeschi are trustees and of which Dominic K. Chan's present and future
offspring are beneficiaries and as to which shares Dominic K. Chan
disclaims beneficial ownership. Julian Chan is Dominic Chan's son.
(5) Mr. McCance, a general partner of Greylock Equity GP Limited Partnership
("Greylock"), the general partner of Greylock Equity Limited Partnership,
is a director of the Company. Mr. McCance, together with the other
general partners of Greylock, shares voting and investment power with
respect to the shares owned by Greylock. Mr. McCance does not own any
shares of the Company in his individual capacity and disclaims beneficial
ownership of the shares held by Greylock Equity Limited Partnership,
except to the extent of his pecuniary interest therein. See "Certain
Transactions."
(6) Includes 57,213 shares held by Matrix IV Entrepreneurs Fund, L.P.
(7) Mr. Humphreys, a general partner of Matrix IV Management Co. L.P., the
general partner of Matrix Partners IV, L.P. ("Matrix") and the general
partner of Matrix IV Entrepreneurs Fund, L.P., is a director of the
Company. Mr. Humphreys, together with the other managing members of
Matrix, shares voting and investment power with respect to the shares
owned by Matrix. Mr. Humphreys does not own any shares of the Company in
his individual capacity and disclaims beneficial ownership of shares
owned by Matrix, except to the extent of his pecuniary interest therein.
See "Certain Transactions."
(8) Mr. Giordano is a director of the Company and Vice President, Chief
Financial Officer and Treasurer of Bull. Mr. Giordano, together with
certain other officers of Bull, shares investment and voting power with
respect to the shares owned by Bull. Mr. Giordano does not own any shares
of the Company in his individual capacity and disclaims beneficial
ownership of shares owned by Bull, except to the extent of his pecuniary
interest therein. See "Certain Transactions."
(9) GPW Partners Limited is the general partner of Y2K Partners, Ltd. John P.
Watters, the President and Chairman of Cross Matrix Corporation, the
general partner of GPW Partners Limited, has sole investment and voting
power over the shares held by Y2K Partners, Ltd., as to which shares Mr.
Watters disclaims beneficial ownership.
(10) Includes 3,125 shares of Common Stock subject to outstanding stock
options which are exercisable within 60 days of June 30, 1997. Also
includes 10,000 shares of Common Stock held by Virginia L. Carr, Mr.
Carr's wife, and 5,000 shares of Common Stock held by a trust, of which
Virginia L. Carr is sole trustee, as to which shares Mr. Carr disclaims
beneficial ownership.
(11) Includes 3,125 shares of Common Stock subject to outstanding stock
options which are exercisable within 60 days of June 30, 1997.
(12) Includes 28,125 shares of Common Stock subject to outstanding stock
options which are exercisable within 60 days of June 30, 1997.
(13) Includes 186,983 shares of Common Stock subject to outstanding stock
options which are exercisable within 60 days of June 30, 1997. Also
includes 10,713 shares held by Mr. Deary's wife and two children, as to
which Mr. Deary disclaims beneficial ownership.
(14) Includes 206,298 shares of Common Stock subject to outstanding stock
options which are exercisable within 60 days of June 30, 1997. Also
includes 1,563 shares of Common Stock held by Ms. Campbell's husband and
13,125 shares of Common Stock subject to outstanding stock options which
are exercisable by her husband within 60 days of June 30, 1997, as to
which Ms. Campbell disclaims beneficial ownership.
(15) Includes an aggregate of 546,406 shares of Common Stock subject to
outstanding options which are exercisable within 60 days of June 30,
1997.
61
<PAGE>
DESCRIPTION OF CAPITAL STOCK
After giving effect to the amendment and restatement of the Company's
Articles of Organization (the "Restated Articles") to be effected upon the
closing of this offering, the authorized capital stock of the Company will
consist of 50,000,000 shares of Common Stock, $.01 par value per share, and
5,000,000 shares of Preferred Stock, $.01 par value per share. As of June 30,
1997 (assuming the conversion of all outstanding shares of Convertible
Preferred Stock and Class B Common Stock into Common Stock), there were
outstanding (i) 10,022,304 shares of Common Stock held by 137 stockholders of
record, (ii) stock options for the purchase of 3,482,457 shares of Common
Stock and (iii) warrants for the purchase of 312,500 shares of Common Stock.
COMMON STOCK
Holders of Common Stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders and do not have cumulative voting
rights. Accordingly, holders of a majority of the shares of Common Stock
entitled to vote in any election of directors may elect all of the directors
standing for election. Holders of Common Stock are entitled to receive ratably
such dividends, if any, as may be declared by the Board of Directors out of
funds legally available therefor, subject to any preferential dividend rights
of outstanding Preferred Stock. Upon the liquidation, dissolution or winding
up of the Company, the holders of Common Stock are entitled to receive ratably
the net assets of the Company available after the payment of all debts and
other liabilities and subject to the prior rights of any outstanding Preferred
Stock. Holders of Common Stock have no preemptive, subscription, redemption or
conversion rights. The outstanding shares of Common Stock are, and the shares
offered by the Company in this offering will be, when issued and paid for,
fully paid and nonassessable. The rights, preferences and privileges of
holders of Common Stock are subject to, and may be adversely affected by, the
rights of the holders of shares of any series of Preferred Stock which the
Company may designate and issue in the future. Certain holders of Common Stock
have the right to require the Company to effect the registration of their
shares of Common Stock in certain circumstances. The shares of Common Stock
have been approved for quotation on the Nasdaq National Market under the
symbol "PTUS." See "Shares Eligible for Future Sale."
PREFERRED STOCK
Under the terms of the Restated Articles, the Board of Directors is
authorized, subject to any limitations prescribed by law, without stockholder
approval, to issue such shares of Preferred Stock in one or more series. Each
such series of Preferred Stock shall have such rights, preferences, privileges
and restrictions, including voting rights, dividend rights, conversion rights,
redemption privileges and liquidation preferences, as shall be determined by
the Board of Directors.
The purpose of authorizing the Board of Directors to issue Preferred Stock
and determine its rights and preferences is to eliminate delays associated
with a stockholder vote on specific issuances. The rights of the holders of
Common Stock will be subject to the rights of holders of any shares of
Preferred Stock issued in the future. The issuance of Preferred Stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult
for a third party to acquire, or of discouraging a third party from acquiring,
a majority of the outstanding voting stock of the Company. The Company has no
present plans to issue any shares of Preferred Stock.
WARRANTS
As of June 30, 1997, the Company had an outstanding warrant to purchase an
aggregate of 312,500 shares of Common Stock at an exercise price of $1.60 per
share. This warrant expires on the later of (i) June 30, 2002 or (ii) upon the
payment in full of the principal amount of the MCRC Note and the interest due
thereon. See "Certain Transactions."
62
<PAGE>
MASSACHUSETTS LAW AND CERTAIN PROVISIONS OF THE COMPANY'S RESTATED ARTICLES OF
ORGANIZATION AND AMENDED AND RESTATED BY-LAWS
The Restated Articles provide that the Company will be subject to Chapter
110F of the Massachusetts General Laws, an anti-takeover law, following this
offering. In general, this statute prohibits a publicly held Massachusetts
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the date of the transaction in
which the person becomes an interested stockholder, unless (i) the interested
stockholder obtains the approval of the Board of Directors prior to becoming
an interested stockholder, (ii) the interested stockholder acquires 90% of the
outstanding voting stock of the corporation (excluding shares held by certain
affiliates of the corporation) at the time it becomes an interested
stockholder, or (iii) the business combination is approved by both the Board
of Directors and the holders of two-thirds of the outstanding voting stock of
the corporation (excluding shares held by the interested stockholder). An
"interested stockholder" is a person who, together with affiliates and
associates, owns (or at any time within the prior three years did own) 5% or
more of the outstanding voting stock of the corporation. A "business
combination" includes a merger, a stock or asset sale, and certain other
transactions resulting in a financial benefit to the interested stockholder.
Massachusetts General Laws Chapter 156B, Section 50A generally requires that
publicly held Massachusetts corporations have a classified board of directors
consisting of three classes as nearly equal in size as possible, unless the
corporation elects to opt out of the statute's coverage. The Company's
Restated By-Laws contain provisions which give effect to Section 50A. See
"Management--Executive Officers and Directors."
The Restated By-Laws include a provision excluding the Company from the
applicability of Massachusetts General Laws Chapter 110D, entitled "Regulation
of Control Share Acquisitions." In general, this statute provides that any
stockholder of a corporation subject to this statute who acquires 20% or more
of the outstanding voting stock of a corporation may not vote such stock
unless the stockholders of the corporation so authorize. The Board of
Directors may amend the Company's Restated By-Laws at any time to subject the
Company to this statute prospectively.
The Restated By-Laws require the Company to call a special stockholders
meeting at the request of stockholders holding at least 80% of the voting
power of the Company. Any stockholder seeking to solicit requests to call a
special meeting of stockholders (the "Call") must notify the Company by notice
in writing setting forth the reasons for the Call and the purposes of such
special meeting. No solicitation of stockholder requests for a Call may be
made before the record date determining those stockholders entitled to request
a Call, or during the period of 90 days following the most recent meeting of
stockholders of the Company. All requests for a Call shall be delivered to the
Company no later than the 30th day (the "Delivery Date") after the record date
for the Call request. If, in response to a Call solicitation, the holders of
record of at least 80% of the voting power submit requests for a Call, the
Board of Directors must call a special meeting no earlier than 60 days and no
later than 90 days after the Delivery Date. The Board of Directors is not
obligated to fix a meeting date or to hold any meeting of stockholders within
60 days of the next scheduled meeting of the stockholders of the Company.
The Restated Articles provide that the directors and officers of the Company
shall be indemnified by the Company to the fullest extent authorized by
Massachusetts law, as it now exists or may in the future be amended, against
all expenses and liabilities reasonably incurred in connection with service
for or on behalf of the Company. In addition, the Restated Articles provide
that the directors of the Company will not be personally liable for monetary
damages to the Company for breaches of their fiduciary duty as directors,
unless they violated their duty of loyalty to the Company or its stockholders,
acted in bad faith, knowingly or intentionally violated the law, authorized
legal dividends or redemptions or derived an improper personal benefit from
their action as directors.
The Restated Articles provide that any amendment to the Restated Articles,
the sale, lease or exchange of all or substantially all of the Company's
property and assets, or the merger or consolidation of the Company into or
with any other corporation may be authorized by the approval of the holders of
a majority of the shares of
63
<PAGE>
each class of stock entitled to vote thereon, rather than by two-thirds as
otherwise provided by statute, provided that the transactions have been
authorized by a majority of the members of the Board of Directors and the
requirements of any other applicable provisions of the Restated Articles have
been met.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Common Stock is BankBoston, N.A.
64
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for the securities
of the Company. Upon completion of this offering, based upon the number of
shares outstanding at June 30, 1997, there will be 12,822,304 shares of Common
Stock of the Company outstanding (assuming no exercise of the Underwriters'
over-allotment option or options outstanding under the Company's stock option
plans). Of these shares, the 3,500,000 shares sold in this offering will be
freely tradeable without restriction or further registration under the
Securities Act of 1933, as amended (the "Securities Act"), except that any
shares purchased by "affiliates" of the Company, as that term is defined in
Rule 144 ("Rule 144") under the Securities Act ("Affiliates"), may generally
only be sold in compliance with the limitations of Rule 144 described below.
SALES OF RESTRICTED SHARES
The remaining 9,322,304 shares of Common Stock are deemed "restricted
securities" under Rule 144. Of the restricted securities, approximately
174,252 shares of Common Stock, which are not subject to the 180-day lock-up
agreements (the "Lock-Up Agreements") with the Representatives of the
Underwriters, will be eligible for immediate sale in the public market
pursuant to Rule 144(k) under the Securities Act. Approximately 139,387
additional shares of Common Stock, which are not subject to Lock-Up
Agreements, will be eligible for sale in the public market in accordance with
Rule 144 or Rule 701 under the Securities Act beginning 90 days after the date
of this Prospectus. Upon expiration of the Lock-Up Agreements 180 days after
the date of this Prospectus (and assuming no exercise of any outstanding
options), approximately 9,008,665 additional shares of Common Stock will be
available for sale in the public market, subject to the provisions of Rule 144
under the Securities Act.
The officers and directors of the Company, and certain securityholders,
which executive officers, directors and securityholders in the aggregate hold
approximately 10,707,071 shares of Common Stock (including 1,068,406 shares of
Common Stock that may be acquired pursuant to the exercise of vested options
held by them and exercisable within 60 days of June 30, 1997) on the date of
this Prospectus, have agreed that, for a period of 180 days after the date of
this Prospectus, they will not sell, offer, contract or grant any option to
sell, pledge, transfer, establish an open put equivalent position or otherwise
dispose of any shares of Common Stock, any options to purchase shares of
Common Stock or any shares convertible into or exchangeable for shares of
Common Stock, owned directly by such persons or with respect to which they
have the power of disposition, without the prior written consent of Montgomery
Securities.
In general, under Rule 144 as currently in effect, beginning 90 days after
the effective date of the Registration Statement of which this Prospectus is a
part, a stockholder, including an Affiliate, who has beneficially owned his or
her restricted securities (as that term is defined in Rule 144) for at least
one year from the later of the date such securities were acquired from the
Company or (if applicable) the date they were acquired from an Affiliate is
entitled to sell, within any three-month period, a number of such shares that
does not exceed the greater of 1% of the then outstanding shares of Common
Stock (128,223 shares immediately after this offering) or the average weekly
trading volume in the Common Stock during the four calendar weeks preceding
the date on which notice of such sale was filed under Rule 144, provided
certain requirements concerning availability of public information, manner of
sale and notice of sale are satisfied. In addition, under Rule 144(k), if a
period of at least two years has elapsed between the later of the date
restricted securities were acquired from the Company or (if applicable) the
date they were acquired from an Affiliate of the Company, a stockholder who is
not an Affiliate of the Company at the time of sale and has not been an
Affiliate of the Company for at least three months prior to the sale is
entitled to sell the shares immediately without compliance with the foregoing
requirements under Rule 144.
Securities issued in reliance on Rule 701 (such as shares of Common Stock
acquired pursuant to the exercise of certain options granted under the
Company's stock plans) are also restricted securities and, beginning 90 days
after the effective date of the Registration Statement of which this
Prospectus is a part, may be sold by stockholders other than Affiliates of the
Company subject only to the manner of sale provisions of Rule 144 and by
Affiliates under Rule 144 without compliance with its one-year holding period
requirement.
65
<PAGE>
OPTIONS
The Company intends to file registration statements on Form S-8 under the
Securities Act to register all shares of Common Stock issuable under the Long-
Term Incentive Plan, Incentive Plan, Director Plan and Purchase Plan. The
Company intends to file registration statements on Form S-8 with respect to
the shares of Common Stock issuable under the Director Plan and the Purchase
Plan promptly following the consummation of this offering, but has agreed with
the Underwriters that it will not file any registration statements on Form S-8
relating to the Long-Term Incentive Plan and the Incentive Plan until at least
90 days after the effective date of the Registration Statement of which this
Prospectus is a part. Shares issued upon the exercise of stock options after
the effective date of the Form S-8 registration statements will be eligible
for resale in the public market without restriction, subject to Rule 144
limitations applicable to Affiliates and the Lock-up Agreements noted above,
if applicable.
REGISTRATION RIGHTS
Pursuant to a Registration Rights Agreement, dated March 15, 1996, between
the Company and certain persons and entities (the "Rightsholders"), including
Matrix IV Partners, L.P., Matrix IV Entrepreneurs Fund, L.P., Greylock Equity
Limited Partnership, Bull and MCRC, are entitled to certain rights with
respect to the registration under the Securities Act of a total of
approximately 5,459,112 shares of Common Stock (the "Registerable Stock"). The
Registration Rights Agreement generally provides that, in the event the
Company proposes to register any of its securities under the Securities Act,
the Rightsholders shall be entitled to include Registerable Stock in such
registration, subject to the right of the managing underwriter of any
underwritten offering to limit for marketing reasons the number of shares of
Registerable Stock included in such "piggyback" registration.
The Rightsholders have the right, exercisable upon the request of holders of
at least 40% of the aggregate outstanding shares of Registerable Stock, to
require the Company to prepare and file registration statements under the
Securities Act with respect to Registerable Stock at any time after the
earliest of (i) six months after the effective date of any registration
statement covering a public offering of securities of the Company, other than
on Form S-8, (ii) six months after the Company becomes a reporting company
under Section 12 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), or (iii) June 30, 1997; provided, however, that (a) such
demand requests the registration of Registerable Stock representing at least
20% of the aggregate outstanding shares of Registerable Stock if the
Rightsholder requests the registration of less than all the shares of
Registerable Stocks (b) the Company need only effect one such demand
registration and (c) the Company is not required to file a demand registration
statement if the previous registration with respect to which the Rightsholders
were entitled to registration pursuant to their piggyback or Form S-3
registration rights became effective less than 180 days prior to such request.
EFFECT OF SALES OF SHARES
Prior to this offering, there has been no public market for the Common Stock
of the Company, and no prediction can be made as to the effect, if any, that
market sales of shares of Common Stock or the availability of shares for sale
will have on the market price of the Common Stock prevailing from time to
time. Nevertheless, sales of significant numbers of shares of the Common Stock
in the public market could adversely affect the market price of the Common
Stock and could impair the Company's future ability to raise capital through
an offering of its equity securities.
66
<PAGE>
UNDERWRITING
The underwriters named below (the "Underwriters"), represented by Montgomery
Securities, Wessels, Arnold & Henderson, L.L.C. and H.C. Wainwright & Co.,
Inc. (the "Representatives"), have severally agreed, subject to the terms and
conditions set forth in the Underwriting Agreement, to purchase from the
Company and the Selling Stockholders the number of shares of Common Stock
indicated below opposite their respective names at the initial public offering
price less the underwriting discount set forth on the cover page of this
Prospectus. The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain terms and conditions precedent and that
the Underwriters are committed to purchase all of such shares, if any are
purchased.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ---------
<S> <C>
Montgomery Securities.............................................. 1,161,000
Wessels, Arnold & Henderson, L.L.C................................. 759,000
H.C. Wainwright & Co., Inc......................................... 380,000
Alex. Brown & Sons Incorporated.................................... 120,000
Cowen & Co......................................................... 120,000
Donaldson, Lufkin & Jenrette Securities Corporation................ 120,000
J.P. Morgan Securities Inc......................................... 120,000
Morgan Stanley & Co., Incorporated................................. 120,000
Oppenheimer & Co., Inc............................................. 120,000
Punk, Ziegel & Knoell, L.P......................................... 120,000
Adams, Harkness & Hill, Inc........................................ 60,000
Cruttenden Roth Incorporated....................................... 60,000
First Albany Corporation........................................... 60,000
Furman Selz LLC.................................................... 60,000
Hampshire Securities Corporation................................... 60,000
Hanifen, Imhoff Inc................................................ 60,000
---------
Total............................................................ 3,500,000
=========
</TABLE>
The Representatives have advised the Company and the Selling Stockholders
that the Underwriters initially propose to offer the Common Stock to the
public on the terms set forth on the cover page of this Prospectus. The
Underwriters may allow to selected dealers a concession of not more than $0.65
per share, and the Underwriters may allow, and any such dealers may reallow, a
concession of not more than $0.10 per share to certain other dealers. After
the initial public offering, the offering price and other selling terms may be
changed by the Representatives. The Common Stock is offered subject to receipt
and acceptance by the Underwriters and to certain other conditions, including
the right to reject orders in whole or in part.
Certain Selling Stockholders have granted an option to the Underwriters,
exercisable during the 30-day period after the date of this Prospectus, to
purchase up to a maximum of 525,000 additional shares of Common Stock to cover
over-allotments, if any, at the same price per share as the initial shares to
be purchased by the Underwriters. To the extent the Underwriters exercise this
option, each of the Underwriters will be committed, subject to certain
conditions, to purchase such additional shares in approximately the same
proportion as set forth in the above table. The Underwriters may purchase such
shares only to cover over-allotments made in connection with this offering.
Each director and officer of the Company and certain other of its
stockholders prior to this offering, as well as certain other holders of
options, warrants or other rights to purchase Common Stock, who immediately
following this offering (assuming no exercise of the over-allotment option)
collectively will beneficially own 10,107,071 shares of Common Stock, have
agreed not to directly or indirectly sell, offer, contract or grant any option
to sell, pledge, transfer, establish an open put equivalent position or
otherwise dispose of any rights with respect to any shares of Common Stock,
any options or warrants to purchase Common Stock, or any securities
67
<PAGE>
convertible or exchangeable for Common Stock, owned directly by such holders
or with respect to which they have the power of disposition for a period of
180 days after the date of this Prospectus without the prior written consent
of Montgomery Securities. Montgomery Securities may, in its sole discretion
and at any time without notice, release all or any portion of the securities
subject to these lock-up agreements. In addition, the Company has agreed not
to sell, offer to sell, contract to sell or otherwise sell or dispose of any
shares of Common Stock or any rights to acquire Common Stock, other than
pursuant to its stock plans or upon the exercise of outstanding options and
warrants, for a period of 180 days after the date of this Prospectus without
the prior consent of Montgomery Securities. See "Shares Eligible for Future
Sale."
The Underwriting Agreement provides that the Company and the Selling
Stockholders will indemnify the Underwriters against certain liabilities,
including civil liabilities, under the Securities Act, or will contribute to
payments the Underwriters may be required to make in respect thereof.
In connection with this offering, the Underwriters may engage in
transactions that stabilize, maintain or otherwise affect the price of the
Common Stock, including over-allotment, stabilization, syndicate covering
transactions and imposition of penalty bids. In an over-allotment, the
Underwriters would allot more shares of Common Stock to their customers in the
aggregate than are available for purchase by the Underwriters under the
Underwriting Agreement. Stabilizing means the placing of any bid, or the
effecting of any purchase, for the purpose of pegging, fixing or maintaining
the price of a security. In a syndicate covering transaction, the Underwriters
would place a bid or effect a purchase to reduce a short position created in
connection with this offering. Pursuant to a penalty bid, Montgomery
Securities, on behalf of the Underwriters, would be able to reclaim a selling
concession from an Underwriter if shares of Common Stock originally sold by
such Underwriter are purchased in syndicate covering transactions. These
transactions may result in the price of the Common Stock being higher than the
price that might otherwise prevail in the open market. These transactions may
be effected on the Nasdaq National Market, in the over-the-counter market or
otherwise, and, if commenced, may be discontinued at any time.
The Representatives have informed the Company that they do not expect to
make sales to accounts over which they exercise discretionary authority in
excess of 5% of the number of shares of Common Stock offered hereby.
Prior to this offering, there has been no public market for the Common Stock
of the Company. Consequently, the initial public offering price has been
determined through negotiations among the Company and the Representatives.
Among the factors considered in such negotiations were the history of, and
prospects for, the Company and the industry in which it competes, an
assessment of the Company's management, the present state of the Company's
development, the prospects for future earnings of the Company, the prevailing
market conditions at the time of this offering, market valuations of publicly
traded companies that the Company and the Representatives believe to be
comparable to the Company, and other factors deemed relevant.
LEGAL MATTERS
The validity of the shares of Common Stock offered by the Company hereby
will be passed upon for the Company by Hale and Dorr LLP, Boston,
Massachusetts. Certain legal matters in connection with this offering will be
passed upon for the Underwriters by Testa, Hurwitz & Thibeault, LLP, Boston,
Massachusetts.
EXPERTS
The Company's financial statements as of December 31, 1995 and 1996, and for
each of the three years in the period ended December 31, 1996 included in this
Prospectus have been so included in reliance on the report of Price Waterhouse
LLP, independent accountants, given on the authority of said firm as experts
in auditing and accounting.
68
<PAGE>
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement (which
term shall include all amendments, exhibits, schedules and supplements
thereto) on Form S-1 under the Securities Act with respect to the shares of
Common Stock offered hereby. This Prospectus, which constitutes a part of the
Registration Statement, does not contain all of the information set forth in
the Registration Statement, certain parts of which are omitted in accordance
with the rules and regulations of the Commission, to which Registration
Statement reference is hereby made. Statements made in this Prospectus as to
the contents of any contract, agreement or other document referred to are not
necessarily complete. With respect to each such contract, agreement or other
document filed as an exhibit to the Registration Statement, reference is made
to the exhibit for a more complete description of the matter involved, and
each such statement shall be deemed qualified in its entirety by such
reference. The Registration Statement and the exhibits thereto may be
inspected and copied at prescribed rates at the public reference facilities
maintained by the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street,
N.W., Washington, D.C. 20549 and at the regional offices of the Commission
located at Seven World Trade Center, 13th Floor, New York, New York 10048 and
500 West Madison Street, Suite 1400, Chicago, Illinois 60661. In addition, the
Company is required to file electronic versions to these documents with the
Commission through the Commission's Electronic Data Gathering, Analysis, and
Retrieval (EDGAR) system. The Commission maintains a World Wide Web site at
http://www.sec.gov that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission.
The Company intends to distribute to its stockholders annual reports
containing audited consolidated financial statements. The Company also intends
to make available to its stockholders, within 45 days after the end of each
fiscal quarter, reports for the first three quarters of each fiscal year
containing interim unaudited financial information.
69
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Accountants......................................... F-2
Consolidated Balance Sheet as of December 31, 1995 and 1996, March 31,
1997 (unaudited) and pro forma March 31, 1997 (unaudited)................ F-3
Consolidated Statement of Operations for the three years ended December
31, 1996, and the three months ended March 31, 1996 and 1997
(unaudited).............................................................. F-4
Consolidated Statement of Changes in Stockholders' Equity for the three
years ended December 31, 1996 and the three months ended March 31, 1997
(unaudited).............................................................. F-5
Consolidated Statement of Cash Flows for the three years ended December
31, 1996 and the three months ended March 31, 1996 and 1997 (unaudited).. F-6
Notes to the Consolidated Financial Statements............................ F-8
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Peritus Software Services, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of changes in stockholders' equity and
of cash flows present fairly, in all material respects, the financial position
of Peritus Software Services, Inc. and its subsidiary at December 31, 1995 and
1996, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
Price Waterhouse LLP
Boston, Massachusetts
May 14, 1997
F-2
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE-RELATED DATA)
<TABLE>
<CAPTION>
DECEMBER 31, PRO FORMA
--------------- MARCH 31, MARCH 31,
1995 1996 1997 1997
------ ------- --------- ---------
(NOTE 10)
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................ $ 264 $ 7,388 $ 5,022
Accounts receivable, net of allowance for
doubtful accounts of $30, $30 and $30
and including amounts receivable from
related parties of $1,131, $260 and
$341, respectively...................... 2,325 4,163 4,661
Costs and estimated earnings in excess of
billings on uncompleted contracts,
including amounts on uncompleted
contracts with related parties of
$1,369, $562 and $431, respectively..... 2,696 2,195 1,962
Unbilled license revenue from related
parties................................. -- 1,400 1,200
Prepaid expenses and other current
assets.................................. 266 119 238
------ ------- -------
Total current assets..................... 5,551 15,265 13,083
Property and equipment, net............... 1,340 1,970 2,042
Other assets.............................. 288 490 587
------ ------- -------
$7,179 $17,725 $15,712
====== ======= =======
LIABILITIES, REDEEMABLE STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Line of credit........................... $ 400 $ -- $ --
Demand notes payable..................... 150 -- --
Current portion of capital lease
obligations............................. 112 74 74
Current portion of long-term debt........ 115 225 225
Accounts payable......................... 708 497 856
Billings in excess of costs and estimated
earnings on uncompleted contracts....... 710 902 1,014
Deferred revenue......................... -- 3,262 906
Other accrued expenses and current
liabilities............................. 1,138 2,087 1,602
------ ------- -------
Total current liabilities................ 3,333 7,047 4,677
Capital lease obligations................. 231 201 170
Long-term debt............................ 1,561 1,337 1,306
Deferred income taxes..................... 186 -- --
------ ------- -------
Total liabilities........................ 5,311 8,585 6,153
------ ------- -------
Minority interest in consolidated
subsidiary............................... 66 155 173
------ ------- -------
Commitments (Note 17)..................... -- -- --
------ ------- -------
Redeemable convertible preferred stock, no
par value:
Series A--1,903,525 shares authorized,
issued and outstanding at issuance cost
plus accretion and accrued dividends
(liquidation preference $7,281,000) at
December 31, 1996 and March 31, 1997; 0
shares authorized, issued and
outstanding pro forma March 31, 1997.... -- 5,912 6,094 $ --
Series B--1,818,182 shares authorized,
issued and outstanding at issuance cost
plus accretion and accrued dividends
(liquidation preference $6,000,000) at
December 31, 1996 and March 31, 1997;
0 shares authorized, issued and
outstanding pro forma March 31, 1997.... -- 6,107 6,158 --
Redeemable common stock right............. -- 268 294 --
------ ------- ------- -------
-- 12,287 12,546 --
------ ------- ------- -------
Stockholders' equity (deficit):
Class A common stock, no par value;
13,295,000 shares authorized; 5,525,075,
6,033,614, 6,156,114 and 0 shares issued
and 5,523,288, 6,033,614, 6,156,114 and
0 shares outstanding, respectively...... 1,216 2,207 2,209 --
Class B non-voting common stock, no par
value; 275,000 shares authorized;
99,912, 101,196, 101,196 and 0 shares
issued and 99,287, 101,196, 101,196 and
0 shares outstanding, respectively...... 160 164 164 --
Common stock, $.01 par value; 50,000,000
shares authorized; 9,979,023 shares
issued and outstanding, pro forma March
31, 1997................................ -- -- -- 100
Additional paid-in capital............... -- -- -- 14,819
Accumulated earnings (deficit)........... 430 (5,593) (5,446) (5,446)
Note receivable from stockholder......... -- (58) (58) (58)
Treasury stock, at cost, 1,787 shares and
625 shares of Class A and Class B common
stock, respectively..................... (4) -- -- --
Cumulative translation adjustment........ -- (22) (29) (29)
------ ------- ------- -------
Total stockholders' equity (deficit)..... 1,802 (3,302) (3,160) $ 9,386
------ ------- ------- -------
$7,179 $17,725 $15,712
====== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE-RELATED DATA)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------- ------------------------
1994 1995 1996 1996 1997
------ ------- ----------- ------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue:
Outsourcing services,
including $3,951,
$10,114, $4,943,
$1,179 and $975 from
related parties,
respectively.......... $7,130 $16,400 $ 10,190 $ 2,244 $ 2,519
License, including
$1,500 from related
parties for 1996...... -- -- 6,526 -- 4,144
Other services,
including $366, $10,
$0, $0 and $0 from
related parties,
respectively.......... 742 2,105 2,519 404 1,196
------ ------- ----------- ------- ----------
Total revenue.......... 7,872 18,505 19,235 2,648 7,859
------ ------- ----------- ------- ----------
Cost of revenue:
Cost of outsourcing
services including
$1,428, $3,318,
$1,984, $482 and $373
from related parties,
respectively.......... 4,700 9,602 8,488 2,234 2,045
License, including $6
from related parties
for 1996.............. -- -- 162 -- 127
Cost of other services
including $153, $3,
$0, $0 and $0 from
related parties,
respectively.......... 319 2,421 2,931 506 1,289
------ ------- ----------- ------- ----------
Total cost of revenue.. 5,019 12,023 11,581 2,740 3,461
------ ------- ----------- ------- ----------
Gross profit (loss)..... 2,853 6,482 7,654 (92) 4,398
------ ------- ----------- ------- ----------
Operating expenses:
Sales and marketing.... 366 2,129 3,116 654 1,383
Research and
development........... 560 1,703 6,033 1,360 1,634
General and
administrative........ 1,283 2,357 3,249 748 925
------ ------- ----------- ------- ----------
Total operating
expenses.............. 2,209 6,189 12,398 2,762 3,942
------ ------- ----------- ------- ----------
Income (loss) from
operations............ 644 293 (4,744) (2,854) 456
Interest income......... 3 18 48 22 73
Interest expense........ (66) (221) (344) (60) (46)
------ ------- ----------- ------- ----------
Income (loss) before
income taxes, minority
interest and equity in
loss of less than
majority-owned
company............... 581 90 (5,040) (2,892) 483
Provision (benefit) for
estimated income
taxes.................. 179 (8) (143) (142) 48
------ ------- ----------- ------- ----------
Income (loss) before
minority interest and
equity in loss of less
than majority-owned
company............... 402 98 (4,897) (2,750) 435
Minority interest in
consolidated
subsidiary............. -- (43) (24) 38 (29)
Equity in loss of less
than majority-owned
company................ (97) -- -- -- --
------ ------- ----------- ------- ----------
Net income (loss)...... $ 305 $ 55 (4,921) $(2,712) 406
====== ======= =======
Accrual of dividends on
Series A and B
preferred stock........ (689) (233)
Accretion to redemption
value of redeemable
stock.................. (413) (26)
----------- ----------
Net income (loss)
available for common
stockholders........... $ (6,023) $ 147
=========== ==========
Unaudited pro forma net
income (loss) per share
assuming conversion of
convertible preferred
stock (Note 2)......... $ (0.46) $ 0.03
=========== ==========
Shares used in computing
unaudited pro forma net
income (loss) per
share.................. 10,695,276 12,711,198
=========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE-RELATED DATA)
<TABLE>
<CAPTION>
CLASS A CLASS B
COMMON STOCK COMMON STOCK TOTAL
----------------- ---------------- RECEIVABLE CUMULATIVE STOCKHOLDERS'
NUMBER NUMBER ACCUMULATED TREASURY FROM TRANSLATION EQUITY
OF SHARES AMOUNT OF SHARES AMOUNT DEFICIT STOCK STOCKHOLDER ADJUSTMENT (DEFICIT)
--------- ------ --------- ------ ----------- -------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1993................... 4,865,950 $ 428 -- $-- $ 70 $ -- $-- $-- $ 498
Issuance of common
stock.................. 145,375 64 64
Net income.............. 305 305
--------- ------ ------- ---- ------- ----- ---- ---- -------
Balance, December 31,
1994................... 5,011,325 492 -- -- 375 -- -- -- 867
Purchase of 95,537
shares of Class A
common stock for
treasury............... (153) (153)
Issuance of common
stock.................. 4,375 7 7
Sale of common stock
pursuant to employee
stock purchase plan.... 95,537 153 153
Purchase of 625 shares
of Class B common stock
for treasury........... (1) (1)
Effect of accelerating
vesting of certain
common stock options... 36 36
Issuance of common stock
warrants............... 76 76
Sale of common stock
pursuant to
stock agreement........ 512,500 758 758
Sale of common stock
pursuant to exercise of
stock options.......... 1,250 (146) 150 4
Net income.............. 55 55
--------- ------ ------- ---- ------- ----- ---- ---- -------
Balance, December 31,
1995................... 5,525,075 1,216 99,912 160 430 (4) -- -- 1,802
Purchase of 189,588
shares of Class A
common stock for
treasury............... (531) (531)
Issuance of common
stock.................. 431,515 1,027 201 1,228
Exercise of employee
stock options,
including related
receivable
from stockholder....... 36,250 58 (58) --
Effect of accelerating
vesting of certain
common stock options... 118 118
Sale of common stock
pursuant to exercise of
stock options.......... 158,587 118 1,909 5 3 126
Retirement of treasury
stock.................. (117,813) (330) (625) (1) 331 --
Accrual of cumulative
dividends on redeemable
convertible preferred
stock and accretion to
redemption value on
redeemable stock....... (1,102) (1,102)
Cumulative translation
adjustment............. (22) (22)
Net loss................ (4,921) (4,921)
--------- ------ ------- ---- ------- ----- ---- ---- -------
Balance, December 31,
1996................... 6,033,614 2,207 101,196 164 (5,593) -- (58) (22) (3,302)
Sale of common stock
pursuant to exercise of
stock options
(unaudited)............ 122,500 2 2
Accrual of cumulative
dividends on redeemable
convertible preferred
stock and accretion to
redemption value on
redeemable stock
(unaudited)............ (259) (259)
Cumulative translation
adjustment
(unaudited)............ (7) (7)
Net income (unaudited).. 406 406
--------- ------ ------- ---- ------- ----- ---- ---- -------
Balance at March 31,
1997 (unaudited)....... 6,156,114 $2,209 101,196 $164 $(5,446) $ -- $(58) $(29) $(3,160)
========= ====== ======= ==== ======= ===== ==== ==== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS, EXCEPT SHARE-RELATED DATA)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------- ---------------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 1994 1995 1996 1996 1997
- ------------------------------------ ------- ------- ------- ------- ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)....................... $ 305 $ 55 $(4,921) $(2,712) $ 406
Adjustments to reconcile net income
(loss) to net cash provided by (used
for) operating activities:
Non-cash sale of services and other
non-cash expenses.................... (7) 12 -- -- --
Depreciation and amortization......... 228 443 854 137 262
Minority interest in consolidated
subsidiary........................... -- 43 24 (38) 18
Equity in loss of less than
majority-owned company............... 97 -- -- -- --
Non-cash employee compensation........ 37 83 118 118 --
Changes in assets and liabilities, net
of effects from acquisitions:
Accounts receivable................. (435) (1,354) (1,690) (536) (498)
Costs and estimated earnings in
excess of billings on uncompleted
contracts.......................... (1,061) (1,635) 501 871 233
Unbilled license revenue from
related parties.................... -- -- (1,400) -- 200
Prepaid expenses and other current
assets............................. (22) (218) 184 (45) (119)
Other assets........................ -- -- (7) (29) 17
Accounts payable.................... 202 226 (222) (90) 359
Billings in excess of costs and
earnings on uncompleted contracts.. 201 509 192 (25) 112
Deferred revenue.................... -- -- 3,262 116 (2,356)
Other accrued expenses and current
liabilities........................ 317 732 949 (36) (485)
Deferred income taxes............... 179 7 (186) (57) --
------- ------- ------- ------- ------
Net cash provided by (used for)
operating activities............. 41 (1,097) (2,342) (2,326) (1,851)
------- ------- ------- ------- ------
Cash flows from investing activities:
Acquisition of business for cash, net of
cash acquired.......................... -- (43) -- -- --
Cash of business acquired for common
stock, net of costs paid in cash....... -- -- 174 174 --
Investment in less than majority-owned
company................................ (32) -- -- -- (161)
Partial sale of investment in consoli-
dated subsidiary....................... -- -- 8 -- --
Purchases of property and equipment..... (93) (824) (1,240) (250) (287)
Acquisition of patents.................. -- (105) (1) -- --
------- ------- ------- ------- ------
Net cash used in investing
activities....................... (125) (972) (1,059) (76) (448)
------- ------- ------- ------- ------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE-RELATED DATA)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER ENDED
31, MARCH 31,
--------------------- ---------------
1994 1995 1996 1996 1997
---- ------ ------- ------ -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from financing activities:
Proceeds from (principal payments on)
short-term borrowings, net........... -- 550 (440) (400) --
Proceeds from long-term debt.......... 500 1,000 450 -- --
Principal payments on long term debt.. (65) (198) (686) (162) (31)
Principal payments on capital lease
obligations.......................... (14) (110) (107) (19) (31)
Proceeds from exercise of stock op-
tions................................ -- 4 126 6 2
Proceeds from sale of common stock
pursuant to purchase agreement....... -- 746 -- -- --
Proceeds from sale of redeemable
convertible preferred stock and
redeemable common stock.............. -- -- 11,184 5,408 --
Proceeds from sale of common stock.... -- 156 500 -- --
Proceeds from sale of subsidiary com-
mon stock............................ -- -- 59 -- --
Treasury stock acquired............... -- (154) (531) (531) --
---- ------ ------- ------ -------
Net cash provided by (used for)
financing activities........... 421 1,994 10,555 4,302 (60)
---- ------ ------- ------ -------
Effects of exchange rates on cash and
cash equivalents....................... -- -- (30) (13) (7)
---- ------ ------- ------ -------
Net increase (decrease) in cash and cash
equivalents............................ 337 (75) 7,124 1,887 (2,366)
Cash and cash equivalents, beginning of
period................................. 2 339 264 264 7,388
---- ------ ------- ------ -------
Cash and cash equivalents, end of peri-
od..................................... $339 $ 264 $ 7,388 $2,151 $ 5,022
==== ====== ======= ====== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS:
Cash paid for income taxes............ $ 11 $ 31 $ -- $ -- $ --
Cash paid for interest................ 57 227 327 60 46
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
In the years ended December 31, 1994, 1995 and 1996, the Company incurred
capital lease obligations of $52, $399 and $39, respectively.
In the year ended December 31, 1996, the Company issued 280,005 shares of
Class A common stock valued at $728 and paid cash of $87 to acquire all of the
outstanding shares of Vista Technologies Incorporated (Note 3).
In the year ended December 31, 1996, the Company issued 36,250 shares of
common stock to a stockholder in exchange for a note receivable of $58 from
the stockholder.
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF THE BUSINESS
Peritus Software Services, Inc. (the "Company") was incorporated in
Massachusetts in August, 1991. The Company provides software products and
services that enable organizations to improve the productivity, quality and
effectiveness of their information technology systems maintenance, or
"software evolution," functions.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its majority-owned subsidiary, Persist, S.A. ("Persist"), a Spanish
software services entity (Note 3). All significant intercompany balances and
transactions are eliminated.
Revenue Recognition
Revenue associated with performance under contracts to provide outsourced
software maintenance, reengineering and development services is recognized
utilizing the percentage-of-completion method in the ratio that labor-hours
incurred to date bear to estimated total labor-hours at completion, provided
that collection of the related receivable is probable. Adjustments to contract
cost estimates are made in the periods in which the facts which require such
revisions become known. When the revised estimates indicate a loss, such loss
is provided for currently in its entirety. The costs of providing warranties
and follow-on customer support related to services performed are not
significant and have been accrued. Costs and estimated earnings in excess of
billings on uncompleted contracts represent revenue recognized in excess of
amounts billed. Billings in excess of costs and estimated earnings on
uncompleted contracts represent billings in excess of revenue recognized.
Revenue from end-user licenses is recognized when an agreement has been
executed, software and methodologies have been delivered, all significant
contractual obligations have been met and collection of the related receivable
is probable. Revenue from usage-based licenses is recognized when licensed
software has been delivered, the fee is fixed or determinable, all significant
contractual obligations have been met and collection of the related receivable
is probable.
Post contract customer support revenue, including that bundled with initial
license fees, is deferred and recognized ratably over the contractual periods
the services are provided. Revenue from consulting and training services is
recognized as the services are provided.
Significant Customers
Revenue from two customers accounted for 52% and 29% of the Company's total
revenue for the year ended December 31, 1994. Revenue from three customers
accounted for 50%, 13% and 11% of the Company's total revenue for the year
ended December 31, 1995. At December 31, 1995, the Company had amounts
receivable from the first customer, a related party, of $991,000 for billed
accounts receivable and $1,291,000 for costs and estimated earnings in excess
of billings on uncompleted contracts (Note 8). At December 31, 1995, the
Company had amounts receivable from the second customer of $52,000 for billed
accounts receivable and $439,000 for costs and estimated earnings in excess of
billings on uncompleted contracts, and from the third customer of $133,000 for
billed accounts receivable and $856,000 for costs and estimated earnings in
excess of billings on uncompleted contracts.
Revenue from three customers accounted for 29%, 15% and 12% of the Company's
total revenue for the year ended December 31, 1996. At December 31, 1996, the
Company had amounts receivable from the first
F-8
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
customer, a related party, of $123,000 for billed accounts receivable,
$501,000 for costs and estimated earnings in excess of billings on uncompleted
contracts and $1,400,000 for unbilled license revenue (Note 8). At December
31, 1996, the Company had amounts receivable from the second customer of
$115,000 for billed accounts receivable and from the third customer of $17,000
for billed accounts receivable and $797,000 for costs and estimated earnings
in excess of billings on uncompleted contracts.
Concentration of Credit Risk
Financial instruments which potentially expose the Company to concentrations
of credit risk include trade accounts receivable. The Company primarily sells
to Fortune 1000 companies and therefore, generally does not require
collateral. Reserves for potential credit losses are maintained and such
losses, in the aggregate, have not exceeded management's expectations.
Fair Value of Financial Instruments
The Company's financial instruments consist of cash, line of credit
borrowings, demand notes payable, long-term debt and redeemable convertible
preferred stock. The carrying amounts of these instruments at December 31,
1996 approximate their fair values.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. The Company
invests its excess cash primarily in money market accounts. Accordingly, these
investments are subject to minimal credit and market risk. The Company had no
cash equivalents in any period presented except for the three months ended
March 31, 1997.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation of property and equipment is provided using the
straight-line method over the estimated useful lives of the assets or, where
applicable, over the lease term.
Software Development Costs
The Company capitalizes qualifying software development costs after
technological feasibility of the software has been established. Costs incurred
prior to the completion of a working model, which is the Company's basis for
determining technological feasibility, are charged to research and development
expense. Capitalized software costs are amortized ratably over the estimated
useful life of the software, generally three years, and are charged to cost of
revenue. During the years ended December 31, 1994, 1995 and 1996, costs
subject to capitalization were not significant and therefore, were not
capitalized. At December 31, 1996, the Company had $104,000 in acquired
unamortized capitalized software costs obtained in the Vista Technologies
Incorporated ("Vista") acquisition (Note 3). Amortization expense related to
capitalized software costs for the years ended December 31, 1994 and 1995 was
$63,000 in each year. Amortization expense related to capitalized software
costs for the year ended December 31, 1996 was $108,000, including $45,000
related to the capitalized software acquired from Vista.
Patent Costs
Costs associated with obtaining patents are capitalized as incurred and will
be amortized using the straight-line method over their estimated economic
lives beginning when each patent is issued. Pending such issuance, the Company
did not record amortization expense relating to capitalized patent costs
during the years ended December 31, 1994, 1995 or 1996.
F-9
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Accounting for Impairment of Long-Lived Assets
In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to
be Disposed Of," the Company records impairment losses on long-lived assets
used in operations when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are less
than the assets' carrying amount. No such significant impairments have
occurred through December 31, 1996.
Foreign Currency
Assets and liabilities of the Company's majority-owned foreign subsidiary
are translated into U.S. dollars at exchange rates in effect at the balance
sheet date. Income and expense items are translated at average exchange rates
for the period. Accumulated net translation adjustments are included in
stockholders' equity.
Accounting for Stock-Based Compensation
Awards under the Company's employee stock option plans are accounted for in
accordance with Accounting Principles Board Opinion No. 25 and related
interpretations ("APB 25"). In January 1996, the Company adopted the
disclosure requirements of Statement of Financial Accounting Standards No.
123, ("SFAS 123"), "Accounting for Stock-Based Compensation" (Note 14).
Unaudited Pro Forma Net Income (Loss) Per Share
Unaudited pro forma net income (loss) per share is determined by dividing
the net income (loss) attributable to common stockholders by the weighted
average number of shares of common stock and common stock equivalents
outstanding during the period, assuming the conversion of all convertible
preferred stock and the redeemable common stock right which will occur upon
the closing of a qualified public offering of the Company's common stock (Note
10).
Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No.
83, common stock equivalents, regardless of their anti-dilutive impact, issued
at prices below the offering price per share during the twelve months
preceding the initial filing of the Company's Registration Statement and
through the effective date of the initial public offering of the Company's
common stock have been included in the calculation of unaudited pro forma net
income (loss) per share using the treasury stock method as if outstanding
since the beginning of each period presented.
Historical net income (loss) per share has not been presented on the basis
that it is irrelevant due to the significant change in the Company's capital
structure and resultant earnings or loss per share which will result upon
conversion of the convertible preferred stock. Supplemental net income (loss)
per share, giving effect to the use of a portion of the net proceeds of this
offering to repay the secured subordinated note payable, is not presented
since it does not differ materially from unaudited pro forma net income (loss)
per share.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the
reporting period. Areas particularly subject to estimation include revenue
based on percentage-of-completion and the valuation allowance on deferred tax
assets. Actual amounts could differ from those estimates.
F-10
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Interim Financial Data
The interim financial data as of March 31, 1997 and for the three months
ended March 31, 1996 and 1997 are unaudited; however, in the opinion of the
Company, the interim data include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair statement of the financial
position and results of operations for the interim periods. The operating
results for the three months ended March 31, 1997 are not necessarily
indicative of the results to be expected for the full year ending December 31,
1997.
3. ACQUISITIONS
At December 31, 1994, the Company owned a 40% voting interest in Persist, a
Spanish corporation which provides software maintenance services, and used the
equity method to account for the investment. In 1995, the Company made
additional investments in Persist in the form of cash of $11,000 and
forgiveness by the Company of accounts receivable owed by Persist of $180,000,
of which $123,000 related to 1995 billings and $57,000 related to 1994
billings. Consequently, the Company's ownership was increased to approximately
69%, resulting in a change in financial reporting from the equity method to
consolidation beginning January 1, 1995. As a result of equity transactions
during 1996, the Company's ownership was reduced to approximately 64%.
The Persist acquisition was accounted for under the purchase method of
accounting in 1995. Accordingly, the purchase price was allocated based on the
estimated fair value of assets purchased and liabilities assumed upon
acquisition. The excess of cost over the fair value of net assets acquired of
$74,000 is being amortized over five years. The Company's results of
operations for the years ended December 31, 1995 and 1996 include the
operating results of Persist.
In January 1996, the Company issued 280,005 shares of its Class A common
stock valued at $728,000 and incurred $87,000 for transaction costs in
exchange for all of the outstanding shares of Vista. Vista is a developer of
computer-aided engineering software.
The Vista merger has been accounted for under the purchase method.
Accordingly, the purchase price was allocated based on the estimated fair
value of the assets purchased and liabilities assumed upon acquisition. No
value was allocated to in-process research and development. The excess of cost
over fair value of the net assets acquired of $173,000 is being amortized over
three years. Pro forma results of operations have not been presented because
the effect of this acquisition was not significant.
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
ESTIMATED
USEFUL LIVES
(YEARS) 1995 1996
------------ ---------- ----------
<S> <C> <C> <C>
Equipment............................... 3-7 $1,369,000 $2,406,000
Furniture and fixtures.................. 5-7 577,000 787,000
Leasehold improvements.................. 5 89,000 149,000
---------- ----------
2,035,000 3,342,000
Less: Accumulated depreciation and amor-
tization............................... 695,000 1,372,000
---------- ----------
$1,340,000 $1,970,000
========== ==========
</TABLE>
Equipment under capital leases at December 31, 1995 and 1996 was $200,000
and $239,000, respectively, with related accumulated depreciation of $72,000
and $151,000, respectively. Furniture and fixtures under capital leases at
December 31, 1995 and 1996 was $271,000, with related accumulated depreciation
of $26,000 and $77,000, respectively. Depreciation expense related to assets
under capital leases was $11,000, $79,000 and
F-11
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
$130,000 for the years ended December 31, 1994, 1995 and 1996, respectively.
Depreciation expense on all fixed assets amounted to $228,000, $376,000 and
$677,000 for the years ended December 31, 1994, 1995 and 1996, respectively.
5. OTHER ACCRUED EXPENSES AND CURRENT LIABILITIES
Other accrued expenses and current liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1995 1996
---------- ----------
<S> <C> <C>
Accrued bonus and commissions......................... $ 434,000 $1,280,000
Other accrued expenses and current liabilities........ 704,000 807,000
---------- ----------
$1,138,000 $2,087,000
========== ==========
</TABLE>
6. BORROWINGS
Revolving Line of Credit
In September 1996, the Company repaid a revolving line of credit facility
with a bank with proceeds obtained from the Company's new line of credit
described below. The repaid line of credit allowed for a maximum borrowing of
$1,500,000, payable on demand, and would have expired on May 30, 1997.
Interest was payable monthly in arrears at the bank's prime rate plus 1%.
In September 1996, the Company entered into a new revolving line of credit
facility (the "Revolver") with a bank which bears interest at the bank's prime
rate plus 0.5% (8.75% at December 31, 1996). The maximum borrowing under the
Revolver is $3,500,000 and is limited to 75% of certain receivables plus 50%
of costs and estimated earnings in excess of billings as defined in the
Revolver agreement. Borrowings are collateralized by all of the assets of the
Company. Interest is payable monthly in arrears. The Revolver expires and all
outstanding amounts thereunder are payable on June 30, 1997. Under the
Revolver agreement, the Company is required to comply with certain financial
covenants. There were no borrowings outstanding, and $3,500,000 was available,
under the Revolver at December 31, 1996. The Company and the bank are
negotiating an extension of the line of credit agreement beyond June 30, 1997.
Equipment Line of Credit
In September 1996, the Company entered into an equipment financing agreement
(the "Equipment Line") with a bank to provide financing of up to $1,500,000
for the purchase through June 30, 1997 of certain equipment as defined in the
Equipment Line. Ratable principal and interest payments on any borrowings
under the Equipment Line are payable during the period July 1, 1997 through
June 1, 2000. Borrowings under the Equipment Line bear interest at the bank's
prime rate plus 1% (9.25% at December 31, 1996). Borrowings are collateralized
by the assets of the Company. Under the Equipment Line, the Company is
required to comply with certain financial covenants. Borrowings under the
Equipment Line were $619,000, and $825,000 remained available, at December 31,
1996.
Demand Note Payable
In September 1995, the Company obtained $150,000 of financing through a
demand note payable from a bank. Interest was payable monthly in arrears at
the bank's prime rate plus 1.0%. In January 1996, the Company repaid all
outstanding principal and interest on this note.
F-12
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1995 1996
---------- ----------
<S> <C> <C>
Notes payable to bank in monthly principal installments
with interest at prime plus 2.5%, due in August 2000
through August 2001, secured by all assets of the
Company, the personal guarantee of the largest
stockholder, and the guarantee of the U.S. Small
Business Administration. These notes were retired in
September 1996......................................... $ 746,000 $ --
Secured subordinated note payable to bank (described
further below), with interest only payable quarterly
through June 30, 1998 at 10% per annum. Beginning
September 30, 1998, principal installments of $63,000
plus interest are payable quarterly through June 30,
2002................................................... 930,000 943,000
Term loan payable to bank in monthly principal
installments of $18,750, with interest at prime plus 1%
(9.25% at December 31, 1996), through September 1999,
secured by all assets of the Company. Under the term
loan, the Company is required to comply with certain
financial covenants. The Company was in violation of
certain of these covenants at December 31, 1996,
however, a waiver of the violations was granted by the
creditor............................................... -- 619,000
---------- ----------
1,676,000 1,562,000
Less--Current portion................................... 115,000 225,000
---------- ----------
$1,561,000 $1,337,000
========== ==========
</TABLE>
Secured Subordinated Note Payable
In May 1995, the Company issued a secured subordinated note payable for
$924,000, having a face value of $1,000,000 with interest payable at 10% per
annum. The note is subordinate to the bank debt and is collateralized by a
second security interest in all assets of the Company. In addition, the note
contains various restrictive covenants including, but not limited to, minimum
earnings and limitations on certain interest coverage, debt and equity ratios.
The Company was in violation of certain of these covenants at December 31,
1995 and 1996, however, a waiver of the violations was granted by the note
holder.
The note also included detachable warrants with an ascribed value of $76,000
for purchase of up to 312,500 shares of common stock for $1.60 per share. The
warrants expire on the later of June 30, 2000 or the repayment of the Note.
The Company has reserved 312,500 shares of common stock in the event of
exercise of the warrants. The warrant value was recorded as a discount from
the face value of the note. Amortization of this discount for the years ended
December 31, 1995 and 1996 was $6,000 and $13,000, respectively, which amounts
are included in interest expense.
F-13
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Maturities
The future aggregate annual principal payments on long-term debt for each of
the years ended December 31 are as follows:
<TABLE>
<S> <C>
1997................................................................. $ 225,000
1998................................................................. 342,000
1999................................................................. 406,000
2000................................................................. 241,000
2001................................................................. 245,000
Thereafter........................................................... 103,000
----------
$1,562,000
==========
</TABLE>
8. RELATED PARTY TRANSACTIONS
For the years ended December 31, 1994, 1995 and 1996, the Company recorded
revenue of $4,070,000, $9,313,000 and $5,579,000, respectively, related to
outsourcing and license agreements with a corporation, Bull HN Information
Systems Inc. ("Bull"), owning 18% of the outstanding stock of the Company at
December 31, 1996. At December 31, 1995 and 1996, $991,000 and $123,000,
respectively, is included in accounts receivable from related parties with
respect to this stockholder, and $1,291,000 and $501,000, respectively, is
included in costs and estimated earnings in excess of billings on uncompleted
contracts with related parties; also, at December 31, 1996, $1,400,000 is
included in unbilled license revenue. Bull also had certain stock purchase
rights (Note 17).
For the years ended December 31, 1994, 1995 and 1996, the Company recorded
revenue of $111,000, $402,000 and $137,000, respectively, related to software
services to a customer. A director of the Company was also an officer and
director of the customer from 1994 through 1996.
For the years ended December 31, 1994, 1995 and 1996, the Company recorded
revenue of $162,000, $1,717,000 and $1,501,000, respectively, related to
software services and licensing to a customer. An employee and officer of the
Company, hired in September 1996, was previously employed by the customer as
an employee and officer until August 1996.
For the year ended December 31, 1996, the Company recorded license revenue
of $190,000 from a customer. An employee and officer of the Company, hired in
December 1996, was previously employed by the customer as an employee and
officer until December 1996.
The Company had an unsecured note payable with a balance outstanding at
December 31, 1994 of $62,000 due to an entity whose principal owner is a
stockholder of the Company. In addition, the Company had an unsecured note
payable with a balance of $34,000 due to its largest stockholder. Each note
incurred interest at 7%. On July 1, 1995, the Company repaid all outstanding
principal and interest on these notes.
During the year ended December 31, 1996, Persist recorded revenue of
$776,000 related to outsourcing services to a corporation owning 27% of the
outstanding stock of Persist at December 31, 1996 (Note 3). During the year
ended December 31, 1994, the Company recorded revenue of $71,000 related to
consulting work performed on behalf of Persist, 40% of which was owned at that
time by the Company (Note 3).
In February 1996, the Company accepted a $58,000 note receivable from an
employee of the Company in connection with the exercise of employee stock
options. This note matures on February 6, 2001, and is secured by the assets
of the now former employee. Interest is payable quarterly in arrears and
accrues on all outstanding principal plus previously accrued but unpaid
interest at the prime rate.
F-14
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. INCOME TAXES
The components of income (loss) before income taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1994 1995 1996
-------- -------- -----------
<S> <C> <C> <C>
Domestic..................................... $581,000 $(45,000) $(5,141,000)
Foreign...................................... -- 135,000 101,000
-------- -------- -----------
$581,000 $ 90,000 $(5,040,000)
======== ======== ===========
</TABLE>
The provision (benefit) for estimated income taxes consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1994 1995 1996
-------- -------- -----------
<S> <C> <C> <C>
Current:
Federal.................................... $ -- $(14,000) $ --
State...................................... -- (1,000) --
Foreign.................................... -- -- 43,000
-------- -------- -----------
-- (15,000) 43,000
-------- -------- -----------
Deferred:
Federal.................................... $147,000 $ 3,000 $(1,798,000)
State...................................... 32,000 4,000 (435,000)
-------- -------- -----------
179,000 7,000 (2,233,000)
Deferred tax asset valuation allowance...... -- -- 2,047,000
-------- -------- -----------
179,000 7,000 (186,000)
-------- -------- -----------
$179,000 $ (8,000) $ (143,000)
======== ======== ===========
</TABLE>
No current federal or state income taxes were payable in the years ended
December 31, 1994, 1995 and 1996 as a result of losses incurred.
The components of deferred tax assets and liabilities follow:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1995 1996
--------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................... $ 423,000 $ 2,641,000
Tax credit carryforwards........................... 102,000 531,000
Deferred revenue................................... -- 238,000
Nondeductible accrued expenses..................... 51,000 64,000
Unexercised stock options.......................... 56,000 56,000
Other.............................................. 44,000 11,000
--------- -----------
Gross deferred tax assets........................... 676,000 3,541,000
--------- -----------
Deferred tax liabilities:
Estimated earnings on uncompleted contracts........ (862,000) (1,317,000)
Capitalized research and development costs, net.... -- (46,000)
--------- -----------
Gross deferred tax liabilities..................... (862,000) (1,363,000)
--------- -----------
Net deferred tax (liabilities) assets............... (186,000) 2,178,000
Deferred tax asset valuation allowance.............. -- (2,178,000)
--------- -----------
$(186,000) $ --
========= ===========
</TABLE>
F-15
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A reconciliation between the amount of reported income tax provision
(benefit) and the amount determined by applying the U.S. federal statutory
rate of 34% to the income (loss) before income taxes, minority interest and
equity in loss of less than majority owned company follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
-------- -------- -----------
<S> <C> <C> <C>
Income (loss) at statutory rate........... $198,000 $ 31,000 $(1,699,000)
Federal research and development credits.. -- (53,000) (251,000)
Income (losses) of foreign subsidiary not
subject to taxation...................... (36,000) 13,000 --
Permanent differences and other, net...... (4,000) (3,000) 70,000
State tax benefit, net of federal effect.. 21,000 4,000 (310,000)
Change in deferred tax asset valuation
allowance................................ -- -- 2,047,000
-------- -------- -----------
$179,000 $ (8,000) $ (143,000)
======== ======== ===========
</TABLE>
At December 31, 1996, the Company has provided a valuation allowance for the
full amount of the net deferred tax assets, since the realization of these
future benefits is not sufficiently assured. If the Company achieves
profitability, these deferred tax assets may be available to offset future
income tax liabilities and expense.
At December 31, 1996, the Company had available net operating loss
carryforwards of approximately $6,659,000 and $6,286,000 for federal and state
income tax reporting purposes, respectively. At December 31, 1996, the Company
had research and development credit carryforwards of $186,000 and $171,000
available to offset future federal tax and state tax, respectively. The
Company also has federal foreign tax credit carryforwards of $175,000. These
carryforwards will expire in the years 1999 through 2011 if not utilized.
In accordance with certain provisions of the Internal Revenue Code, a change
in ownership of greater than 50% within a three-year period will place an
annual limitation on the Company's ability to utilize its existing federal net
operating loss and research and development tax credit carryforwards. The
change in ownership that may result from an initial public offering could
result in such a limitation.
10. REDEEMABLE CONVERTIBLE PREFERRED STOCK
Issuances
During March and October 1996, the Company issued 1,903,525 shares of Series
A redeemable convertible preferred stock and 1,818,182 shares of Series B
redeemable convertible preferred stock ("Series A and B preferred stock") for
cash proceeds of $5,207,000 and $5,776,000, respectively, net of issuance
costs of $123,000 and $224,000, respectively.
Conversion
Each preferred share is convertible into one common share at the option of
the preferred stockholder or automatically upon the closing of an initial
public offering of the Company's common stock in which proceeds from the
public equal or exceed $15,000,000.
At December 31, 1996, Series A and B preferred stock are convertible into a
total of 3,721,707 common shares. The conversion rates are to be adjusted for
certain dilutive and anti-dilutive events. The Company has reserved 1,903,525
and 1,818,182 shares of common stock for the conversion of Series A and B
preferred stock, respectively.
F-16
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Liquidation
In the event of any liquidation, dissolution or winding up of the Company,
the holders of Series A and B preferred stock are entitled to receive, on a
pro-rata basis, $3.825 and $3.30 per share, plus all accrued and unpaid
dividends, respectively.
Voting
The holders of Series A and B preferred stock are entitled to vote, together
with the holders of common stock on all matters submitted to stockholders for
a vote. Each preferred stockholder is entitled to the number of votes equal to
the number of shares of common stock into which each Series A and B share is
convertible at the time of such vote.
Dividends
The holders of the Series A and B preferred stock are entitled to receive
cumulative annual dividends in the amount of $0.3825 and $0.33 per share plus
10% of previously accrued and unpaid dividends, respectively, whether or not
declared by the Board of Directors. These dividends are payable upon
liquidation, dissolution or winding-up of the Company, or upon redemption of
the respective preferred stock. Cumulative and unpaid dividends on the Series
A and B preferred stock at December 31, 1996 were $582,000 and $107,000,
respectively.
Redemption
On each of the fifth, sixth and seventh anniversaries of the applicable
series closing date, the Company is required to redeem 33 1/3 percent of the
Series A and B preferred stock at a redemption price equal to $2.80 and $3.30
per share, respectively, plus accrued and unpaid dividends through the
redemption date. During 1996, the Company recorded a charge to accumulated
deficit of $347,000 to reflect the accretion of Series A and B preferred stock
to redemption value. The carrying value of the Series A and B preferred stock
reflects the original issuance price, net of issuance costs, plus accrued and
unpaid dividends and accretion to redemption value.
Redeemable Common Stock Right
In connection with the 1996 issuance of Series A preferred stock, the
Company sold from treasury 71,775 shares of its Class A common stock to
certain purchasers of the Series A preferred stock for cash proceeds of
$201,000. Also in connection with this issuance, an officer of the Company
sold 625,000 shares of the Company's Class A common stock to certain
purchasers of the Series A preferred stock. In conjunction with any redemption
of the Series A preferred stock, the holders of the Series A preferred stock
must redeem, at a redemption price equal to $2.80 per share, 0.366 shares of
Class A common stock for each redeemed share of the Series A preferred stock.
The Company incurred during 1996 a charge to accumulated deficit of $66,000 to
reflect the accretion of this Class A common stock to redemption value. The
carrying value of the redeemable common stock right reflects the cash proceeds
to the Company for the underlying Class A common stock, plus accretion to
redemption value.
Future Redemptions
Required redemption amounts for the Series A and B preferred stock and the
redeemable common stock right, excluding any cumulative and unpaid dividends,
are as follows:
<TABLE>
<CAPTION>
REDEMPTION
YEAR AMOUNT
---- ----------
<S> <C>
2001........................................................... $4,427,000
2002........................................................... 4,427,000
2003........................................................... 4,427,000
</TABLE>
F-17
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Unaudited Pro Forma Balance Sheet
Upon the closing of the Company's initial public offering, all of the
outstanding shares of Series A and B preferred stock will automatically
convert into 3,721,707 shares of common stock. In addition, the redeemable
common stock right also automatically terminates upon the closing of the
Company's initial public offering, as its redemption feature is directly
associated to the redemption of the Series A preferred stock. These
conversions have been reflected in the unaudited pro forma balance sheet as of
March 31, 1997.
In connection with the initial public offering, the Company expects to file
Articles of Amendment to the Articles of Organization which will (i) authorize
50,000,000 shares of common stock, $.01 par value, (ii) authorize 5,000,000
shares of Preferred Stock, $.01 par value, under terms that allow the Board of
Directors to designate one or more classes of preferred stock and to designate
rights, privileges, preferences and limitations of each class, and (iii)
redesignate each share of its Class A common stock into one share of Common
Stock. The effects of this amendment to the Articles of Organization have been
reflected in the unaudited pro forma balance sheet as of March 31, 1997.
11. COMMON STOCK
In April and March 1995, the Company amended its Articles of Organization to
create two classes of common stock, Class A and Class B, with 6,250,000 and
100,000 shares authorized, respectively. Class A and Class B shares maintain
identical rights in all respects except that Class B shares are non-voting and
convert to Class A common stock upon the closing of an initial public offering
with proceeds greater than $10,000,000. Upon adoption of the amended Articles
of Organization, each share of common stock then outstanding was converted to
one share of Class A common stock.
In March 1996, the Company effected a two-and-one-half-for-one stock split
of the Company's Class A and Class B common stock in the form of a 150% stock
dividend. Share amounts in these financial statements have been retroactively
adjusted to reflect this stock split.
On December 31, 1996, the Company retired all Class A and Class B common
stock remaining in treasury as a result of various previous repurchases.
12. DIRECTOR STOCK OPTION PLAN
In May 1997, the Board of Directors authorized the 1997 Director Stock
Option Plan (the "Director Plan"). The Director Plan authorizes the grant of
up to 200,000 options to purchase Common Stock of the Company. Under the
Director Plan, each non-employee director of the Company at the time of the
effective date of the Company's initial public offering will receive options
to purchase 15,000 shares of common stock. Any director elected after the
Company's initial public offering will receive an option to purchase 15,000
shares of the Company's common stock upon his or her election to the Board of
Directors. In addition, each director will receive an option to purchase 3,000
shares of the Company's common stock at each annual meeting of the
stockholders beginning with the 1998 annual meeting. All option grants made
under the Director Plan have exercise prices equivalent to the fair market
value on the date grant, and will vest in three annual installments beginning
on the anniversary date of the grant, so long as the optionee remains a
director of the Company.
13. EMPLOYEE STOCK PURCHASE PLANS
In February 1995, the Company adopted the 1995 Employee Stock Purchase Plan
("1995 Plan") for all employees of the Company. The 1995 Plan allows for the
repurchase of up to 100,000 shares of Class A voting common stock from
existing stockholders at $1.60 per share and the subsequent issuance of Class
B non-voting
F-18
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
common stock. In March 1995, the Company repurchased 95,537 shares of Class A
common stock from existing shareholders at $1.60 per share and maintained
these shares in treasury at cost. In order to provide substantially all
employees an opportunity for equity participation, the Company then sold
95,537 shares of Class B common stock at $1.60 per share to those employees
electing to subscribe. The 1995 Plan was no longer effective at December 31,
1995.
In May 1997, the Board of Directors authorized the 1997 Employee Stock
Purchase Plan (the "1997 Plan"). The 1997 Plan authorizes the issuance of up
to 200,000 shares of the Company's common stock to eligible employees. Under
the 1997 Plan, the Company is authorized to make four consecutive six month
offerings during which employees may purchase shares of the Company's common
stock through payroll deductions made over the term of the offering. The per
share purchase price of each offering is equal to the lesser of 85% of the
fair market value at the beginning or end of the offering period (as defined
by the 1997 Plan). The first offering period will commence on October 1, 1997.
14. LONG TERM INCENTIVE PLAN
In January 1992, the Board of Directors established a Long Term Incentive
Plan (the "Plan") which allows for the grant of awards in the form of
incentive and non-qualified stock options, stock units, restricted common
stock and stock appreciation rights to employees, directors, independent
contractors and consultants. In 1996, the Board of Directors authorized the
issuance of both Class A and Class B common stock under the Plan. The total
number of shares which have been reserved under the Plan is 3,388,820,
comprised of 3,046,695 shares of Class A and 342,145 shares of Class B common
stock. Incentive stock options are granted at an exercise price equal to the
fair market value of the Company's common stock as determined by the Board of
Directors at the grant date (or no less than 110% of the fair market value in
the case of optionees holding more than 10% of the voting stock of the
Company) and expire 10 years from the date of grant or upon termination of
employment. Non-qualified stock options are granted at an exercise price
determined by the Board of Directors and expire 10 years from the date of
grant. Both the incentive and non-qualified stock options are exercisable at
various dates as determined by the Board of Directors. At December 31, 1995
and 1996, no stock units, restricted stock or stock appreciation rights were
issued under the Plan. In May 1997, the Board of Directors authorized the 1997
Stock Incentive Plan (the "Incentive Plan"). The Incentive Plan is intended to
replace the Company's Long Term Incentive Plan and provides for the issuance
of up to 1,950,000 shares of Common Stock.
Transactions for stock options under the Plan during the years ended
December 31, 1994, 1995 and 1996 and the three months ended March 31, 1997 are
summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------
THREE MONTHS ENDED
1994 1995 1996 MARCH 31, 1997
------------------- ------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- -------- --------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of period.............. 1,071,575 $0.10 1,356,700 $0.23 1,606,025 $0.64 2,925,667 $1.88
Granted................. 297,875 0.72 455,250 1.96 1,558,292 3.04 255,000 5.67
Exercised............... -- -- (95,000) 0.05 (198,533) 0.92 (122,500) 0.01
Forfeited............... (12,750) 0.08 (110,925) 1.58 (40,117) 1.20 (1,923) 2.60
--------- --------- --------- ---------
Outstanding at end of
period................. 1,356,700 0.23 1,606,025 0.64 2,925,667 1.88 3,056,244 2.27
========= ========= ========= =========
Options exercisable at
end of period.......... 454,927 0.07 692,462 0.21 1,030,036 0.47 982,991 0.75
========= ========= ========= =========
</TABLE>
F-19
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following summarizes information regarding stock options outstanding
under the Plan at December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
NUMBER CONTRACTUAL EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE
------------------------ ----------- ------------ --------
<S> <C> <C> <C>
$0.01-0.10............................... 675,875 5.9 $0.07
0.15-0.24............................... 174,075 6.5 0.23
0.48-0.80............................... 291,900 7.5 0.66
1.60.................................... 93,750 8.2 1.60
2.60-3.30............................... 1,690,067 9.8 3.00
---------
2,925,667 1.88
=========
</TABLE>
<TABLE>
<CAPTION>
OPTIONS EXERCISABLE
---------------------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
NUMBER CONTRACTUAL EXERCISE
RANGE OF EXERCISE PRICES EXERCISABLE LIFE (YEARS) PRICE
------------------------ ----------- ------------ --------
<S> <C> <C> <C>
$0.01-0.10............................... 577,125 5.8 $0.07
0.15-0.24............................... 174,075 6.5 0.23
0.48-0.80............................... 155,888 7.5 0.65
1.60.................................... 28,125 8.1 1.60
2.60-3.30............................... 94,823 9.3 2.70
---------
1,030,036 0.47
=========
</TABLE>
The following summarizes information regarding stock options outstanding
under the Plan at March 31, 1997 (unaudited):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
---------------------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
NUMBER CONTRACTUAL EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE
------------------------ ----------- ------------ --------
<S> <C> <C> <C>
$0.01-0.10............................... 553,375 5.6 $0.08
0.15-0.24............................... 174,075 6.2 0.23
0.48-0.80............................... 291,900 7.2 0.66
1.60.................................... 93,750 7.9 1.60
2.60-3.30............................... 1,693,144 9.5 3.00
4.65.................................... 175,000 9.8 4.65
8.20.................................... 75,000 9.8 8.20
---------
3,056,244 2.27
=========
</TABLE>
F-20
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
OPTIONS EXERCISABLE
---------------------------------
WEIGHTED
AVERAGE WEIGHTED
REMAINING AVERAGE
NUMBER CONTRACTUAL EXERCISE
RANGE OF EXERCISE PRICES EXERCISABLE LIFE (YEARS) PRICE
------------------------ ----------- ------------ --------
<S> <C> <C> <C>
$0.01-0.10............................... 454,625 5.5 $0.08
0.15-0.24............................... 174,075 6.2 0.23
0.48-0.80............................... 167,644 7.2 0.66
1.60.................................... 40,625 7.8 1.60
2.60-3.30............................... 102,272 9.0 2.70
4.65.................................... 43,750 9.8 4.65
8.20.................................... -- 9.8 --
-------
982,991 0.75
=======
</TABLE>
In accordance with APB 25, the Company recognized $83,000 and $118,000 in
compensation expense under the Plan for the years ended December 31, 1995 and
1996, respectively. Had compensation cost for the Plan been determined based
upon the fair value of options at their grant dates, as prescribed in SFAS
123, the Company's net income (loss) would have been as follows:
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31, 1997
------------------- ------------------
1995 1996
------- ----------- (UNAUDITED)
<S> <C> <C> <C>
As reported.......................... $55,000 $(4,921,000) $406,000
Pro forma............................ 36,000 (5,049,539) 196,000
</TABLE>
The fair value of options at date of grant was estimated using the minimum
value method with the following weighted average assumptions:
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31, 1997
-------------- ------------------
1995 1996
------ ------ (UNAUDITED)
<S> <C> <C> <C>
Expected life (years).................... 5 5 5
Risk-free interest rate.................. 7.37% 6.25% 6.20%
Dividend yield........................... 0% 0% 0%
Fair value of option grants--exercise
price equal to the fair value of the
related stock........................... $ 0.35 $ 0.52 $1.88
Fair value of option grants--exercise
price less than the fair value of the
related stock........................... $ 0.14 $ -- $ --
</TABLE>
Because options vest over several years and additional option grants are
expected to be made in future years, the above pro forma results applying the
provisions of SFAS 123 are not representative of pro forma results for future
years.
15. DEFINED CONTRIBUTION PLAN
The Company maintains a defined contribution plan under Section 401(k) of
the Internal Revenue Code covering substantially all employees. Under the
plan, employees may contribute the lower of up to 20% of their salaries or a
dollar amount prescribed by the Internal Revenue Code. The Board of Directors
may elect to make a discretionary contribution to the plan. Vesting with
respect to the Company's discretionary contribution occurs four years from the
date the employee is admitted to the plan. There were no contributions made by
the Company to the Plan during the years ended December 31, 1994, 1995 and
1996.
F-21
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
16. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in a single industry segment: software maintenance,
tools and services.
The Company operates in diverse geographic areas. Intercompany sales and
transfers between geographical areas are accounted for at prices which are
designed to be representative of unaffiliated party transactions. Information
by geographic area at December 31, 1995 and 1996, and for the years then
ended, is summarized below; the Company operated only in North America during
the year ended December 31, 1994.
<TABLE>
<CAPTION>
GEOGRAPHIC AREAS
------------------------
NORTH AMERICA EUROPE ELIMINATIONS TOTAL
------------- ---------- ------------ -----------
<S> <C> <C> <C> <C>
1995
Revenue to unaffiliated
customers................. $17,426,000 $1,079,000 $ -- $18,505,000
Intercompany revenue....... 159,000 -- (159,000) --
----------- ---------- --------- -----------
Total revenue............ 17,585,000 1,079,000 (159,000) 18,505,000
Income from operations..... 164,000 129,000 -- 293,000
Identifiable assets........ 6,977,000 430,000 (228,000) 7,179,000
Capital expenditures....... 804,000 20,000 -- 824,000
Depreciation and
amortization.............. 441,000 2,000 -- 443,000
1996
Revenue to unaffiliated
customers................. $17,435,000 $1,800,000 $ -- $19,235,000
Intercompany revenue....... -- 84,000 (84,000) --
----------- ---------- --------- -----------
Total revenue............ 17,435,000 1,884,000 (84,000) 19,235,000
Income (loss) from
operations................ (4,821,000) 77,000 -- (4,744,000)
Identifiable assets........ 16,635,000 1,575,000 (485,000) 17,725,000
Capital expenditures....... 1,227,000 13,000 -- 1,240,000
Depreciation and
amortization.............. 850,000 4,000 -- 854,000
</TABLE>
17. COMMITMENTS
Stock Purchase Agreement
Pursuant to a stock purchase agreement between a stockholder, Bull (the
Company's largest customer--Note 8), and the Company dated May 29, 1992, and a
follow-on agreement dated September 1, 1994, the Company granted to the
stockholder certain rights and privileges. Among these is the right of first
refusal to purchase a pro rata portion of any new securities issued by the
Company through the date of closing of the first public offering of the
Company's common stock, the right of first refusal to acquire a majority
voting interest in the Company should any third party seek to acquire such an
interest during the period through September 1, 1999, an option to purchase up
to 15% of the authorized common shares of the Company before December 31, 1995
at a price not to exceed $1.48 per share, and the right to purchase at the
then fair market value a greater than 15% voting interest if the Company
grants to any third party the right to acquire such an interest during the
period through September 1, 1999. Under this agreement, in October 1995, the
stockholder acquired 512,500 shares of Class A common stock at $1.48 per share
resulting in proceeds, net of interest costs of $12,000, of $746,000 to
increase their interest in the Company at that time to 15% of the authorized
shares.
F-22
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Operating and Capital Leases
The Company leases its operating facilities and certain equipment under
noncancelable operating and capital lease agreements. Rent expense for the
years ended December 31, 1994, 1995 and 1996 was $282,000, $839,000 and
$999,000, respectively. Future minimum lease payments under noncancelable
leases as of December 31, 1996 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING OPERATING CAPITAL
DECEMBER 31, LEASES LEASES
------------ ---------- --------
<S> <C> <C>
1997.................................................... $1,022,000 $ 94,000
1998.................................................... 952,000 73,000
1999.................................................... 51,000 133,000
2000.................................................... -- 9,000
2001.................................................... -- 6,000
---------- --------
$2,025,000 315,000
==========
Less--Amount representing interest...................... 40,000
--------
Present value of minimum lease payments................. $275,000
========
</TABLE>
F-23
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
No dealer, sales representative or any other person has been authorized to
give any information or to make any representations in connection with this
offering other than those contained in this Prospectus, and, if given or made,
such information or representations must not be relied upon as having been
authorized by the Company or the Underwriters. This Prospectus does not
constitute an offer to sell or a solicitation of an offer to buy any
securities other than the shares of Common Stock to which it relates or an
offer to, or a solicitation of, any person in any jurisdiction where such an
offer or solicitation would be unlawful. Neither the delivery of this
Prospectus nor any sale made hereunder shall, under any circumstances, create
any implication that there has been no change in the affairs of the Company or
that the information contained herein is correct as of any time subsequent to
the date hereof.
-------------------
TABLE OF CONTENTS
-------------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 7
Use of Proceeds.......................................................... 17
Dividend Policy.......................................................... 17
Capitalization........................................................... 18
Dilution................................................................. 19
Selected Consolidated Financial Data..................................... 20
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 21
Business................................................................. 33
Management............................................................... 47
Certain Transactions..................................................... 56
Principal and Selling Stockholders....................................... 60
Description of Capital Stock............................................. 62
Shares Eligible for Future Sale.......................................... 65
Underwriting............................................................. 67
Legal Matters............................................................ 68
Experts.................................................................. 68
Additional Information................................................... 69
Index to Consolidated Financial Statements............................... F-1
</TABLE>
-------------------
Until July 27, 1997 (25 days after the date of this Prospectus), all dealers
effecting transactions in the registered securities, whether or not
participating in this distribution, may be required to deliver a Prospectus.
This is in addition to the obligation of dealers to deliver a Prospectus when
acting as Underwriters and with respect to their unsold allotments or
subscriptions.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
3,500,000 SHARES
[LOGO OF PERITUS SOFTWARE APPEARS HERE]
COMMON STOCK
---------------
PROSPECTUS
---------------
Montgomery Securities
Wessels, Arnold & Henderson
H.C. Wainwright & Co., Inc.
July 2, 1997
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
