<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Quarterly Period Ended September 30, 1998.
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition Period from_________to________.
COMMISSION FILE NUMBER 000-22647
PERITUS SOFTWARE SERVICES, INC.
(Exact Name of Registrant as Specified in its Charter)
MASSACHUSETTS 04-3126919
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
2 FEDERAL STREET, BILLERICA, MASSACHUSETTS 01821
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(978) 670-0800
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
NOT APPLICABLE
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ ]. No [X ].
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Shares outstanding
Title of Class at December 7, 1998
- ----------------------------- ------------------------
Common Stock, $0.01 par value 16,349,986
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet as of September 30, 1998 and December 31, 1997........................ 3
Consolidated Statement of Operations for the Three and Nine Months Ended
September 30, 1998 and 1997.................................................................... 4
Consolidated Statement of Cash Flows for the Nine Months Ended September 30,
1998 and 1997.................................................................................. 5
Notes to Unaudited Consolidated Financial Statements............................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................................. 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk................................ 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... 26
Item 2. Changes in Securities and Use of Proceeds................................................. 27
Item 3. Defaults Upon Senior Securities .......................................................... 27
Item 4. Submission of Matters to a Vote of Security Holders....................................... 27
Item 5. Other Information......................................................................... 27
Item 6. Exhibits and Reports on Form 8-K.......................................................... 27
Signatures......................................................................................... 29
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PERITUS SOFTWARE SERVICES, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE-RELATED DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997*
--------------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents......................................................... $ 4,004 $ 11,340
Short-term investments............................................................ 2,500 3,000
Accounts receivable, net of allowance for doubtful accounts of $745 and $95,
respectively, and including amounts receivable from related parties of $-- and
$289, respectively............................................................... 5,554 12,627
Costs and estimated earnings in excess of billings on uncompleted contracts,
including amounts on uncompleted contracts with related parties of $-- and
$250, respectively............................................................... 1,692 2,547
Prepaid expenses and other current assets......................................... 1,264 710
-------- --------
Total current assets............................................................ 15,014 30,224
Property and equipment, net........................................................ 5,239 3,859
Intangible and other assets, net................................................... 676 5,787
-------- --------
$ 20,929 $ 39,870
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of capital lease obligations...................................... $ 91 $ 51
Current portion of long-term debt................................................. 342 292
Accounts payable.................................................................. 843 1,650
Billings in excess of costs and estimated earnings on uncompleted contracts....... 394 976
Deferred revenue.................................................................. 2,125 2,818
Other accrued expenses and other current liabilities.............................. 5,760 3,506
-------- --------
Total current liabilities....................................................... 9,555 9,293
Capital lease obligations.......................................................... 308 144
Long-term debt..................................................................... -- 269
Other long-term liabilities........................................................ 1,037 --
-------- --------
Total liabilities............................................................... 10,900 9,706
-------- --------
Minority interest in majority-owned subsidiary..................................... -- 159
-------- --------
Stockholders' equity:
Common stock, $.01 par value; 50,000,000 shares authorized; 16,294,985 and
15,361,800 shares issued and outstanding at September 30, 1998 and December 31,
1997, respectively............................................................... 163 154
Additional paid-in capital........................................................ 105,081 103,808
Accumulated deficit............................................................... (95,144) (73,815)
Note receivable from stockholder.................................................. -- (58)
Cumulative translation adjustment................................................. (71) (84)
-------- --------
Total stockholders' equity...................................................... 10,029 30,005
-------- --------
$ 20,929 $ 39,870
======== ========
* Restated--See Note 2.
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
3
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE-RELATED DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three months Nine months
ended ended
September 30, September 30,
------------------------------ ----------------------
1998 1997* 1998 1997*
-------------- -------------- ----------- ----------
<S> <C> <C> <C> <C>
Revenue:
Outsourcing services, including $106, $959,
$872, and $2,912 from related parties,
respectively...................................... $ 2,270 $ 2,979 $ 7,685 $ 8,542
License, including $--, $--, $255, and $-- from
related parties, respectively...................... 763 3,957 8,602 12,744
Other services, including $--, $--, $204, and $--
from related parties, respectively................. 2,260 1,716 9,522 4,207
-------- --------- -------- -------
Total revenue.................................... 5,293 8,652 25,809 25,493
-------- --------- -------- -------
Cost of revenue:
Cost of outsourcing services, including $86,
$615, $750 and $1,580 from related
parties, respectively.............................. 1,826 2,444 5,833 6,847
Cost of license..................................... 474 155 1,520 430
Cost of other services, including $--, $--, $56,
and $--from related parties, respectively.......... 2,551 1,280 7,636 3,605
-------- --------- -------- -------
Total cost of revenue............................ 4,851 3,879 14,989 10,882
-------- --------- -------- -------
Gross profit..................................... 442 4,773 10,820 14,611
-------- --------- -------- -------
Operating expenses:
Sales and marketing................................. 3,980 2,197 10,355 5,615
Research and development............................ 2,150 1,975 7,195 5,578
General and administrative.......................... 2,969 1,053 6,017 2,853
Impairment of long-lived assets..................... 4,294 -- 4,294 --
Restructuring charge................................ 3,279 -- 4,718 --
-------- --------- -------- -------
Total operating expenses......................... 16,672 5,225 32,579 14,046
-------- --------- -------- -------
Income (loss) from operations.................... (16,230) (452) (21,759) 565
Interest income, net................................. 95 462 440 482
-------- --------- -------- -------
Income (loss) before gain on disposition of
majority-owned subsidiary, income taxes and
minority interest in majority-owned subsidiary..... (16,135) 10 (21,319) 1,047
Gain on disposition of majority-owned subsidiary..... (11) -- (11) --
Provision (benefit) for
income taxes........................................ -- (68) 25 104
-------- --------- -------- -------
Income (loss) before minority interest in
majority-owned subsidiary.......................... (16,124) 78 (21,333) 943
Minority interest in majority-owned subsidiary....... 8 (6) (4) 15
-------- --------- -------- -------
Net income (loss)................................ (16,132) 84 (21,329) 928
Accrual of dividends on Series A and B preferred
stock............................................... -- -- -- 675
Accretion to redemption value of redeemable stock.... -- -- -- 57
-------- --------- -------- -------
Net income (loss) available to common
stockholders.............................. $(16,132) $ 84 $(21,329) $ 196
======== ========= ======== =======
Net income (loss) per common share:
Basic.............................................. $ (0.99) $ 0.01 $ (1.32) $ 0.02
======== ========= ======== =======
Diluted............................................ $ (0.99) $ 0.01 $ (1.32) $ 0.02
======== ========= ======== =======
Weighted average common shares outstanding:
Basic............................................... 16,294 12,432 16,121 8,107
======== ========= ======== =======
Diluted............................................. 16,294 14,280 16,121 11,466
======== ========= ======== =======
</TABLE>
* Restated--See Note 2.
The accompanying notes are an integral part
of these consolidated financial statements.
4
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine months
ended
September 30,
---------------------------------------
1998 1997*
---------------- --------------
<S> <C> <C>
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Cash flows from operating activities:
Net income (loss).................................................................. $ (21,329) $ 928
Adjustments to reconcile net income (loss) to net cash provided by (used for)
operating activities:
Depreciation and amortization..................................................... 2,444 797
Minority interest in majority-owned subsidiary.................................... (4) 15
Impairment of long-lived assets................................................... 4,294 --
Gain on disposition of majority-owned subsidiary.................................. (11) --
Changes in assets and liabilities, net of effects from disposition:
Accounts receivable.............................................................. 6,837 (1,806)
Costs and estimated earnings in excess of billings on uncompleted contracts...... 855 235
Unbilled license revenue from related parties.................................... -- 1,741
Prepaid expenses and other current assets........................................ (585) (451)
Other assets..................................................................... (188) 37
Accounts payable................................................................. (598) 415
Billings in excess of costs and estimated earnings on uncompleted contracts...... 290 (176)
Deferred revenue................................................................. (693) (1,880)
Other accrued expenses and other current liabilities............................. 2,575 405
Other long-term liabilities...................................................... 1,037 --
--------------- ---------------
Net cash provided by (used for) operating activities............................ (5,076) 260
--------------- ---------------
Cash flows from investing activities:
Cash of majority-owned subsidiary disposed, net of cash received.................. (1,074) --
Sale of short-term investments.................................................... 500 --
Investments in subsidiary......................................................... -- (272)
Purchases of property and equipment............................................... (2,726) (1,262)
--------------- ---------------
Net cash used for investing activities.......................................... (3,300) (1,534)
--------------- ---------------
Cash flows from financing activities:
Proceeds from long-term debt...................................................... -- 200
Principal payments on long-term debt.............................................. (219) (1,112)
Principal payments on capital lease obligations................................... (70) (65)
Proceeds from issuance of common stock, net of issuance costs..................... 1,282 41,201
Proceeds from repayment of note receivable from stockholder....................... 58 --
--------------- ---------------
Net cash provided by financing activities....................................... 1,051 40,224
--------------- ---------------
Effects of exchange rates on cash and cash equivalents............................. (11) (46)
--------------- ---------------
Net increase (decrease) in cash and cash equivalents............................... (7,336) 38,904
Cash and cash equivalents, beginning of period..................................... 11,340 7,388
--------------- ---------------
Cash and cash equivalents, end of period........................................... $ 4,004 $ 46,292
=============== ===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS:
Cash paid for income taxes........................................................ $ 78 $ 60
Cash paid for interest............................................................ 49 142
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES:
In the nine months ended September 30, 1998 and 1997, the Company incurred
capital lease obligations of $458 and $--, respectively.
* Restated--See Note 2.
The accompanying notes are an integral part
of these consolidated financial statements.
5
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation and Company Status
The accompanying unaudited consolidated financial statements include the
accounts of Peritus Software Services, Inc. and its subsidiaries (the
"Company") and have been prepared by the Company without audit in accordance
with the Company's accounting policies, as described in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997, as filed with the
Securities and Exchange Commission ("SEC"). In the opinion of management, the
accompanying unaudited consolidated financial statements contain all
adjustments, which other than the restatement adjustments for the three month
periods ended September 30, 1997, December 31, 1997, March 31, 1998 and June 30,
1998, restructuring charges for the three and nine months ended September 30,
1998, the impairment on long-lived assets for the three months ended September
30, 1998 and the disposition of the Company's majority-owned subsidiary during
the three months ended September 30, 1998, consist only of those of a normal
recurring nature, necessary for a fair presentation of the Company's financial
position, results of operations and cash flows at the dates and for the periods
indicated. While the Company believes that the disclosures presented are
adequate to make the information not misleading, these financial statements
should be read in conjunction with the consolidated financial statements and
related notes included in the Company's 1997 Annual Report on Form 10-K which
will be amended to reflect the restatement of the Company's results of
operations for 1997. The operating results for the three and nine months ended
September 30, 1998 are not necessarily indicative of the results to be expected
for the full year ending December 31, 1998.
The Company's consolidated financial statements have been presented on the
basis that it is a going concern, which contemplates continuity of operations,
realization of assets and the satisfaction of liabilities in the ordinary course
of business. However, the Company experienced net losses of $67,490,000 and
$21,329,000 in the year ended December 31, 1997 and the nine months ended
September 30, 1998, respectively, and anticipates a net loss of $2,000,000 to
$4,500,000 in the fourth quarter of 1998, which raise doubt about its ability to
continue as a going concern after 1998. The Company believes that it has
sufficient cash to finance its operations through 1998. Thereafter, the
Company's cash flow requirements will depend on the results of future
operations. There can be no assurance that these expectations will be
realized. After 1998, the Company's continued existence is dependent upon its
ability to achieve a cash flow breakeven position and/or to obtain additional
sources of financing. The Company implemented a restructuring plan on December
2, 1998 to further reduce its expenses which included the elimination of
approximately 45 employees and related facilities costs. It is anticipated that
this plan will result in a charge to earnings in the fourth quarter of 1998 of
approximately $1,200,000. The Company is also exploring strategic initiatives to
raise additional funds. In addition, the Nasdaq Stock Market, Inc. has several
requirements for listing on the Nasdaq National Market or the Nasdaq SmallCap
Market. Failure to meet listing requirements may result in the Company being
moved from the National Market to the SmallCap Market or being de-listed. There
can be no assurance that the Company will not be de-listed.
The Company's bank has indicated that it will not renew or further extend its
revolving line of credit facility and demanded that cash collateral be provided
for all amounts outstanding under its equipment financing agreement with the
Company since the Company was in default of certain financial and operating
covenants thereunder. As of September 30, 1998, the Company has classified all
borrowings under this credit facility as short-term obligations. There are no
amounts outstanding under the revolving credit facility as of September 30,
1998, and the Company will provide cash collateral for all amounts outstanding
under the equipment financing agreement and for a $300,000 standby letter of
credit issued by the bank subsequent to September 30,1998. There can be no
assurance that the Company will achieve a cash flow breakeven position or that
it will be able to raise additional funds through bank borrowings and/or debt
and/or equity financings. Reductions in expenses or the sale of assets may not
be adequate to bring the Company to a cash breakeven position. In addition,
there can be no assurance that such actions will not have an adverse affect on
the Company's ability to generate revenue or successfully implement any
strategic alternatives under consideration. Failure to establish a cash flow
breakeven position or raise additional funds through bank borrowings and/or
equity and/or debt financings would adversely impact the Company's ability to
continue as a going concern after 1998.
2. RESTATEMENT OF QUARTERLY AND ANNUAL RESULTS OF OPERATIONS
During a review of the Company's 1998 third quarter financial results
performed by Peritus' management, the Audit Committee of the Company's Board of
Directors and the Company's independent auditor, PricewaterhouseCoopers LLP
("PwC"), the Company determined that the Company's results of operations for the
quarterly periods ended September 30, 1997, December 31, 1997, March 31, 1998
and June 30, 1998 and for the year ended December 31, 1997 require restatement.
The 1998 restatements first relate to the recording by Peritus of approximately
$1.09 million of software license revenue for a single customer in the second
quarter of 1998. Peritus believed that the amount of software license revenue as
originally recorded reflected a part of an approximately $1.9 million business
arrangement agreed to between the parties under a signed purchase order. The
Company has since determined that the customer did not require a separate
license and, therefore, no license revenue
6
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
should have been recorded. The balance of the 1998 restatements relate
primarily to the Company's incorrect interpretation of the complex provisions
regarding recognition of revenue for combined software/services arrangements
under Statement of Position ("SOP") 97-2, "Software Revenue Recognition," issued
by the American Institute of Certified Public Accountants ("AICPA"), and
effective for the Company as of January 1, 1998. In applying the Statement to
its new year 2000 renovation offerings which the Company commenced in the first
quarter, the Company mistimed the recognition of revenue between quarters under
certain contracts providing for the delivery of combined software and services.
The 1997 restatements involve two instances where the Company had recorded
revenue for software licenses in advance of shipment of the software. The first
instance involved the recording of software license revenue of $1.2 million in
the third quarter of 1997. The Company has determined that the software
involved was not shipped until early in the fourth quarter of 1997 and that
payment of the license fee was received in the fourth quarter. Therefore, the
Company will restate its third quarter 1997 results to exclude the $1.2 million
license fee and its fourth quarter 1997 results to include the $1.2 million
license fee. The second instance involved $571,000 of license revenue and
$21,000 of associated maintenance revenue originally recorded in the fourth
quarter of 1997. The Company has determined that the software involved was not
shipped until 1998. The Company encountered collection difficulties with the
customer during 1998. Despite entering into a settlement agreement with the
customer in the second quarter of 1998, the Company concluded in the third
quarter of 1998 that it would be unable to realize the amounts recorded.
Accordingly, the Company will restate its fourth quarter 1997 results to remove
the $592,000 of revenue involved and has not recorded this revenue in any
subsequent period. As a result of the restatements of results for 1997, the
Company was informed by PwC that users of the Company's 1997 financial
statements should no longer rely upon PwC's opinion for the year ended December
31, 1997. The Company expects the opinion will be reinstated once it completes
and files its amended Form 10-K.
The Company intends to amend its prior filings on Form 10-Q for the quarters
ended September 30, 1997, March 31, 1998 and June 30, 1998 as well as its Form
10-K for the year ended December 31, 1997. In the opinion of management, all
adjustments necessary to revise the quarterly and year-end financial statements
have been recorded. Following is a summary of the unaudited results of
operations for these periods (in thousands, except per share-related data):
<TABLE>
<CAPTION>
Quarterly Periods Ended
------------------------------------------------------------ Year Ended
September 30, December 31, March 31, June 30, December 31,
1997 1997 1998 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
As previously reported:
Revenue $9,852 $ 13,608 $10,150 $11,830 $ 40,301
Income (loss) from operations 748 (69,346) (2,775) (1,102) (67,582)
Net income (loss) 1,166 (68,920) (2,566) (979) (66,910)
Diluted net income (loss) per share $ 0.08 $ (4.97) $ (0.16) $ (0.06) $ (6.97)
<CAPTION>
Quarterly Periods Ended
----------------------------------------------------------- Year Ended
September 30, December 31, March 31, June 30, December 31,
1997 1997 1998 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
As restated:
Revenue $8,652 $ 14,216 $ 9,433 $11,083 $ 39,709
Income (loss) from operations (452) (68,738) (3,567) (1,962) (68,173)
Net income (loss) 84 (68,418) (3,358) (1,839) (67,490)
Diluted net income (loss) per share $ 0.01 $ (4.93) $ (0.21) $ (0.11) $ (7.03)
</TABLE>
7
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Revenue Recognition
Revenue under contracts to provide outsourced software maintenance,
reengineering and development services 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. 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 or revenue has been deferred, as appropriate. 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.
The Company licenses its software products and methodologies 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 or number of CPUs licensed.
License fees charged to value added integrators are generally royalties based on
lines of code processed or to be processed or number of CPUs licensed. Revenue
from software licenses is recognized when licensed software and methodologies
have been delivered, the fee is fixed and determinable and collection of the
related receivable is probable. The Company generally does not provide its
customers with the right to return software licenses and, once due, license fees
are non-refundable.
Other services provided by the Company include direct delivery contracts as
well as technology transfer arrangements, product training, value added
integrator sales training, consulting services and software product maintenance.
Under direct delivery contracts, the Company provides full and pilot year 2000
renovations and renovation quality evaluation ("RQE") services for clients using
the Company's AutoEnhancer/2000 and/or Vantage YR2000 software. Revenue from
full year 2000 renovation and RQE 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. Revenue from pilot direct delivery contracts
is recognized over the duration of such contracts as work is performed and
defined milestones are attained. 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. In cases where vendor-specific objective evidence of fair
value of both the license and service component exists under a direct delivery
contract, revenue recognized is allocated between license revenue and other
services revenue for income statement classification purposes based on their
relative fair values. Revenue from technology transfer arrangements, product
and sales training and consulting services is billed on a time-and-materials
basis and is recognized as the services are provided. Revenue from software
product maintenance contracts on the Company's licensed software 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.
4. LEGAL PROCEEDINGS
The Company and certain of its officers and directors have been named as
defendants in purported class action lawsuits filed in the United States
District Court for the District of Massachusetts by Robert Downey on April 1,
1998, by Scott Cohen on April 7, 1998, by Timothy Bonnett on April 9, 1998, by
Peter Lindsay on April 17, 1998, by Harry Teague on April 21, 1998, by Jesse
Wijntjes on April 29, 1998, by H. Vance Johnson and H. Vance Johnson as Trustee
for the I.O.R.D. Profit-Sharing Plan on May 6, 1998, by John B. Howard, M.D. on
May 21, 1998 and by Helen Lee on May 28, 1998 (collectively, the "complaints").
The Downey complaint alleges a class period of October 22, 1997 to March 27,
1998. The Cohen, Bonnett, Wijntjes and Lee complaints allege a class period of
January 27, 1998 to March 27, 1998. The Lindsay, Teague and Johnson complaints
allege a class period of January 28, 1998 to March 27, 1998. The Howard
complaint alleges a class period of July 3, 1997 to March 27, 1998. The
complaints principally allege that the defendants violated federal securities
laws by making false and misleading statements and by failing to disclose
material information concerning the Company's December 1997 acquisition of
substantially all of the assets and assumption of certain liabilities of the
Millennium Dynamics, Inc. ("MDI") business from American Premier Underwriters,
Inc., thereby allegedly causing the value of the Company's common stock to be
artificially inflated during the purported class periods. In addition, the
Howard complaint alleges violation of federal securities laws as a result of the
Company's purported failure to disclose material information in connection with
the Company's initial public offering on July 2,
8
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1997, and also names Montgomery Securities, Inc., Wessels, Arnold & Henderson,
and H.C. Wainwright & Co., Inc. as defendants. The complaints further allege
that certain officers and/or directors of the Company sold stock in the open
market during the class periods and seek unspecified damages. On or about June
1, 1998, all of the named plaintiffs and additional purported class members
filed a motion for the appointment of several of those individuals as lead
plaintiffs, for approval of lead and liaison plaintiffs' counsel and for
consolidation of the actions. The court granted that motion on June 18, 1998.
Although the Company believes that it and the other defendants have meritorious
defenses to the claims made in the complaints and intends to contest the
lawsuits vigorously, an adverse resolution of the lawsuits could have a material
adverse effect on the Company's financial condition and results of operations in
the period in which the litigation is resolved. The Company is not presently
able to reasonably estimate potential losses, if any, related to the complaints.
5. RESTRUCTURING CHARGES
In September 1998, the Company announced and recorded a non-recurring charge
of $3,372,000 consisting in part of severance payments associated with the
termination of approximately 33% of the Company's employees (89 employees). At
September 30, 1998, all 89 employees had been terminated with no further
terminations remaining under the restructuring. In addition, a significant
portion of the restructuring charge related to the closure of two research and
development centers and a reduction of occupied space at the Company's
headquarters in Billerica, MA, consisting primarily of accrual of future lease
payments and other related costs, net of estimated sublease income. Payments
related to terminated employees are expected to be completed by December 1998
for 82 employees and September 1999 for the remaining 7 employees. Payments
related to the closure of facilities and reduction of occupied space are
expected to be completed by June 2003. The Company has estimated that the
restructuring will result in a reduction of approximately $1,900,000 in salary
and related costs and $250,000 in lease related costs on a quarterly basis
beginning in the fourth quarter of 1998.
In March 1998, the Company announced its intentions for a strategic
restructuring to refocus the Company's investments and to reduce its operating
expenses. The Company effected this restructuring, which was finalized in the
second quarter of 1998, and recorded a non-recurring charge of $1,439,000
consisting in part of severance payments associated with the termination of
approximately 12% of the Company's employees in April 1998 (48 employees). At
June 30, 1998, all 48 employees had been terminated with no further terminations
remaining under the restructuring. In addition, a significant portion of the
restructuring charge related to the closure of two research and development and
outsourcing centers, consisting primarily of accrual of future lease payments
and other related costs, net of estimated sublease income, and support costs for
a discontinued product, in excess of related services revenue. Payments related
to terminated employees were completed in June 1998 for 46 employees and are
expected to be completed by September 1999 for the remaining 2 employees.
Payments related to the closure and reduction of facilities are expected to be
complete by April 2003. The restructuring resulted in a reduction of
approximately $960,000 in salary and related costs and $90,000 in facility
related costs on a quarterly basis beginning in second quarter of 1998.
The amounts accrued to, charged against and other adjustments made to the
restructuring accrual during the third quarter of 1998 and the composition of
the remaining balance at September 30, 1998 was as follows:
<TABLE>
<CAPTION>
Balance Q3 1998 Q3 1998 Other Balance
June 30, 1998 Accrual Charges Adjustments September 30, 1998
-------------- ------- -------- ----------- -------------------
<S> <C> <C> <C> <C> <C>
(in thousands)
Provision for severance and benefit payments to
terminated employees........................... $421 $1,909 $(115) $ -- $2,215
Provisions related to closure of facilities and
reduction of occupied space..................... 327 1,463 (132) (61) 1,597
Other............................................ 124 -- (62) (32) 30
---- ------ ----- ---- ------
Total........................................... $872 $3,372 $(309) $(93) $3,842
==== ====== ===== ==== ======
</TABLE>
As of September 30, 1998, $2,902,000 of the remaining balance of the
restructuring accrual is expected to be paid by September 30, 1999 with the
remaining balance of $940,000 being paid thereafter.
9
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. IMPAIRMENT OF LONG-LIVED ASSETS
The Company periodically assesses whether any events or changes in
circumstances have occurred that would indicate that the carrying amount of a
long-lived asset might not be recoverable. When such an event or change in
circumstance occurs, the Company evaluates whether the carrying amount of such
asset is recoverable by comparing the net book value of the asset to estimated
future undiscounted cash flows, excluding interest charges, attributable to such
asset. If it is determined that the carrying amount is not recoverable, the
Company recognizes an impairment loss equal to the excess of the carrying amount
of the asset over the estimated fair value of such asset.
Due to lower than anticipated revenue and losses in excess of expectations
during the quarter ended September 30, 1998, the Company adopted a plan to stop
development of all existing and in-process products originally acquired from MDI
in December 1997, including all Vantage YR2000 renovation and testing software
tools and the generic mass change product. Substantially all direct sales
efforts relating to existing Vantage YR2000 products was also stopped. In
connection with these actions, the Company also undertook a restructuring of its
operations (Note 5) which included the closure of the Company's research and
development facilities in Cincinnati, Ohio and Lisle, IL. and the termination
of substantially all the employees at these facilities. As a result of these
events, management concluded that an assessment of the recoverability of
intangible assets recorded in connection with the acquisition of MDI in December
1997 was required at September 30, 1998. The Company determined that its
property and equipment at these locations was not subject to impairment as
substantially all such assets were scheduled to be redeployed within the
Company.
In connection with the assessment, management prepared forecasts of the
expected future cash flows related to these intangible assets on an undiscounted
basis and without interest charges. Due to the fact that product development
efforts had been stopped, the Company concluded that the existing technology
acquired as part of the MDI acquisition would only be used in existing Vantage
YR2000 products. As a result of this analysis, management determined that the
estimated undiscounted net cash flows to be generated by acquired technology
recorded as part of the MDI acquisition were less than the asset's net book
value as of September 30, 1998. Accordingly, the acquired technology was
written-down to $289,000, its estimated fair value, using a discounted cash flow
model. With regard to intangible assets relating to assembled workforce and
goodwill acquired from MDI, management concluded that the net book value of
these amounts could no longer be supported due to the termination of
substantially all former MDI employees and the shift of the Company's strategy
away from MDI-related products. Accordingly, the Company recorded a non-
recurring impairment charge totaling $4,294,000 during the quarter ended
September 30, 1998.
Management's estimates of forecasted cash flows required an evaluation of
various risks and uncertainties. Although management has made its best estimate
of these factors based on current conditions and expected trends and events, it
is reasonably possible that changes could occur in the near term which could
adversely affect management's estimates of forecasted cash flows. If such
changes occur, asset impairment write-downs could be required in the future and
such write-downs could be material to the Company's financial statements.
7. IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the acquisition of MDI, the Company recorded a charge to
operations during the fourth quarter of 1997 of $70,800,000 representing
purchased in-process technology that had not yet reached technological
feasibility and had no alternative future use. The value was determined via an
independent appraisal. At the time of the acquisition of MDI, the Company's plan
for the acquired projects included continued development of MDI's core
technologies aiming to significantly enhance their features and functionality in
order to gain an increasing share of the year 2000 software market. In addition,
the Company planned to continue to focus product plans around developing
comprehensive testing capabilities for MDI's Vantage YR2000 product and a
generic mass change software product with capabilities other than year 2000
corrections, including a Euro currency conversion application. The cost to
complete the in-process development was originally estimated at approximately
$18.7 million to be incurred through the end of the year 2000. These estimated
costs were largely for personnel involved in the planning, design, coding,
integration, testing and modification of products to be derived from the in-
process technologies. However, due to lower than anticipated revenue and losses
in excess of expectations during the quarter ended September 30, 1998, the
Company stopped development of all new versions of existing Vantage YR2000
products, the Vantage YR2000 testing product and the generic mass change
software product. As a result of these actions, the Company closed its research
and development centers in Cincinnati, Ohio, and Lisle, IL, terminated
substantially all employees at those facilities and recorded a related non-
recurring restructuring charge (Note 5). Through September 30, 1998, the Company
had incurred approximately $2,200,000 in costs to develop these in-process
technologies. The Company does not expect to incur additional development costs
for these in-process technologies.
10
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company has received and responded to a comment letter related to the
Company's Form 10-K for the year ended December 31, 1997 from the Securities and
Exchange Commission ("SEC") regarding, among other things, the Company's
accounting for in-process research and development in connection with its
acquisition of MDI. A response to the Company's letter has not yet been received
from the SEC. Although the Company believes it has properly accounted for the
item, a different conclusion would require further restatement of the Company's
results beginning with the fourth quarter of 1997.
8. COMPREHENSIVE INCOME (LOSS)
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
130, "Reporting Comprehensive Income" effective January 1, 1998. This statement
establishes standards for the reporting and display of comprehensive income and
its components. Comprehensive income is defined as the change in equity of a
business enterprise during a period from transactions and other events and
circumstances from non-owner sources. It includes all changes in equity during a
period except those resulting from investments by owners and distributions to
owners. This standard requires that an enterprise display an amount representing
total comprehensive income for the period.
For the three and nine months ended September 30, 1998 and 1997, the Company's
comprehensive income (loss) was as follows (in thousands):
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------------------- ------------------
1998 1997 1998 1997
------------ ------------- ---------- ------
<S> <C> <C> <C> <C>
Net income (loss).................. $(16,132) $ 84 $(21,329) $ 928
Cumulative translation adjustment.. 2 (7) 13 (45)
-------- ----- -------- -----
$(16,130) $ 77 $(21,316) $ 883
======== ===== ======== =====
</TABLE>
9. NET INCOME (LOSS) PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, "Earnings per Share", which supersedes Accounting Principles
Board Opinion Accounting ("APB") No. 15 and specifies the computation,
presentation and disclosure requirements of earnings per share. SFAS No. 128
requires the presentation of "basic" earnings per share and "diluted"
earnings per share. Basic earnings per share is computed by dividing the net
income (loss) available to common stockholders by the weighted average shares of
outstanding common stock. For purposes of calculating diluted earnings per
share, the denominator includes both the weighted average shares of common stock
outstanding and, when not anti-dilutive, potential common stock, including
outstanding stock options.
The Company adopted SFAS No. 128 in the fourth quarter of 1997 and has
restated income (loss) per share amounts for all periods presented herein, as
required.
10. RECENTLY ISSUED ACCOUNTING STANDARDS
In October 1997, the Accounting Standards Executive Committee ("AcSEC") of the
AICPA issued SOP 97-2, "Software Revenue Recognition." SOP 97-2 provides
guidance on the timing and amount of revenue recognition when licensing,
selling, leasing or otherwise marketing computer software and became effective
for transactions entered into by the Company beginning on January 1, 1998.
Subsequently, in March 1998, AcSEC issued SOP 98-4, "Deferral of the Effective
Date of a Provision of SOP 97-2, Software Revenue Recognition." SOP 98-4
deferred certain provisions of SOP 97-2 pertaining to its requirements for what
constitutes vendor-specific objective evidence ("VSOE") of the fair value of
individual elements of a multiple-element arrangement for a one-year period. At
the same time, AcSEC immediately began a project to further clarify the
requirements surrounding VSOE. This project resulted in SOP 98-9, "Modification
of SOP 97-2, `Software Revenue Recognition,' with Respect to Certain
Transactions," which was cleared by the FASB in November 1998. In SOP 98-9,
AcSEC decided to retain the limitations on what is considered VSOE of fair value
in a software arrangement. Accordingly, the limitations on VSOE of fair value
that were deferred by SOP 98-4 will be effective for transactions that are
entered into in fiscal years beginning after March 15, 1999. However, SOP 98-9
provides a limited exception to the full deferral of revenue that the provisions
of SOP 97-2 may require for arrangements in which the entity has a contracted
price for the entire arrangement and VSOE of the fair value of each undelivered
element exists. Formal issuance of SOP 98-9 is expected in December 1998.
Based upon its reading and interpretation of SOP 97-2, SOP 98-4 and SOP 98-9,
the Company believes that its current revenue recognition policies and
11
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
practices are materially consistent with the provisions of the guidance set
forth in these pronouncements. Accordingly, the adoption of this guidance has
not materially affected its financial position or results of operations and is
not expected to have a material impact in future periods.
In February 1998, AcSEC issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 establishes
the accounting for costs of software products developed or purchased for
internal use, including when such costs should be capitalized. The Company does
not expect SOP 98-1, which is effective for the Company beginning January 1,
1999, to have a significant impact on the Company's financial condition or
results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" which supersedes SFAS No. 14. This
statement changes the way that public business enterprises report segment
information, including financial and descriptive information about their
selected segment information. Operating segments are defined as revenue-
producing components of the enterprise which are generally used internally for
evaluating segment performance. SFAS No. 131 will be effective for the Company's
fiscal year ending December 31, 1998, is for disclosure only and will not affect
the Company's financial position or results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. The Company does
not invest in derivative instruments or engage in hedging activities. As a
result, SFAS No. 133 is not expected to have a material affect on its financial
position or results of operations.
11. DISPOSITION OF MAJORITY-OWNED SUBSIDIARY
In July 1998, the Company divested 100% of its equity interest in its
majority-owned Spanish subsidiary, Persist, S. A. ("Persist"), to Persist for
cash proceeds totaling $470,000. Accordingly, the results of operations of
Persist subsequent to the date of disposition have been excluded from the
Company's consolidated results for the quarter ended September 30, 1998 and the
Company's consolidated September 30, 1998 balance sheet excludes Persist's
assets and liabilities. The gain on this transaction was determined as the
excess of cash proceeds received by the Company over the net assets of Persist
at the date of disposition and reflects the realization of the cumulative impact
of foreign exchange rates on the balance sheet of Persist while a subsidiary of
the Company.
12. SUBSEQUENT EVENT
On December 2, 1998, the Company announced additional restructuring plans to
reorient the Company for transition to greater outsourcing emphasis while
continuing to satisfy its year 2000 customers. The restructuring included the
termination of 45 employees or 24% of its workforce. In addition, a significant
portion of the restructuring relates to the further reduction of occupied space
at its headquarters in Billerica, MA. The restructuring charge to be recorded
in the quarter ended December 31, 1998 relating to these actions is expected to
be approximately $1.2 million. In addition, the Company plans to review its
equipment to determine if these employee reductions warrant disposal of excess
equipment.
12
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Peritus Software Services, Inc. ("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 ("Vista"), a developer of computer-aided
engineering software. In 1997, the Company expanded its products offerings and
research and development efforts by releasing an enhanced version of the
AutoEnhancer/2000 software, which enables a client to perform logic correction
only changes with regard to year 2000 renovations, and through the acquisition
of substantially all of the assets and the assumption of certain liabilities of
the business of Millennium Dynamics, Inc. ("MDI"), a software tools company
with year 2000 products and research and development projects for the IBM
mainframe and AS/400 platforms, from American Premier Underwriters, Inc.
("APU"). Although the Company continues to license tools to address the year
2000 problem, the Company, in response to changes in the markets for the
Company's products and services, emphasized the direct delivery of year 2000
renovation services and renovation quality evaluation ("RQE") services in the
beginning of 1998 and also began to refocus the Company's business on software
maintenance outsourcing services. As the market continued to shift from the
Company's year 2000 products and services during the third quarter of 1998, the
Company's overall strategy is to grow its software maintenance outsourcing
business over the long term and to meet its clients needs for year 2000
renovation services and RQE services. In July 1998, the Company announced its
software maintenance outsourcing offerings, "Software Asset Maintenance for
Software Providers" and "Software Asset Maintenance for Information Systems",
which are outsourcing solutions designed specifically for the manufacturers of
system software and software products and for information technology departments
that maintain application software, respectively.
The Company derives its revenue from software maintenance outsourcing
services, software and methodology licensing and other services (including
direct delivery of year 2000 renovation and RQE services) sold directly to end
users or indirectly via value added integrators, 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 Europe, and through
value added integrators operating worldwide.
During a review of the Company's 1998 third quarter financial results performed
by Peritus' management, the Audit Committee of the Company's Board of Directors
and the Company's independent auditor, PricewaterhouseCoopers LLP ("PwC"), the
Company determined that the Company's results of operations for the quarterly
periods ended September 30, 1997, December 31, 1997, March 31, 1998 and June 30,
1998 and for the year ended December 31, 1997 require restatement. The 1998
restatements first relate to the recording by Peritus of approximately $1.09
million of software license revenue for a single customer in the second quarter
of 1998. Peritus believed that the amount of software license revenue as
originally recorded reflected a part of an approximately $1.9 million business
arrangement agreed to between the parties under a signed purchase order. The
Company has since determined that the customer did not require a separate
license and, therefore, no license revenue should have been recorded. The
balance of the 1998 restatements relate primarily to the Company's incorrect
interpretation of the complex provisions regarding recognition of revenue for
combined software/services arrangements under Statement of Position ("SOP") 97-
2, "Software Revenue Recognition," issued by the American Institute of Certified
Public Accountants ("AICPA"), and effective for the Company as of January 1,
1998. In applying the Statement to its new year 2000 renovation offerings which
the Company commenced in the first quarter, the Company mistimed the recognition
of revenue between quarters under certain contracts providing for the delivery
of combined software and services. The 1997 restatements involve two instances
where the Company had recorded revenue for software licenses in advance of
shipment of the software. The first instance involved the recording of software
license revenue of $1.2 million in the third quarter of 1997. The Company has
determined that the software involved was not shipped until early in the fourth
quarter of 1997 and that payment of the license fee was received in the fourth
quarter. Therefore, the Company will restate its third quarter 1997 results to
exclude the $1.2 million license fee and its fourth quarter 1997 results to
include the $1.2 million license fee. The second instance involved $571,000 of
license revenue and $21,000 of associated maintenance revenue originally
recorded in the fourth quarter of 1997. The Company has determined that the
software involved was not shipped until 1998. The Company encountered collection
difficulties with the customer during 1998. Despite entering into a settlement
agreement with the customer in the second quarter of 1998, the Company concluded
in the third quarter of 1998 that it would be unable to realize the amounts
recorded. Accordingly, the Company will restate its fourth quarter 1997 results
to remove the $592,000 of revenue involved and has not recorded this revenue in
any subsequent period. As a result of the restatements of results for 1997, the
Company was informed by PwC that users of the Company's 1997 financial
statements should no longer rely upon PwC's opinion for the year ended December
31, 1997. The Company expects the opinion will be reinstated once it completes
and files its amended Form 10-K.
13
<PAGE>
The Company intends to amend its prior filings on Form 10-Q for the quarters
ended September 30, 1997, March 31, 1998 and June 30, 1998 as well as its Form
10-K for the year ended December 31, 1997. In the opinion of management, all
adjustments necessary to revise the quarterly and year-end financial statements
have been recorded. Following is a summary of the unaudited results of
operations for these periods (in thousands, except per share-related data):
<TABLE>
<CAPTION>
Quarterly Periods Ended
-------------------------------------------------------------- Year Ended
September 30, December 31, March 31, June 30, December 31,
1997 1997 1998 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
As previously reported:
Revenue $9,852 $ 13,608 $10,150 $11,830 $ 40,301
Income (loss) from operations 748 (69,346) (2,775) (1,102) (67,582)
Net income (loss) 1,166 (68,920) (2,566) (979) (66,910)
Diluted net income (loss) per share $ 0.08 $ (4.97) $ (0.16) $ (0.06) $ (6.97)
<CAPTION>
Quarterly Periods Ended
-------------------------------------------------------------- Year Ended
September 30, December 31, March 31, June 30, December 31,
1997 1997 1998 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
As restated:
Revenue $8,652 $ 14,216 $ 9,433 $11,083 $ 39,709
Income (loss) from operations (452) (68,738) (3,567) (1,962) (68,173)
Net income (loss) 84 (68,418) (3,358) (1,839) (67,490)
Diluted net income (loss) per share $ 0.01 $ (4.93) $ (0.21) $ (0.11) $ (7.03)
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1997
REVENUE
Total revenue decreased 38.8% to $5,293,000 in the three months ended
September 30, 1998 from $8,652,000 in the three months ended September 30, 1997.
This decrease in revenue was primarily due to a decrease in the licensing of the
Company's year 2000 Auto Enhancer/2000 software. During the three months ended
September 30, 1998, three customers generated 15.2%, 13.4% and 10.4% of total
revenue, respectively. International revenue decreased 36.7% to $505,000 in 1998
from $801,000 in 1997. In July 1998, the Company divested 100% of its equity
interest in its majority-owned Spanish subsidiary, Persist, S. A. ("Persist"),
to Persist for cash proceeds totaling $470,000. Accordingly, the results of
operations of Persist subsequent to the date of disposition have been excluded
from the Company's consolidated results for the quarter ended September 30,
1998. Persist generated 28.1% of the Company's international revenue in the
three months ended September 30, 1998 while sales to value added integrators and
end users accounted for the remaining 71.9%. Persist generated substantially all
of the Company's international revenue in 1997. For the three months ended
September 30, 1998, the Company recorded $106,000 of related party revenue from
one customer which is a shareholder of Persist.
Outsourcing Services
Outsourcing services revenue decreased 23.8% to $2,270,000 in the three months
ended September 30, 1998 from $2,979,000 in the three months ended September 30,
1997. The decrease in outsourcing services revenue in absolute dollars was
14
<PAGE>
primarily attributable to the divestiture of Persist in July 1998, the
termination of one outsourcing contract and the recognition of lesser amounts of
revenue under the percentage-of-completion method on existing outsourcing
contracts that were in their later phases during 1998. As a percentage of total
revenue, outsourcing services revenue increased to 42.9% in the three months
ended September 30, 1998 from 34.4% in the three months ended September 30,
1997. The increase in outsourcing services revenue as a percentage of total
revenue reflects the decreased contribution of license and other services
revenue to total revenue during the three months ended September 30, 1998 when
compared to the comparable period for the prior year. 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. In July 1998,
the Company announced its software maintenance outsourcing offerings, "Software
Asset Maintenance for Software Providers" and "Software Asset Maintenance for
Information Systems", which are outsourcing solutions designed specifically for
the manufacturers of system software and software products and for information
technology departments that maintain application software, respectively.
License
License revenue was $763,000 in the three months ended September 30, 1998, or
14.4% of total revenue, compared to $3,957,000, or 45.7% of total revenue, in
the three months ended September 30, 1997. The decrease in license revenue for
the three months ended September 30, 1998 was primarily attributable to the
decrease in direct delivery of licensed software to end users and to decreased
license fees from value added integrators. In the future, the Company does not
expect any sustained increases to license revenue.
Other Services
Other services revenue increased 31.7% to $2,260,000 in the three months ended
September 30, 1998, from $1,716,000 in the three months ended September 30,
1997. As a percentage of total revenue, other services revenue was 42.7% in the
three months ended September 30, 1998 and 19.8% in the three months ended
September 30, 1997. The increase in other services revenue in absolute dollars
was primarily attributable to an increase in year 2000 renovation and RQE
services performed by Company personnel using the Company's year 2000 products,
offset by a decrease in consulting and maintenance revenues.
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 25.3% to $1,826,000 in the
three months ended September 30, 1998 from $2,444,000 for the three months ended
September 30, 1997. Cost of outsourcing services revenue as a percentage of
outsourcing services revenue decreased to 80.4% in the three months ended
September 30, 1998 from 82.0% in the three months ended September 30, 1997. The
decrease in cost of outsourcing services revenue in absolute dollars was due
primarily to the reduction of resources related to the termination of one
outsourcing contract.
Cost of License Revenue
Cost of license revenue consists primarily of salaries, benefits, amortization
expense of intangibles related to the MDI acquisition and related overhead costs
associated with license-related materials packaging and freight. Cost of license
revenue was $474,000 in the three months ended September 30, 1998, or 62.1% of
license revenue, compared to $155,000, or 3.9% of license revenue, in the three
months ended September 30, 1997. The increase in cost of license revenue in
absolute dollars was primarily attributable to the addition of employees and
related resources to support additional end users and value added integrators
and the amortization of intangibles related to the MDI acquisition.
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 99.3% to $2,551,000 in the three months
ended September 30, 1998 from $1,280,000 in the three months ended September 30,
1997. Cost of the services revenue as a percentage of other services revenue
increased to 112.9% in the three months ended September 30, 1998 from 74.6% in
the three months ended September 30, 1997. The increase in these costs both in
absolute dollars and as a percentage of revenues in the three months ended
September 30, 1998 was due primarily to excess capacity which resulted from the
hiring of additional staff earlier in the
15
<PAGE>
year to support the Company's year 2000 renovation and RQE services. Demand for
these services during the third quarter of 1998 was less than expected.
OPERATING EXPENSES
Sales and Marketing
Sales and marketing expenses consist primarily of salaries, commissions and
related overhead costs for sales and marketing personnel; sales referral fees to
third parties; advertising programs; and other promotional activities. Sales and
marketing expenses increased 81.2% to $3,980,000 in the three months ended
September 30, 1998 from $2,197,000 in the three months ended September 30, 1997.
As a percentage of total revenue, sales and marketing expenses increased to
75.2% in the three months ended September 30, 1998 from 25.4% in the three
months ended September 30, 1997. The increase in expenses in absolute dollars
and as a percentage of revenue was primarily attributable to increased staffing,
commissions, including an increase in sales referral fees to third parties, and
promotional activities in conjunction with the Company's year 2000 software
products and services in 1998.
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 8.9% to
$2,150,000 in the three months ended September 30, 1998 from $1,975,000 in the
three months ended September 30, 1997. As a percentage of total revenue,
research and development expenses increased to 40.6% in the three months ended
September 30, 1998 from 22.8% in the three months ended September 30, 1997. In
the future, the Company's research and development efforts will primarily be
related to developing technologies to support its service offerings.
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 intangible assets
associated with the Vista acquisition. General and administrative expenses
increased 182.0% to $2,969,000 in the three months ended September 30, 1998 from
$1,053,000 in the three months ended September 30, 1997. As a percentage of
total revenue, general and administrative expenses increased to 56.1% in the
three months ended September 30, 1998 from 12.2% in the three months ended
September 30, 1997. The increase in general and administrative expenses in
absolute dollars was primarily due to the write-down of a customer receivable
balance, an increase in the Company's allowance for doubtful accounts
receivable, additions to the Company's administrative staff to support growth,
higher professional fees and increases in other general corporate expenses as
well as increased costs associated with being a publicly traded company.
Impairment of Long-Lived Assets
The Company periodically assesses whether any events or changes in
circumstances have occurred that would indicate that the carrying amount of a
long-lived asset might not be recoverable. When such an event or change in
circumstance occurs, the Company evaluates whether the carrying amount of such
asset is recoverable by comparing the net book value of the asset to estimated
future undiscounted cash flows, excluding interest charges, attributable to such
asset. If it is determined that the carrying amount is not recoverable, the
Company recognizes an impairment loss equal to the excess of the carrying amount
of the asset over the estimated fair value of such asset.
Due to lower than anticipated revenue and losses in excess of expectations
during the quarter ended September 30, 1998, the Company adopted a plan to stop
development of all existing and in-process products originally acquired from MDI
in December 1997, including all Vantage YR2000 renovation and testing software
tools and the generic mass change product. Substantially all direct sales
efforts relating to existing Vantage YR2000 products was also stopped. In
connection with these actions, the Company also undertook a restructuring of its
operations (Note 5) which included the closure of the Company's research and
development facilities in Cincinnati, Ohio and Lisle, IL. and the termination
of substantially all the employees at these facilities. As a result of these
events, management concluded that an assessment of the recoverability of
intangible assets recorded in connection with the acquisition of MDI in December
1997 was required at September 30, 1998. The Company determined that its
property and equipment at these locations was not subject to impairment as
substantially all such assets were scheduled to be redeployed within the
Company.
16
<PAGE>
In connection with the assessment, management prepared forecasts of the
expected future cash flows related to these intangible assets on an undiscounted
basis and without interest charges. Due to the fact that product development
efforts had been stopped, the Company concluded that the existing technology
acquired as part of the MDI acquisition would only be used in existing Vantage
YR2000 products. As a result of this analysis, management determined that the
estimated undiscounted net cash flows to be generated by acquired technology
recorded as part of the MDI acquisition were less than the asset's net book
value as of September 30, 1998. Accordingly, the acquired technology was
written-down to $289,000, its estimated fair value, using a discounted cash flow
model. With regard to intangible assets relating to assembled workforce and
goodwill acquired from MDI, management concluded that the net book value of
these amounts could no longer be supported due to the termination of
substantially all former MDI employees and the shift of the Company's strategy
away from MDI-related products. Accordingly, the Company recorded a non-
recurring impairment charge totaling $4,294,000 during the quarter ended
September 30, 1998.
Management's estimates of forecasted cash flows required an evaluation of
various risks and uncertainties. Although management has made its best estimate
of these factors based on current conditions and expected trends and events, it
is reasonably possible that changes could occur in the near term which could
adversely affect management's estimates of forecasted cash flows. If such
changes occur, asset impairment write-downs could be required in the future and
such write-downs could be material to the Company's financial statements.
Restructuring Charge
In September 1998, the Company announced and recorded a non-recurring charge
of $3,372,000 consisting in part of severance payments associated with the
termination of approximately 33% of the Company's employees (89 employees). At
September 30, 1998, all 89 employees had been terminated with no further
terminations remaining under the restructuring. In addition, a significant
portion of the restructuring charge related to the closure of two research and
development centers and a reduction of occupied space at the Company's
headquarters in Billerica, MA, consisting primarily of accrual of future lease
payments and other related costs, net of estimated sublease income. Payments
related to terminated employees are expected to be completed by December 1998
for 82 employees and September 1999 for the remaining 7 employees. Payments
related to the closure of facilities and reduction of occupied space are
expected to be completed by June 2003. The Company has estimated that the
restructuring will result in a reduction of approximately $1,900,000 in salary
and related costs and $250,000 in lease related costs on a quarterly basis
beginning in the fourth quarter of 1998.
The amounts accrued to, charged against and other adjustments made to the
restructuring accrual during the third quarter of 1998 and the composition of
the remaining balance at September 30, 1998 was as follows:
<TABLE>
<CAPTION>
Balance Q3 1998 Q3 1998 Other Balance
June 30, 1998 Accrual Charges Adjustments September 30, 1998
-------------- ------- ------- ----------- -------------------
<S> <C> <C> <C> <C> <C>
(in thousands)
Provision for severance and benefit payments to
terminated employees............................. $421 $1,909 $(115) $ -- $2,215
Provisions related to closure of facilities and
reduction of occupied space..................... 327 1,463 (132) (61) 1,597
Other............................................ 124 -- (62) (32) 30
---- ------ ----- ---- ------
Total........................................... $872 $3,372 $(309) $(93) $3,842
==== ====== ===== ==== ======
</TABLE>
As of September 30, 1998, $2,902,000 of the remaining balance of the
restructuring accrual is expected to be paid by September 30, 1999 with the
remaining balance of $940,000 being paid thereafter.
INTEREST INCOME, NET
Interest income, net, is primarily composed of interest earned on cash
balances and interest expense on debt including capital lease obligations. The
Company had interest income, net, of $95,000 in the three months ended September
30, 1998 compared to interest expense, net, of $462,000 in the three months
ended September 30, 1997. This change in interest income, net, was primarily
attributable to decreased interest income from decreased cash balances.
17
<PAGE>
PROVISION (BENEFIT) FOR INCOME TAXES
The Company's income tax provision (benefit) was $-- and $(68,000) in the
three months ended September 30, 1998 and 1997, respectively. The benefit in
1997 reflects a decrease in taxable income for the three months ended September
30, 1997 offset, in part, by international tax obligations.
MINORITY INTEREST IN MAJORITY-OWNED SUBSIDIARY
The minority interest in majority-owned subsidiary represents the equity
interest in the operating results of Persist held by stockholders of Persist
other than the Company. The minority interest in majority-owned subsidiary
increased to a net income of $8,000 in the three months ended September 30, 1998
from a loss of $6,000 in the three months ended September 30, 1997. This change
was the result of the increased profitability of Persist from July 1, 1998 to
July 20, 1998; the date the Company divested its interest in Persist by
transferring shares back to Persist.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
Revenue
Total revenue increased 1.2% to $25,809,000 in the nine months ended September
30, 1998 from $25,493,000 in the nine months ended September 30, 1997. This
increase in revenue was primarily due to an increase in year 2000 renovation and
RQE services performed by the Company partially offset by decreased licensing of
the Company's year 2000 Auto Enhancer/2000 software and Vantage YR2000 products.
During the nine months ended September 30, 1998, one customer generated 11.9% of
total revenue. International revenue increased 70.3% to $3,579,000 in the nine
months ended September 30, 1998 from $2,101,000 in the nine months ended
September 30, 1997. In July 1998, the Company divested 100% of its equity
interest in its majority-owned Spanish subsidiary, Persist, S. A. ("Persist"),
to Persist for cash proceeds totaling $470,000. Accordingly, the results of
operations of Persist subsequent to the date of disposition have been excluded
from the Company's consolidated results for the quarter ended September 30,
1998. Persist generated 34.4% of the Company's international revenue in the nine
months ended September 30, 1998 while sales to value added integrators and end
users accounted for the remaining 65.6%. Persist generated substantially all of
the Company's international revenue in the nine months ended September 30, 1997.
For the nine months ended September 30, 1998, the Company recorded $872,000 and
$459,000 of related party revenue from one customer which is a shareholder of
Persist and one customer which is a wholly-owned subsidiary of APU,
respectively.
Outsourcing Services
Outsourcing services revenue decreased 10.0% to $7,685,000 in the nine months
ended September 30, 1998 from $8,542,000 in the nine months ended September 30,
1997. The decrease in outsourcing services revenue in absolute dollars was
primarily attributable to the divestiture of Persist, the termination of one
significant outsourcing contract and by the recognition of lesser amounts of
revenue under the percentage-of-completion method on existing outsourcing
contracts that were in their later phases during 1998. As a percentage of total
revenue, outsourcing services revenue decreased to 29.8% in the nine months
ended September 30, 1998 from 33.5% in the nine months ended September 30, 1997.
The decrease in outsourcing revenue as a percentage of total revenue reflects
the increased contribution of renovation and RQE services revenue to total
revenue during the nine months ended September 30, 1998. 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. In July 1998,
the Company announced its software maintenance outsourcing offerings, "Software
Asset Maintenance for Software Providers" and "Software Asset Maintenance for
Information Systems", which are outsourcing solutions designed specifically for
the manufacturers of system software and software products and for information
technology departments that maintain application software, respectively.
License
License revenue was $8,602,000 in the nine months ended September 30, 1998, or
33.3% of total revenue, compared to $12,744,000, or 50.0% of total revenue, in
the nine months ended September 30, 1997. The decrease in license revenue for
the nine months ended September 30, 1998 was primarily attributable to the
decreased delivery of licensed software to end users and to decreased license
fees from value added integrators. In the future, the Company does not expect
any sustained increases to license revenue.
18
<PAGE>
Other Services
Other services revenue increased 126.3% to $9,522,000 in the nine months ended
September 30, 1998 from $4,207,000 in the nine months ended September 30, 1997.
As a percentage of total revenue, other services revenue was 36.9% in the nine
months ended September 30, 1998 and 16.5% in the nine months ended September 30,
1997. The increase in other services revenue in absolute dollars was primarily
attributable to an increase in year 2000 services performed by Company personnel
using Company's year 2000 products, offset by a decrease in consulting and
maintenance revenues.
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 14.8% to $5,833,000 in the
nine months ended September 30, 1998 from $6,847,000 for the nine months ended
September 30, 1997. Cost of outsourcing services revenue as a percentage of
outsourcing services revenue decreased to 75.9% in the nine months ended
September 30, 1998 and from 80.2% in the nine months ended September 30, 1997.
The decrease in costs of outsourcing services revenue in absolute dollars was
due primarily to the termination of one outsourcing contract.
Cost of License Revenue
Cost of license revenue consists primarily of salaries, benefits, amortization
expense of intangibles related to the MDI acquisition and related overhead costs
associated with license-related materials packaging and freight. Cost of license
revenue was $1,520,000 in the nine months ended September 30, 1998, or 17.7% of
license revenue, compared to $430,000, or 3.4% of license revenue, in the nine
months ended September 30, 1997. The increase in cost of license revenue in
absolute dollars was primarily attributable to the addition of employees and
related resources to support additional end users and value added integrators
and the amortization of intangibles related to the MDI acquisition.
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 111.8% to $7,636,000 in the nine months
ended September 30, 1998 from $3,605,000 in the nine months ended September 30,
1997. Cost of the services revenue as a percentage of other services revenue
decreased to 80.2% in the nine months ended September 30, 1997 from 85.7% in the
nine months ended September 30, 1997. The increase in these costs both in
absolute dollars and as a percentage of revenues in the nine months ended
September 30, 1998 was due primarily to excess capacity which resulted from the
hiring of additional staff earlier in the year to support the Company's year
2000 renovation and RQE services. Demand for these services during the nine
months ended September 30, 1998 was less than expected.
OPERATING EXPENSES
Sales and Marketing
Sales and marketing expenses consist primarily of salaries, commissions and
related overhead costs for sales and marketing personnel; sales referral fees to
third parties; advertising programs; and other promotional activities. Sales and
marketing expenses increased 84.4% to $10,355,000 in the nine months ended
September 30, 1998 from $5,615,000 in the nine months ended September 30, 1997.
As a percentage of total revenue, sales and marketing expenses increased to
40.1% in the nine months ended September 30, 1998 from 22.0% in the three months
ended September 30, 1997. The increase in expenses in absolute dollars and as a
percentage of revenue was primarily attributable to increased staffing,
commissions, including an increase in sales referral fees to third parties, and
promotional activities in conjunction with the Company's year 2000 software
products and services in 1998.
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
19
<PAGE>
products. Research and development expenses increased 29.0% to $7,195,000 in the
nine months ended September 30, 1998 from $5,578,000 in the nine months ended
September 30, 1997. As percentage of total revenue, research and development
expenses increased to 27.9% in nine months ended September 30, 1998 from 21.9%
in the nine months ended September 30, 1997. 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, internal transfers and the acquisition of
MDI. In the future, the Company's research and development efforts will
primarily be related to developing technologies to support its service
offerings.
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 intangible assets
associated with Vista acquisition. General and administrative expenses increased
110.9% to $6,017,000 in the nine months ended September 30, 1998 from $2,853,000
in the nine months ended September 30, 1997. As a percentage of total revenue,
general and administrative expenses increased to 23.3% in the nine months ended
September 30, 1998 from 11.2% in the nine months ended September 30, 1997. The
increase in general and administrative expenses in absolute dollars was
primarily due to the write-down of a customer receivable balance, an increase in
the Company's allowance for doubtful accounts reserve, additions to the
Company's administrative staff to support growth, higher professional fees and
increases in other general corporate expenses as well as increased costs
associated with being a publicly traded company.
Impairment of Long-Lived Assets
The Company periodically assesses whether any events or changes in
circumstances have occurred that would indicate that the carrying amount of a
long-lived asset might not be recoverable. When such an event or change in
circumstance occurs, the Company evaluates whether the carrying amount of such
asset is recoverable by comparing the net book value of the asset to estimated
future undiscounted cash flows, excluding interest charges, attributable to such
asset. If it is determined that the carrying amount is not recoverable, the
Company recognizes an impairment loss equal to the excess of the carrying amount
of the asset over the estimated fair value of such asset.
Due to lower than anticipated revenue and losses in excess of expectations
during the quarter ended September 30, 1998, the Company adopted a plan to stop
development of all existing and in-process products originally acquired from MDI
in December 1997, including all Vantage YR2000 renovation and testing software
tools and the generic mass change product. Substantially all direct sales
efforts relating to existing Vantage YR2000 products was also stopped. In
connection with these actions, the Company also undertook a restructuring of its
operations (Note 5) which included the closure of the Company's research and
development facilities in Cincinnati, Ohio and Lisle, IL. and the termination
of substantially all the employees at these facilities. As a result of these
events, management concluded that an assessment of the recoverability of
intangible assets recorded in connection with the acquisition of MDI in December
1997 was required at September 30, 1998. The Company determined that its
property and equipment at these locations was not subject to impairment as
substantially all such assets were scheduled to be redeployed within the
Company.
In connection with the assessment, management prepared forecasts of the
expected future cash flows related to these intangible assets on an undiscounted
basis and without interest charges. Due to the fact that product development
efforts had been stopped, the Company concluded that the existing technology
acquired as part of the MDI acquisition would only be used in existing Vantage
YR2000 products. As a result of this analysis, management determined that the
estimated undiscounted net cash flows to be generated by acquired technology
recorded as part of the MDI acquisition were less than the asset's net book
value as of September 30, 1998. Accordingly, the acquired technology was
written-down to $289,000, its estimated fair value, using a discounted cash flow
model. With regard to intangible assets relating to assembled workforce and
goodwill acquired from MDI, management concluded that the net book value of
these amounts could no longer be supported due to the termination of
substantially all former MDI employees and the shift of the Company's strategy
away from MDI-related products. Accordingly, the Company recorded a non-
recurring impairment charge totaling $4,294,000 during the nine months ended
September 30, 1998.
Management's estimates of forecasted cash flows required an evaluation of
various risks and uncertainties. Although management has made its best estimate
of these factors based on current conditions and expected trends and events, it
is reasonably possible that changes could occur in the near term which could
adversely affect management's estimates of forecasted cash flows. If such
changes occur, asset impairment write-downs could be required in the future and
such write-downs could be material to the Company's financial statements.
20
<PAGE>
Restructuring Charges
In September 1998, the Company announced and recorded a non-recurring charge
of $3,372,000 consisting in part of severance payments associated with the
termination of approximately 33% of the Company's employees (89 employees). At
September 30, 1998, all 89 employees had been terminated with no further
terminations remaining under the restructuring. In addition, a significant
portion of the restructuring charge related to the closure of two research and
development centers and a reduction of occupied space at the Company's
headquarters in Billerica, MA, consisting primarily of accrual of future lease
payments and other related costs, net of estimated sublease income. Payments
related to terminated employees are expected to be completed by December 1998
for 82 employees and September 1999 for the remaining 7 employees. Payments
related to the closure of facilities and reduction of occupied space are
expected to be completed by June 2003. The Company has estimated that the
restructuring will result in a reduction of approximately $1,900,000 in salary
and related costs and $250,000 in lease related costs on a quarterly basis
beginning in the fourth quarter of 1998.
In March 1998, the Company announced its intentions for a strategic
restructuring to refocus the Company's investments and to reduce its operating
expenses. The Company effected this restructuring, which was finalized in the
second quarter of 1998, and recorded a non-recurring charge of $1,439,000
consisting in part of severance payments associated with the termination of
approximately 12% of the Company's employees in April 1998 (48 employees). At
June 30, 1998, all 48 employees had been terminated with no further terminations
remaining under the restructuring. In addition, a significant portion of the
restructuring charge related to the closure of two research and development and
outsourcing centers, consisting primarily of accrual of future lease payments
and other related costs, net of estimated sublease income, and support costs for
a discontinued product, in excess of related services revenue. Payments related
to terminated employees were completed in June 1998 for 46 employees and are
expected to be completed by September 1999 for the remaining 2 employees.
Payments related to the closure and reduction of facilities are expected to be
complete by April 2003. The restructuring resulted in a reduction of
approximately $960,000 in salary and related costs and $90,000 in facility
related costs on a quarterly basis beginning in second quarter of 1998.
The amounts accrued to, charged against and other adjustments made to the
restructuring accrual during the nine months ended September 30, 1998 and the
composition of the remaining balance at September 30, 1998 was as follows:
<TABLE>
<CAPTION>
Balance Other Balance
December 31, 1997 Accrual Charges Adjustments September 30, 1998
----------------- ------- ------- ----------- ------------------
<S> <C> <C> <C> <C> <C>
(in thousands)
Provision for severance and benefit payments to
terminated employees............................. $ -- $2,856 $(641) $ -- $2,215
Provisions related to closure of facilities and
reduction of occupied space..................... -- 1,790 (132) (61) 1,597
Other............................................ -- 165 (103) (32) 30
---- ------ ----- ---- ------
Total........................................... $ -- $4,811 $(876) $(93) $3,842
==== ====== ===== ==== ======
</TABLE>
As of September 30, 1998, $2,902,000 of the remaining balance of the
restructuring accrual is expected to be paid by September 30, 1999 with the
remaining balance of $940,000 being paid thereafter.
INTEREST INCOME, NET
Interest income, net, is primarily composed of interest income earned on cash
balances and interest expense on debt including capital lease obligations. The
Company had interest income, net ,of $440,000 in the nine months ended September
30, 1998 compared to interest income, net, of $482,000 in the nine months ended
September 30, 1997. This change in interest income, net, was primarily
attributable to decreased interest income from decreased cash balances.
PROVISION FOR INCOME TAXES
The Company's income tax provision was $25,000 and $104,000 in the nine months
ended September 30, 1998 and 1997, respectively. The provision in the nine
months ended September 30, 1998 reflects international tax obligations.
21
<PAGE>
MINORITY INTEREST IN MAJORITY-OWNED SUBSIDIARY
The minority interest in majority-owned subsidiary represents the equity
interest in the operating results of Persist held by stockholders of Persist
other than the Company. The minority interest in majority-owned subsidiary
decreased to a loss of $4,000 in the nine months ended September 30, 1998 from
income of $15,000 in the nine months ended September 30, 1997. This change was
the result of the decreased profitability of Persist from January 1, 1998 to
July 20, 1998; the date the Company divested its interest in Persist by
transferring shares back to Persist.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has financed its operations and capital expenditures
primarily with the proceeds from sales of the Company's convertible preferred
stock and common stock, borrowings and advance payments for services from
clients. The Company's cash balances and short term investments were $6,504,000
and $14,340,000 at September 30, 1998 and December 31, 1997, respectively. The
Company's working capital was $5,459,000 and $20,931,000 at September 30, 1998
and December 31, 1997, respectively. The Company's operating activities used
cash of $5,076,000 during the nine months ended September 30, 1998 and provided
cash of $260,000 during the nine months ended September 30, 1997. The Company's
use of cash during the nine months ended September 30, 1998 was primarily caused
by net loss of $21,329,000 offset by depreciation and amortization expense of
$2,444,000, an impairment of intangible assets of $4,294,000, a decrease in
accounts receivable of $6,837,000, and an increase in other accrued expenses and
other current liabilities of $2,575,000.
The Company used cash of $3,300,000 and $1,534,000 for investing activities
during the nine months ended September 30, 1998 and 1997, respectively.
Investing activities in the nine months ended September 30, 1998 consisted
principally of the purchases of property and equipment, most notably computer
equipment and software, furniture and fixtures and leasehold improvements
related to the Company's relocations of its headquarters and regional offices.
Although the Company has no significant commitments for capital expenditures in
the remainder of 1998, the Company expects to continue to purchase property and
equipment to further maintain its infrastructure as required.
The Company's financing activities provided cash of $1,051,000 and $40,224,000
during the nine months ended September 30, 1998 and 1997, respectively.
Financing activities in the nine months ended September 30, 1998 and 1997
primarily reflect proceeds from the exercise of stock options and the Company's
initial public offering, respectively.
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% (8.75% at
September 30, 1998). The line of credit expired and all borrowings were payable
in full on September 30, 1998. At September 30, 1998, there were no borrowings
outstanding under the line of credit. 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 September
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% (9.25% at September 30, 1998). At September 30,1998, 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 September 30, 1998, the
Company was in violation of such financial covenants and, accordingly, has
classified all borrowings under this credit facility as short-term obligations.
The bank notified the Company in November that the Company was in default under
its line of credit facility and equipment financing agreement and requested
that the Company provide cash collateral for the amount of equipment financing
outstanding, and provide cash collateral for a $300,000 standby letter of credit
issued by the bank. There were no borrowings outstanding under the revolving
credit facility and $342,000 was outstanding under the equipment financing
agreement at September 30, 1998. The Company will provide cash collateral for
all amounts outstanding under the equipment financing agreement and for the
$300,000 letter of credit. The bank has indicated that it will not renew or
further extend the Company's revolving credit facility.
To date, the Company has not invested in derivative securities or any other
financial instruments that involve a high level of complexity or risk. Excess
cash has been, and the Company contemplates that it will continue to be,
invested in interest-bearing, investment grade securities.
The Company experienced net losses of $67,490,000 and $21,329,000 in the year
ended December 31, 1997 and the nine months ended September 30, 1998,
respectively, and anticipates a net loss of $2,000,000 to $4,500,000 in the
fourth quarter of 1998, which raise doubt about its ability to continue as a
going concern after 1998. The Company anticipates that the net proceeds from
the sale of common stock in its July 1997 initial public offering, together with
cash generated from operations and existing cash balances will be adequate to
finance its operations through 1998. Thereafter, the Company's cash flow
requirements will depend on the results of future operations.
22
<PAGE>
There can be no assurance that these expectations will be realized. After 1998,
the Company's continued existence is dependent upon its ability to achieve a
cash flow breakeven position and/or to obtain additional sources of financing.
The Company implemented a restructuring plan on December 2, 1998 to further
reduce its expenses which included the elimination of approximately 45 employees
and related facilities costs. It is anticipated that this plan will result in a
charge to earnings in the fourth quarter of 1998 of approximately $1.2 million.
The Company is also exploring strategic initiatives to raise additional funds.
There can be no assurance that the Company will achieve a cash flow breakeven
position or that it will be able to raise additional funds through bank
borrowings and/or debt and/or equity financings. Reductions in expenses or the
sale of assets may not be adequate to bring the Company to a cash breakeven
position. In addition, there can be no assurance that such actions will not have
an adverse effect on the Company's ability to generate revenue or successfully
implement any strategic alternatives under consideration. Failure to establish a
cash flow breakeven position or raise additional funds through bank borrowings
and/or equity and/or debt financings would advesely impact the Company's ability
to continue as a going concern after 1998.
FOREIGN CURRENCY
Assets and liabilities of the Company's subsidiaries are translated into
United States 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.
INFLATION
To date, inflation has not had a material impact on the Company's results of
operations.
RECENTLY ISSUED ACCOUNTING STANDARDS
In October 1997, the Accounting Standards Executive Committee ("AcSEC") of the
AICPA issued SOP 97-2, "Software Revenue Recognition." SOP 97-2 provides
guidance on the timing and amount of revenue recognition when licensing,
selling, leasing or otherwise marketing computer software and became effective
for transactions entered into by the Company beginning on January 1, 1998.
Subsequently, in March 1998, AcSEC issued SOP 98-4, "Deferral of the Effective
Date of a Provision of SOP 97-2, Software Revenue Recognition." SOP 98-4
deferred certain provisions of SOP 97-2 pertaining to its requirements for what
constitutes vendor-specific objective evidence ("VSOE") of the fair value of
individual elements of a multiple-element arrangement for a one-year period. At
the same time, AcSEC immediately began a project to further clarify the
requirements surrounding VSOE. This project resulted in SOP 98-9, "Modification
of SOP 97-2, `Software Revenue Recognition,' with Respect to Certain
Transactions," which was cleared by the FASB in November 1998. In SOP 98-9,
AcSEC decided to retain the limitations on what is considered VSOE of fair value
in a software arrangement. Accordingly, the limitations on VSOE of fair value
that were deferred by SOP 98-4 will be effective for transactions that are
entered into in fiscal years beginning after March 15, 1999. However, SOP 98-9
provides a limited exception to the full deferral of revenue that the provisions
of SOP 97-2 may require for arrangements in which the entity has a contracted
price for the entire arrangement and VSOE of the fair value of each undelivered
element exists. Formal issuance of SOP 98-9 is expected in December 1998.
Based upon its reading and interpretation of SOP 97-2, SOP 98-4 and SOP 98-9,
the Company believes that its current revenue recognition policies and practices
are materially consistent with the provisions of the guidance set forth in these
pronouncements. Accordingly, the adoption of this guidance has not materially
affected its financial position or results of operations and is not expected to
have a material impact in future periods.
In February 1998, AcSEC issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use". SOP 98-1 establishes
the accounting for costs of software products developed or purchased for
internal use, including when such costs should be capitalized. The Company does
not expect SOP 98-1, which is effective for the Company beginning January 1,
1999, to have a significant impact on the Company's financial condition or
results of operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" which supersedes SFAS No. 14. This
statement changes the way that public business enterprises report segment
information, including financial and descriptive information about their
selected segment information. Operating segments are defined as revenue-
producing components of the enterprise which are generally used internally for
evaluating segment performance. SFAS No. 131 will be effective for the Company's
fiscal year ending December 31, 1998 and will not affect the Company's financial
position or results of operations.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The new standard establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. SFAS No. 133 is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999. The Company does
not invest in derivative instruments or engage in
23
<PAGE>
hedging activities. As a result, SFAS No. 133 is not expected to have a material
affect on its financial position or results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by the Company or statements made by
its employees may contain "forward-looking" statements, as that term is
defined in the Private Securities Litigation Reform Act of 1995. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes", "anticipates", "plans", "expects", and
similar expressions are intended to identify forward-looking statements.
This Quarterly Report on Form 10-Q may contain forward looking statements
which involve risks and uncertainties. The Company's actual results may differ
materially from the results discussed in such statements. Certain factors that
could cause such a difference include, without limitation, the risks
specifically described in the Company's Annual Report on Form 10-K for the year
ended December 31, 1997 and other public documents, filed by the Company with
the Securities and Exchange Commission (the "Commission"), which factors are
incorporated herein by reference, and other factors such as the Company's
limited operating history, the dependence on the year 2000 market, the need to
develop additional products and services, the concentration of clients and
credit risk, the management of growth and increases in expenditures in sales and
marketing, research and development and finance and administration, the
dependence upon third-party channels and potential for channel conflict, the
impact of competitive products and services and pricing, competition for
qualified technical personnel, the offering of fixed-price, fixed time-frame
contracts rather than contracts on a time and materials basis, the potential for
contract liability related to the provision of year 2000 and other products and
services, the potential for software errors or bugs in the Company's products,
the operating difficulties and expenditures associated with acquisitions
including the Company's MDI acquisition, limited protection of proprietary
rights, dependence on third party technology, rapid technological change, risks
associated with international operations and dependence on Indian offshore
software development centers, the impact of the government regulation of
immigration, dependence on government contracts, product or services demand and
market acceptance risks, product development and services capacity,
commercialization and technological difficulties, capacity and supply
constraints or difficulties and the effect of general business or economic
conditions.
In addition, actual results may differ materially from the results in forward
looking statements that may be contained in this Quarterly Report on Form 10-Q
as a result of the following factors:
Failure to Achieve Cash Flow Breakeven/Strategic Initiatives. The Company's
--------------------------------------------------------------
ability to achieve a cash flow breakeven position after 1998 will be critical
for achieving financial stability. Reductions in expenses or the sale of assets
may not be sufficient to bring the Company to a cash breakeven position. In
addition, there can be no assurance that any actions taken to sell assets or
reduce expenses will not have a material adverse impact on the Company's ability
to generate revenue or successfully implement any strategic alternatives under
consideration. Failure to establish a cash flow break even position or raise
additional funds through bank borrowings and/or equity and/or debt financings
would adversely impact the Company's ability to continue as a going concern
after 1998.
Financing. There can be no assurance that the Company will be able to
---------
successfully negotiate a borrowing arrangement with a bank or obtain additional
funds through equity and/or debt financings. Failure to establish a cash flow
break even position or raise additional funds through bank borrowings and/or
equity and/or debt financings would adversely impact the Company's ability to
continue as a going concern after 1998.
National Market Listing. The Nasdaq Stock Market, Inc. has several
-----------------------
requirements for listing on the Nasdaq National Market or the Nasdaq SmallCap
Market. The Company has received correspondence from the Nasdaq National Market
regarding the Company's inability to meet certain continued listing criteria for
the Nasdaq National Market. The Company has requested and received a hearing to
review its continued listing on the Nasdaq National Market. Failure to meet
listing requirements may result in the Company being moved from the National
Market to the SmallCap Market or being de-listed. There can be no assurance that
the Company will not be de-listed.
Revenue Risk. The Company's strategy to stem revenue decline is based on the
------------
transition from selling Year 2000 products and services to software
maintenance outsourcing services. The sale of software maintenance outsourcing
services typically involves a long sales cycle and competition from other
vendors that have substantially greater financial, marketing and personnel
resources than the Company. There can be no assurance that these new services
will be accepted by customers and will generate revenues sufficient to offset
continued decline in revenues from Year 2000 business.
Litigation Risk. The future course of the class action claims against the
---------------
Company described in footnote 2 to the unaudited consolidated financial
statements above could have a material adverse impact on the Company's financial
condition and results of operations in the period in which the litigation is
resolved.
Fluctuations in Quarterly Performance. 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
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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.
YEAR 2000 ISSUE
The Year 2000 issue relates to computer programs and systems that recognize
dates using two-digit year data rather than four-digit year data. As a result,
such programs and systems may fail or provide incorrect information when using
dates after December 31, 1999. If the Year 2000 issue were to disrupt the
Company's internal information technology systems, or the information technology
systems of entities with whom the Company has significant commercial
relationships, the Company's business and financial condition could be
materially adversely affected.
The Year 2000 issue is relevant to three areas of the Company's business: (1)
the Company's products and services, (2) the Company's internal computer systems
and (3) the computer systems of significant suppliers or customers of the
Company. Each such area is addressed below.
1. The Company's Products. In some cases, the Company warrants to its clients
that its software will be year 2000 compliant generally subject to certain
limitations or conditions. The Company also provides solutions consisting
of products and services to address the year 2000 problem involving key
aspects of a client's computer systems. A failure in a client's system or
failure of the Company's software to be year 2000 compliant would result
in substantial damages and therefore have a material adverse effect on the
Company's business, financial condition and results of operations. The
Company does not intend to adopt a formal Year 2000 compliance program for
its existing products, however, it will use commercially reasonable
efforts to make new products Year 2000 compliant. However, there can be
no assurance that these future efforts will be successful.
2. Internal Systems. The Company's internal computer programs and operating
systems relate to certain segments of the Company's business, including
customer database management, marketing, order processing, order
fulfillment, inventory management, customer service, accounting and
financial reporting. These programs and systems consist primarily of:
. Business Systems. These systems automate and manage business functions
such as customer database management, marketing, order-taking and
order-processing, inventory management, customer service, accounting
and financial reporting,
. Personal Computers and Networks. These systems are used for word
processing, document management and other similar administrative
functions, and
. Telecommunications Systems. These systems provide telephone, voicemail,
e-mail, Internet and intranet connectivity, and enable the Company to
manage overall internal and external communications.
The Company's business systems are licensed from an outside vendor and the
Company expects that these business systems installed in 1997 will be Year
2000 compliant through upgrades and maintenance. Other internal systems
consist of widely available office applications and application suites for
word-processing, voicemail and other office-related functions. The Company
maintains current versions of all such key applications and all are, or
are expected to be, Year 2000 compliant. Accordingly, the Company does not
intend to adopt a formal Year 2000 compliance program for these systems.
However, there can be no assurance that these internal systems will be
Year 2000 compliant.
3. Third-Party Systems. The computer programs and operating systems used by
entities with whom the Company has commercial relationships pose potential
problems relating to the Year 2000 issue, which may affect the Company's
operations in a variety of ways. These risks are more difficult to assess
than those posed by internal programs and systems, and the Company has not
yet begun the process of formulating a plan for assessing them. The Company
believes that the programs and operating systems used by entities with whom
it has commercial relationships generally fall into two categories: (A)
First, the Company relies upon programs and systems used by providers of
basic services necessary to enable the Company to reach, communicate and
transact business with its suppliers and customers. Examples of such
providers include the United States Postal Service, overnight delivery
services, telephone companies, other utility companies and banks. Services
provided by such entities affects almost all facets of the Company's
operations. However, these third-party dependencies are not specific to the
Company's business, and disruptions in their availability would likely have
a negative impact on most enterprises within the software and
25
<PAGE>
services industry and on many enterprises outside the software and services
industry. The Company believes that all of the most reasonably likely worst-
case scenarios involving disruptions to its operations stemming from the
Year 2000 issue relate to programs and systems in this first category. (B)
Second, the Company relies upon third parties for certain software code or
programs that are embedded in, or work with, its products. The Company
believes that the functionality of its products would not be materially
adversely affected by a failure of such third-party software to be Year 2000
compliant.
There can be no assurance that the Company may not experience unanticipated
expenses or be otherwise adversely impacted by a failure of third-party systems
or software to be Year 2000 compliant. The most reasonably likely worst-case
scenarios may include: (i) corruption of data contained in the Company's
internal information systems, (ii) hardware failure, and (iii) failure of
infrastructure services provided by utilities and/or government. The Company
intends to include an evaluation of such scenarios in its plan for assessing the
programs and systems of the entities with whom it has commercial relationships.
The Company expects to complete the formulation of its plan for assessing its
internal programs and systems and the programs and systems of the entities with
whom it has commercial relationships by the end of the first quarter of fiscal
1999 and the identification of related risks and uncertainties by the end of the
second quarter of fiscal 1999. Once such identification has been completed, the
Company intends to resolve any material risks and uncertainties that are
identified by communicating further with the relevant vendors and providers, by
working internally to identify alternative sourcing and by formulating
contingency plans to deal with such material risks and uncertainties. To date,
however, the Company has not formulated such a contingency plan. The Company
expects the resolution of such material risks and uncertainties to be an ongoing
process until all key year 2000 problems are satisfactorily resolved. The
Company does not currently anticipate that the total cost of any Year 2000
remediation efforts that may be needed will be material.
EURO-CURRENCY ISSUE
The participating member countries of the European Union have agreed to adopt
the Euro as the common legal currency on January 1, 1999. On that same date
they will establish the fixed conversion rates between their existing sovereign
currencies and the Euro. The Company has begun to assess the potential impact
on the Company that may result from the Euro conversion. At this early state of
its assessment, the Company cannot yet predict the impact of the Euro
conversion. However, the Company does not expect the Euro conversion to have a
material impact on financial results because the Company does not have a
significant number of transactions within the European market.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and certain of its officers and directors have been named as
defendants in purported class action lawsuits filed in the United States
District Court for the District of Massachusetts by Robert Downey on April 1,
1998, by Scott Cohen on April 7, 1998, by Timothy Bonnett on April 9, 1998, by
Peter Lindsay on April 17, 1998, by Harry Teague on April 21, 1998, by Jesse
Wijntjes on April 29, 1998, by H. Vance Johnson and H. Vance Johnson as Trustee
for the I.O.R.D. Profit-Sharing Plan on May 6, 1998, by John B. Howard, M.D. on
May 21, 1998 and by Helen Lee on May 28, 1998 (collectively, the
"complaints"). The Downey complaint alleges a class period of October 22, 1997
to March 27, 1998. The Cohen, Bonnett, Wijntjes and Lee complaints allege a
class period of January 27, 1998 to March 27, 1998. The Lindsay, Teague and
Johnson complaints allege a class period of January 28, 1998 to March 27, 1998.
The Howard complaint alleges a class period of July 3, 1997 to March 27, 1998.
The complaints principally allege that the defendants violated federal
securities laws by making false and misleading statements and by failing to
disclose material information concerning the Company's December 1997 acquisition
of substantially all of the assets and assumption of certain liabilities of the
Millennium Dynamics, Inc. business from American Premier Underwriters, Inc.,
thereby allegedly causing the value of the Company's common stock to be
artificially inflated during the purported class periods. In addition, the
Howard complaint alleges violation of federal securities laws as a result of the
Company's purported failure to disclose material information in connection with
the Company's initial public offering on July 2, 1997, and also names Montgomery
Securities, Inc., Wessels, Arnold & Henderson, and H.C. Wainwright & Co., Inc.
as defendants. The complaints further allege that certain officers and/or
directors of the Company sold stock in the open market during the class periods
and seek unspecified damages. On or about June 1, 1998, all of the named
plaintiffs and additional purported class members filed a motion for the
appointment of several of those individuals as lead plaintiffs, for approval of
lead and liaison plaintiffs' counsel and for consolidation of the actions. The
Court granted the motion on June 18, 1998. Although the Company believes that it
and the other defendants have meritorious defenses to the claims made in the
complaints and intends to contest the lawsuits vigorously, an
26
<PAGE>
adverse resolution of the lawsuits could have a material adverse effect on the
Company's financial condition and results of operations in the period in which
the litigation is resolved. The Company is not able to reasonably estimate
potential losses, if any, related to the complaints.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company is furnishing the following information with respect to the use of
proceeds from its initial public offering of common stock, $0.01 par value per
share on July 2, 1997:
(1) The effective date of the registration statement of the offering and
the commission file number were July 1, 1997 and 333-27087, respectively.
(4)(vii) From July 1, 1997 to September 30, 1998, $500,000 of the offering
proceeds were used to repay certain indebtedness under a secured subordinated
note, $30,000,000 were paid to APU in connection with the MDI acquisition and
$ 4,364,000 were used to fund the Company's operations. The balance of the
offering proceeds ($5,800,000) was invested in commercial paper, corporate
bonds and money market accounts.
Except for the $30,000,000 paid to APU which, as a result of the MDI
acquisition, owns 10% or more of the Company's common stock, payment of the
offering proceeds were to persons other than directors, officers, general
partners of the Company or their associates, persons owning 10% or more of the
equity securities of the Company or affiliates of the Company.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Documents listed below, except for documents identified by footnotes, are
being filed as exhibits herewith. Documents identified by footnotes, if any, are
not being filed herewith and, pursuant to Rule 12b-32 of the General Rules and
Regulations promulgated by the Commission under the Securities Exchange Act of
1934 (the ''Exchange Act'') reference is made to such documents as previously
filed as exhibits with the Commission. The Company's file number under the
Exchange Act is 000-22647.
Exhibit 10.1. Employment Agreement dated August 13, 1998 between the Company
and John Giordano.
Exhibit 10.2. Share Purchase Agreement dated July 20, 1998 between the
Company and Persist S.A.
Exhibit 11. Statement re computation of per share earnings
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<PAGE>
Exhibit 27. Financial Data Schedule
(b) Reports on Form 8-K
A Current Report on Form 8-K dated August 17, 1998 was filed by the Company on
August 28, 1998 to announce under Item 5 (Other Events) the resignation of
Douglas A. Catalano as President and Chief Executive Officer of the Company and
the promotion of Allen K. Deary, the Company's Vice President and Chief
Financial Officer to President and Chief Executive Officer. The Company also
announced that Mr. Catalano would remain on the Company's Board of Directors and
that Mr. Deary would remain acting Chief Financial Officer of the Company until
a successor was named.
A Current Report on Form 8-K dated September 23, 1998 was filed by the Company
on September 28, 1998 to announce the Company's preliminary results for the
quarter ended September 30, 1998. The Company reported under Item 5 (Other
Events) that total revenue in the 1998 third quarter was expected to be between
$4.2 million and $7.7 million and that it expected a net loss for the quarter
(excluding any restructuring charge) of between $8.2 and $4.7 million.
28
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: December 14, 1998
Peritus Software Services, Inc.
By: /s/ John D. Giordano
------------------------------------------
John D. Giordano
Vice President, Finance and Chief Financial
Officer (Principal Financial Officer)
29
<PAGE>
Exhibit No. Description
- ----------- -----------
Exhibit 10.1. Employment Agreement dated August 13, 1998 between the Company
and John Giordano.
Exhibit 10.2. Share Purchase Agreement dated July 20, 1998 between the Company
and Persist S.A.
Exhibit 11. Statement recomputation of per share earnings
Exhibit 27. Financial Data Schedule
30
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Exhibit 10.1
EMPLOYMENT AGREEMENT
Agreement made as of the 13th day of August, 1998 (the "Effective
Date"), by and between Peritus Software Services, Inc., a Massachusetts
corporation (the "Company"), and John Giordano (the "Employee").
The Company wishes to employ the Employee, and the Employee wishes to
be employed by the Company. In consideration of the mutual covenants and
promises contained herein, and other good and valuable consideration, the
receipt and sufficiency of which are hereby acknowledged by the parties hereto,
the parties agree as follows:
I. Titles and Reporting Responsibilities
-------------------------------------
The Employee's title will be Vice President, Finance and Chief
Financial Officer or such other title as may be mutually agreed upon between
Employee and the Company. The Employee will report to the President and CEO .
II. Term of Employment
------------------
The Company hereby agrees to employ the Employee and the Employee
hereby accepts employment with the Company for a period (the "Employment
Period") commencing on the September 14, 1998 and ending May 31, 2001 unless
earlier terminated pursuant to the provisions of Section VII below. This
Agreement shall remain in full force and effect until expiration hereof unless
and until earlier terminated in accordance with Section VII of this Agreement.
III. Responsibilities of the Employee
--------------------------------
The Employee agrees to undertake the duties and responsibilities
inherent in the position described in Section I above and such other duties and
responsibilities as the Company or its designee shall from time to time
reasonably assign. The Employee agrees to devote his entire business time,
attention and energies to the business and interests of the Company during the
term of this Agreement. The Employee agrees to abide by the rules, regulations,
instructions, personnel practices and policies of the Company and any changes
therein which may be adopted from time to time by the Company.
IV. Expense Reimbursement
---------------------
The Company will reimburse the Employee for all reasonable documented
travel and other business expenses incurred in furthering the business of the
Company and in accordance with the Company's then current travel and business
expense policy. Expenditures of an extraordinary nature shall require prior
written approval of the Company.
1
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V. Prohibitions
------------
During the term of this Agreement, the Employee shall not:
(a) be employed by or otherwise represent any other company, product,
service or enterprise, without the prior written approval of the
Company; or
(b) make any representation, warranty, guarantee, or statement, orally
or in writing, which would contravene any Company policy or compromise
the Company's interests.
VI. Compensation, Initial Stock Option Grant and Relocation
-------------------------------------------------------
(a) The Employee shall be paid a base salary (the "Base Salary") and,
when appropriate, bonuses (Bonus Compensation") as described in this
Section VI. The Employee's initial bi-weekly Base Salary shall be
$7,500 (Initial Base Salary), which is the equivalent of $195,000 per
year. Provided neither party has exercised the right to terminate this
Agreement under Section VII, performance and compensation reviews will
be conducted annually beginning January 1, 1999.
(b) Bonus Compensation will be paid to the Employee provided the
Employee successfully meets the bonus criteria as approved by the
Board of Directors of the Company, by a Committee of the Board of
Directors of the Company established for the purpose of determining
bonus compensation or by a designee of the Board of Directors or such
Committee who has been granted the authority to determine bonuses.
Employee's bonus rate shall be 50% (Initial Bonus Rate) of base
salary. The Employee's bonus criteria will be consistent with the
criteria set for other senior executives of the Company taking into
account his duties and responsibilities. Notwithstanding the above
provisions, the Employee shall receive a minimum bonus of $25,000
provided he is employed through December 31, 1998 payable when bonuses
are payable to senior executives.
(c) Except as otherwise provided, the Employee shall be entitled to
participate in any and all benefit programs that the Company
establishes and makes generally available to its employees for which
he may be eligible under plan documents and applicable laws. In any
case where contributions or benefits related to participation in a
plan vary on the basis of compensation, "compensation" shall mean
Employee's Base Salary only and shall not include expense
reimbursements, advances, Bonus Compensation or any other compensation
which may be paid by the Company. The Employee shall be entitled to
four weeks vacation to be taken at such times as may be approved by
the President and CEO.
2
<PAGE>
(d) Any future revisions to Base Salary or Bonus Compensation may be
implemented by the Board of Directors of the Company, by a Committee of the
Board of Directors of the Company established for the purpose of
determining bonus compensation or by a designee of the Board of Directors
or such Committee who has been granted the authority to determine bonuses
provided however that no reduction may be made to either the Initial Base
Salary or the Initial Bonus Rate.
(e) The Employee's initial stock option grant under the Company's 1997
Stock Incentive Plan shall be 120,000 shares vesting in increments of 25%
per year or an exercise price set at the fair market value of the Company's
common stock on the date of grant. The grant date shall be on Employee'
commencement of employment with the Company. All stock option grants must
be approved by the Company's Board of Directors.
If during the first year of his employment, the Employee desires to move his
residence closer to the Billerica area, the Company will pay up to $15,000 of
documented relocation expenses (including real estate commissions but without
benefit of tax gross up); provided however that any such amount will be
subtracted from any 1999 Bonus Compensation earned that exceeds $80,000.
VII. Termination
-----------
The employment of the Employee by the Company pursuant to this Agreement
shall terminate:
(a) By the Employee, without cause, by giving 30 days' prior written notice
of termination to the Company or within such shorter period as is
established by mutual agreement of the parties or upon Employee's
commencement of employment or consulting with a third party, or by the
Company, without cause, upon at least 52 weeks prior written notice (the
"Notice Period") of termination to the Employee.
(b) By either party, if the other party breaches any of its obligations
under this Agreement and fails to remedy such breach within 30 days after
written notice of such breach is provided to such other party. Failure of
the Employee to adequately perform the duties and responsibilities
specified in Section III hereof shall be considered a breach of this
Agreement provided however that the remedy period for such breach shall be
120 days.
(c) By the Company, effective immediately and without notice, for cause.
For purposes of this Section VII (c), "cause" for termination shall be
deemed to exist upon (a)dishonesty, gross negligence or misconduct, (b) the
conviction of the Employee of, or the entry of a pleading of guilty or nolo
contendere by the Employee to, any crime involving moral turpitude or any
felony.
(d) Upon the death or disability of the Employee. As used in this
Agreement, the term "disability" shall mean the inability of the Employee,
due to a physical or mental
3
<PAGE>
disability, to perform the essential functions of his/her job with or
without a reasonable accommodation by the Company.
VIII. Rights Following Termination
----------------------------
(a) Following termination of this Agreement, pursuant to Section VII(b),
VII(c), VII(d), or at the option of the Employee pursuant to Section
VII(a), or upon expiration of this Agreement, the Company shall have no
further responsibility to Employee except to pay Base Salary up to and
including the last day of employment.
(b) Following termination of this Agreement at the option of the Company
pursuant to Section VII (a), the Company shall continue to pay to the
Employee the Base Salary in accordance with its then current payroll
policies until the earlier of either expiration of the Notice Period or
the date Employee commences employment or consulting with a third party
during the Notice Period; provided however that if the compensation
earned by the employee under any such arrangement is less than the Base
Salary at the time of termination, Employee shall continue to be paid the
difference between such compensation and the Base Salary for the
remainder of the Notice Period. Employee shall perform such services for
the Company as mutually agreed upon between Company and Employee as to
scope, timing and location during such Notice Period. The Employee shall
not be eligible to receive the payments during the Notice Period unless
and until the Employee signs a release in the form attached hereto as
Exhibit A.
(c) In the event of termination or expiration of this Agreement, Employee
shall, at the instruction of the Company, promptly return to the Company
or its designee all files, letters, memoranda, reports, records, data,
sketches, drawings, laboratory notebooks, program listings, or other
written, photographic, or other tangible material supplied by the Company
to the Employee or created or maintained for the Company by the Employee.
(d) Except as set forth above, neither party shall be entitled to any
compensation or claim for goodwill or other loss, suffered by reason or
termination of this Agreement.
(e) The rights and obligations of the parties to this Agreement set forth
in Section VIII and Section IX shall survive any termination or
expiration of this Agreement. The termination or expiration of this
Agreement shall in no case relieve either party from its obligations to
pay to the other any monies accrued hereunder prior to such termination
or expiration.
(f) Employee shall not disclose the terms of this Agreement to any third
party unless such third party is obligated to keep such information
confidential.
IX. Non-Competition
---------------
4
<PAGE>
(a) During the Employment Period and (i) for a period of one year after
the termination of this Agreement pursuant to Sections VII(b),
VII(c), VII(d) or at the option of the Employee pursuant to Section
VII(a) or (ii) in the event of termination of this Agreement by the
Company without cause under Section VII (a) for the period of the
Notice Period during which the Company is continuing to make payments
to the Employee, the Employee will not directly or indirectly:
(i) as an individual, proprietor, partner, stockholder, officer,
employee, director, joint venturer, investor, lender, or in any other
capacity whatsoever (other than as the holder of not more than one
percent (1%) of the total outstanding stock of a publicly held company),
engage in the business of developing, producing, marketing or selling
products or services of the kind or type developed or being developed,
produced, marketed or sold by the Company or any subsidiary of the
Company while the Employee was employed by the Company provided that the
foregoing restriction shall not apply after the end of the Employment
Period to activities that are not related to the Company's year 2000
business activities.; or
(ii) recruit, solicit or induce, or attempt to induce, any employee
or employees of the Company to terminate their employment with, or
otherwise cease their relationship with, the Company; or
(iii) solicit, divert or take away, or attempt to divert or take
away, the business or patronage of any of the clients, customers or
accounts, or prospective clients, customers or accounts, of the Company
which were contacted, solicited, served or known by the Employee while
employed by the Company.
(b) If any restriction set forth in this Section IX is found by any court
of competent jurisdiction to be unenforceable because it extends for too
long a period of time or over too great a range of activities or in too
broad a geographic area, it shall be interpreted to extend only over the
maximum period of time, range of activities or geographic area as to
which it may be enforceable.
(c) The restrictions contained in this Section IX are necessary for the
protection of the business and goodwill of the Company and are considered
by the Employee to be reasonable for such purpose. The Employee agrees
that any breach of this Section IX will cause the Company substantial and
irrevocable damage and therefore, in the event of any such breach, in
addition to such other remedies which may be available, the Company shall
have the right to seek specific performance and injunctive relief.
X. Other Agreements
----------------
Employee represents that his performance of all the terms of this
Agreement and as an employee of the Company does not and will not breach any
employment agreement with any previous employer or any agreement with any
previous employer or other party to keep in confidence proprietary information,
knowledge or data acquired by him in accordance or in trust
5
<PAGE>
prior to his employment with the Company or to refrain from competing, directly
or indirectly, with the business of such previous employer or any other party.
Employee has executed the Company's standard confidentiality and nondisclosure
agreement.
XI. Notices
-------
All notices, requests, demands, and other communications under this
Agreement shall be in writing and shall be deemed to have been duly given when
delivered in person or, if mailed, when mailed by certified or registered mail,
postage prepaid, or by recorded delivery service to the parties at the addresses
set forth below their signatures to this Agreement or at such other address as
may be given in writing by either party to the other party in accordance with
this Section XI.
XII. Assignability
-------------
Employee acknowledges that the Company is entering into this Agreement
in reliance upon the personal reputation, qualifications and abilities of the
Employee and accordingly, the Employee may not assign his rights or obligations
under this Agreement, either voluntary or by operation of law.
XIII. Miscellaneous
-------------
(a) This Agreement shall not be binding upon the Company until it has
been executed by a duly authorized officer of the Company. This
Agreement shall be binding on the parties and their respective
successors and assigns.
(b) This Agreement shall be governed by, and construed in accordance
with, the substantive laws of The Commonwealth of Massachusetts.
(c) This Agreement constitutes the entire understanding between the
parties relating to the subject matter of this Agreement and supersedes
all prior writings, negotiations or understanding with respect thereto
except the confidentiality and nondisclosure agreement referenced in
Section X above. No modification or addition to the Agreement shall have
any effect unless it is set forth in writing and signed by both parties.
(d) The waiver by the Company or the Employee of any breach of any
provision of this Agreement shall not be construed as a continuing
waiver of such breach or as a waiver of other breaches of the same or of
other provisions of this Agreement.
(e) Should any provision of this Agreement be declared or be determined
by any court of competent jurisdiction to be illegal or invalid, the
validity of the remaining parts, terms, or provisions shall not be
affected thereby and said illegal and invalid part, term or provision
shall be deemed not to be a part of this Agreement.
6
<PAGE>
(f) The exercisability of Employee's options granted under the Company's
1997 Stock Incentive Plan in the event of an "acquisition event" as such
term is defined in such respective plan shall be governed by the terms of
plan under which such options are granted and any related option
agreements.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the
date first above written.
Peritus Software Services, Inc.
/s/ John Giordano /s/ Allen Deary
_________________________________ By:_______________________________
Employee Signature
Address: 5 Queen Anne Road Address: 2 Federal Street
Hopkinton, Ma 01748 Billerica, MA 01821-3540
Attn: President
7
<PAGE>
EXHIBIT A
---------
RELEASE
1. Release. In consideration of the payments provided to me under a certain
-------
employment contract between Peritus Software Services, Inc., a Massachusetts
Corporation (the "Company") and me, I hereby fully, forever, irrevocably and
unconditionally release, remise and discharge the Company, and any subsidiary or
affiliated organization of the Company or their respective current or former
officers, directors, stockholders, corporate affiliates, attorneys, agents and
employees (the "Released Parties") from any and all claims, charges, complaints,
demands, actions, causes of action, suits, rights, debts, amounts of money,
promises, doings, omissions, damages, executions, obligations, liabilities, and
expenses (including attorneys' fees and costs), of every kind and nature, known
or unknown, which I ever had or now have against the Released Parties,
including, but not limited to, all claims arising out of my employment, all
claims arising out of your separation of my employment, all claims arising from
any failure to reemploy me, all claims of race, sex, national origin, handicap,
religious, sexual orientation, benefit and age discrimination, all employment
discrimination claims under Title VII of the Civil Rights Act of 1964, 42 U.S.C.
(S)2000 et seq., the Age Discrimination in Employment Act, 29 U.S.C. (S)621 et
seq., the Americans with Disabilities Act of 1990, 29 U.S.C. (S)12101 et seq.,
The Employee Retirement Income Security Act of 1974, 29 U.S.C. (S)1001 et seq.,
and similar state or local statutes, wrongful discharge claims, common law tort,
defamation, breach of contract and other common law claims, and any claims under
any other federal, state or local statutes or ordinances not expressly
referenced above.
2. Entire Understanding and Applicable Law. This Release contains and
---------------------------------------
constitutes my entire understanding with respect to the settlement of claims
against the Company and the Released Parties and cancels all previous oral and
written negotiations, agreements, commitments, and writings in connection
therewith. This Release shall be governed by the substantive laws of The
Commonwealth of Massachusetts to the extent not preempted by federal law.
3. Acknowledgements. I acknowledge that I have been given at least twenty-one
----------------
(21) days to consider this Release and that the Company advised me to consult
with any attorney of my own choosing prior to signing this Release. I
acknowledge that I may revoke this Release for a period of seven (7) days after
signing it, and the Release shall not be effective or enforceable until the
expiration of this seven (7) day revocation period.
Date: __________________ Employee's Signature: __________________
Employee's Name: John Giordano
8
<PAGE>
EXHIBIT 10.2
SHARE PURCHASE AGREEMENT
------------------------
EXECUTED AS A DEED
BEFORE A COMMERCIAL STOCKBROKER
("CORREDOR DE COMERCIO")
This agreement is entered into in Barcelona, on July 20, 1998
BY AND BETWEEN
--------------
ON THE FIRST PART: Persist, S.A, a company duly incorporated and existing under
the laws of Spain, with registered office at Avda. Sofia 45-53 Local Commerical
Torre 7, 08870 Sitges, Barcelona, and tax identification number A-60661295
(hereinafter, the "PURCHASER"), duly represented herein by Mr. Abel Gerber
Mexas, by virtue of the powers that were specifically granted to him by the
Board of Directors of the Purchaser.
ON THE SECOND PART: Peritus Software Services, Inc., a company duly incorporated
and existing under laws of Massachusetts, with registered office at 2 Federal
Street, Billerica, Massachusetts 01821, United States of America (hereinafter,
the "SELLER"), duly represented herein by Mrs. Arancha Seva Garcia, by virtue of
a power of attorney granted before the public notary of Massachusetts, Ms. Linda
K. Boyle duly legalized by an Apostille pursuant to The Hague Convention of
October 5, 1961.
ON THE THIRD PART: Solintec, S.A. a company duly incorporated and existing
under the laws of Spain, with registered office at Sant Fruitos del Bages,
Barcelona, Poligono Pla de Santa Ana, Parcela 8, and tax identification number
A-60105129 (hereinafter, "SOLINTEC"), duly represented herein by Mr. Manuel
Duenas Bailon, by virtue of the powers of attorney granted to him on December
28, 1995 before the notary public of Sabadell Mr. Maximo Catalan Pardo, number
5,545 of his files.
ON THE FOURTH PART: Mr. Abel Gerber Mexas, a US citizen, legal age, with address
at 12595 N. 88 Way, Scotsdale, Arizona, United States of America with passport
number Z6207896 (hereinafter, "MR. MEXAS"). Mr.Abel Gerber Mexas acts in his own
name and behalf.
The Purchaser and the Seller will be referred to collectively hereinafter for
the purposes of this agreement as the "PARTIES".
<PAGE>
RECITALS
--------
I. Whereas the Purchaser, is a Spanish Company incorporated on September 30,
1994, before the Notary Public of Sant Feliu de Llobregat Mr. Jesus-
Julian Fuentes Martinez, with number 990 of his files and is engaged in,
among other activities, the maintenance of computer software and the
consulting and auditing of programs.
II. Whereas the Seller owns shares representing approximately sixty three
point zero seven per cent (63.07%) of the capital of the Purchaser free
of all liens, charges, options, encumbrances and claims; such percentage
is represented by thirty thousand one hundred and fifty (30,150) shares,
each with a par value of one thousand Pesetas (Ptas 1,000), of which
1,900 are class A shares (numbers 1,201 to 2,500, 2,501 to 2,800, 3,201
to 3,350 and 3,601 to 3,750), 2,700 are class B shares (numbers 1,301 to
4,000) and 25,550 are class D shares (numbers 1 to 21,900 and 30,001 to
33,650) (hereinafter, collectively, the "Shares" and each a "Share").
III. Whereas the Purchaser is interested in purchasing and the Seller is
interested in selling the Shares at the price and subject to the terms
and conditions described below.
Therefore, the Parties hereto agree to enter into this sale and purchase
agreement (hereinafter, the "Agreement") pursuant to the following
CLAUSES
-------
1. PURCHASE AND SALE
-----------------
1.1 PURCHASE AND SALE: Subject to the fulfilment of the condition precedent
-----------------
described in section 11 below, the Seller hereby sells to the Purchaser,
who purchases, the Shares, free from any lien, encumbrance or third
party's right.
1.2 DELIVERY OF POSSESSION: Subject to the fulfilment of the condition
----------------------
precedent described in section 11 below, the Seller hereby delivers the
possession of the Shares and transfers title thereof to the Purchaser by
endorsing a global share certificate number 2 representing all the Shares
to the Purchaser.
2. PRICE AND METHOD OF PAYMENT
---------------------------
2.1 TOTAL PURCHASE PRICE: The total price to be paid by the Purchaser to the
--------------------
Seller for the Shares is U.S. dollars SIX HUNDRED THOUSAND (600,000)
(hereinafter, the "Purchase Price"), that is, NINETEEN DOLLARS AND NINETY
CENTS (US $19.90) per Share.
2
<PAGE>
2.2 PAYMENT: The Purchaser will deliver to the Commercial Stockbroker for the
-------
benefit of the Seller a certified check ("cheque conformado") in the
amount of U.S. dollars FOUR HUNDRED AND SEVENTY THOUSAND (470,000) not
later than July 21, 1998, 2:00 p.m. (Barcelona time). Such amount is the
result of deducting from the Purchase Price U.S. dollars ONE HUNDRED AND
THIRTY THOUSAND (130,000) which the Seller owes to the Purchaser in
relation to the so-called MicroAge Contract. The Parties sign
simultaneously to the execution of this agreement a letter which is
attached hereto as Annex 1 containing the final terms of settlement of
-------
costs and expenses of Seller to Purchaser in connection with the MicroAge
Contract.
3. REPRESENTATIONS AND WARRANTIES OF THE SELLER
--------------------------------------------
The Seller hereby irrevocably represents and warrants as follows:
3.1 The Shares (i) have been validly issued; (ii) are fully paid-up; (iii)
are freely transferable, other than as established in the Purchaser's by-
laws; and (iv) are free of encumbrances, liens, pledges, burdens,
attachments, third party's right or any other type of rights "in rem.
3.2 The Seller (i) has full legal title to the Shares sold under this
Agreement; (ii) has no obligation to transfer the Shares to a third
party, or to create any mortgage, pledge, lien, claim, charge or
encumbrance in respect to the Shares; and (iii) has full right, power and
authority to sell, transfer and deliver the Shares.
3.3 The execution and performance of this Agreement and the consummation of
all transactions contemplated hereby by the Seller will not require any
consent approval or notice and will not conflict with, or result in the
breach or termination of, or constitute a default under, any contract,
agreement or other instrument to which the Seller is a party or by which
the Seller is bound.
4. REPRESENTATIONS AND WARRANTIES OF THE PURCHASER
-----------------------------------------------
The Purchaser hereby irrevocably represents and warrants as follows:
4.1 The Purchaser has full right, power and authority to buy and acquire the
Shares.
4.2 The execution and performance of this Agreement and the consummation of
all transactions contemplated hereby by the Purchaser will not require
any consent approval or notice and will not conflict with, or result in
the breach or termination of, or constitute a default under, any
contract, agreement or other instrument to which the Purchaser is a party
or by which the Purchaser is bound.
4.3 The Purchaser has been operated in the regular and ordinary course of
business for all periods prior to the purchase and sale of the Shares.
3
<PAGE>
5. WAIVER TO PREFERENTIAL ACQUISITION RIGHT
----------------------------------------
Solintec and Mr. Mexas waive any preferential acquisition right that he may
have pursuant to Article 10 of the Purchaser's by-laws as a result of the
sale of the Shares from the Seller to the Purchaser.
6. WAIVER TO ACTIONS
-----------------
The Seller has delivered to the Purchaser before the execution of this
Agreement the resignation letters of the directors in the Purchaser
appointed at the request or proposal of the Purchaser. Subject to the
fulfilment of the condition precedent described in section 11 below, the
management of such directors, as well as the management of any other
present or former director of the Purchaser, is approved by the Parties and
by Solintec and Mr. Mexas as shareholders representing all the capital of
the Purchaser.
In addition, subject to the fulfilment of the condition precedent described
in section 11 below the Parties, Solintec and Mr. Mexas declare that with
the execution of this Agreement and the letter relating to the MicroAge
Contract which is being executed simultaneously, they do not have anything
to claim from each other and, accordingly, they irrevocably and
unconditionally renounce to any action that they could have, except for
any action arising from the falseness or inaccuracy of the representations
and warranties of clauses 3 and 4 of this Agreement.
7. COSTS AND EXPENSES
------------------
All costs and expenses incurred by the Parties arising from the
preparation, execution and performance of this Agreement shall be borne by
each Party in equal amounts.
8. NOTICES
-------
8.1 FORM: All notices between the Parties relating to or arising from this
----
Agreement shall be made by mail recorded delivery service or by facsimile.
If made by facsimile, the notices shall be deemed valid and binding,
provided that the facsimiles are signed by an authorized officer of the
Party giving the notice. No special code shall be required.
8.2 ADDRESSES: The Parties have designated the addresses indicated in the
---------
heading of this Agreement as the valid addresses for the purpose of
receiving notices.
8.3 CHANGE OF ADDRESSES: Any notice sent to the above referenced addresses will
-------------------
be deemed to be received by the addressee, except if prior to the sending
of such notice the addressee had notified to the other Party a change of
address or telefax numbers.
4
<PAGE>
9. MISCELLANEOUS
-------------
9.1 AMENDMENTS: No variation of this Agreement shall be valid unless it is
----------
made in writing and signed by or on behalf of each of the Parties,
Solintec and Mr. Mexas.
9.2 WAIVERS: The failure to exercise or delay in exercising a right or remedy
-------
under this Agreement shall not be interpreted as a waiver of the right or
remedy or a waiver of any other rights or remedies and no single or
partial exercise of any right or remedy under this Agreement shall prevent
any further exercise of that or of any other right or remedy.
9.3 PARTIAL INVALIDITY: The invalidity, illegality or unenforceability of any
------------------
provision of this Agreement shall not affect or impair the continuation in
force of the remainder of this Agreement. Furthermore, in lieu of any such
invalid, illegal or unenforceable term or provision, the intent of the
Parties, Solintec and Mr. Mexas is that there shall be added as a part of
this Agreement a provision as similar in terms to such invalid or
unenforceable provision as may be possible and be valid and enforceable.
9.4 LANGUAGE: This Agreement is executed in English.
--------
10. GOVERNING LAW AND JURISDICTION
------------------------------
10.1 This Agreement shall be governed and construed in accordance with the laws
of the Commonwealth of Massachusetts.
10.2 The Parties, expressly waiving their rights to their own forum, expressly
and irrevocably submit to the courts of the cities of Barcelona, Spain,
and Boston, MA USA, for any disputes arising from the interpretation,
validity, or enforceability of this Agreement.
11. CONDITION PRECEDENT
-------------------
11.1 The effectiveness of this Agreement, the transfer of the Shares from the
Seller to the Purchaser and the effectiveness of the MicroAge letter
attached as Annex 1 are all subject in all respects to the Purchaser
delivering to the Commercial Stockbroker Mr. Carlos Cuatrecasas for the
benefit of the Seller a certified check ("cheque conformado") in the
amount of U.S. Dollars FOUR HUNDRED SEVENTY THOUSAND (U.S. $470,000)
not later than 2:00 p.m. (Barcelona time) of July 21, 1998.
11.2 If by such time and date, the Purchaser has not delivered the indicated
amount by a certified check and in U.S. Dollars then the Parties, Mr.
Mexas and Solintec irrevocably instruct the Commercial Stockbroker to:
(i) Return the property titles ("titulos de propiedad") and share
certificate number 2 ("titulo fisico multiple") representing the Shares to
the Seller's representative;
5
<PAGE>
(ii) Destroy the signed copies of this Agreement; and
(iii) Deliver to the Seller the minutes of the Shareholders' Meeting of
the Purchaser dated July 15, 1998 together with any resignation letters,
all of which are delivered to the Commercial Stockbroker in this act.
11.3 If, on the contrary, the condition precedent is fulfilled, then the
Parties, Mr. Mexas and Solintec irrevocably instruct the Commercial
Stockbroker to:
(i) Deliver the certified check to the Seller's representative;
(ii) Deliver to the representative of each of the Parties, Mr. Mexas and
Solintec a signed and sealed copy of this Agreement;
(iii) Deliver to the Purchaser's representative the property titles and
share certificate number 2; and
(iv) Deliver to the Purchaser's representative the minutes of the
Shareholders' Meeting of July 15, 1998 together with any resignation
letters.
IN WITNESS WHEREOF, the Parties, Solintec and Mr. Mexas have caused this
Agreement to be executed at the place and on the date indicated above.
Persist, S.A. Peritus Software Services, Inc.
/s/ Abel G. Mexas /s/ Arancha S. Garcia
- --------------------------------- ---------------------------------------
Mr. Abel Gerber Mexas in the name Mrs. Arancha Seva Garcia in the name
and on behalf of Persist, S.A. and on behalf of Peritus Software
Services, Inc.
6
<PAGE>
For the purposes of clauses 5 and 6: For the purposes of clauses 5 and 6
/s/ Abel Gerber /s/ Manuel Duenas
- --------------------------------- -----------------------------------
Mr. Abel Gerber Mexas, in his own Mr. Manuel Duenas Bailon in the
name and behalf name and on behalf of Solintec, S.A
With my intervention, in my presence and in the same act,
[SEAL APPEARS HERE]
/s/ D. Carlos Cuatrecasas
-------------------------
D. Carlos Cuatrecasas
Commerial Stockbroker of Barcelona
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
July 20, 1998
Persist S.A.
Avda, Sofia 45-53
08870 Sitges (Barcelona), Spain
Dear Sir or Madam:
In connection with the transfer of Peritus Software Services Inc.'s shares
in Persist S.A. to Persist S.A., we hereby agree as follows with respect to the
final settlement of all expenses related to MicroAge:
(i) All MicroAge expenses payable or accrued for all periods prior to
April 1, 1998, shall be satisfied by payment of $50,000 from Peritus
to Persist;
(ii) All MicroAge expenses payable or accrued for the period from April 1,
1998 through June 30, 1998 shall be satisfied by payment of $80,000
from Peritus to Persist; and
(iii) Commencing July 1, 1998, Peritus will pay all MicroAge expenses
including salaries, office rent and telephone expenses accrued on or
after that date, provided that Persist assists Peritus in the orderly
transition of the MicroAge work, persons, office lease and telephone
line currently administered by Persist.
Please acknowledge your agreement by signing below.
Sincerely,
/s/ John MacPhee
John MacPhee
V.P. and Treasurer
Agreed to by Persist S.A.
By: /s/ Abel Gerber Mexas
----------------------
<PAGE>
EXHIBIT 11
PERITUS SOFTWARE SERVICES, INC.
STATEMENT RE COMPUTATION OF EARNINGS PER COMMON SHARE
(IN THOUSANDS, EXCEPT PER SHARE-RELATED DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------------------------- --------------------
1998 1997* 1998 1997*
------------------ ------------------ -------- ----------
<S> <C> <C> <C> <C>
Net income (loss).......................................... $(16,132) $ 84 $(21,329) $ 928
Preferred stock preference items:
Accrual of cumulative dividends on Series A and B
preferred stock.......................................... - - - 675
Accretion to redemption value of redeemable stock......... - - - 57
-------- -------- -------- -------
Total preferred stock preference items.................. - - - 732
-------- -------- -------- -------
Net income (loss) attributable to common stockholders......
$(16,132) $ 84 $(21,329) $ 196
-------- -------- -------- -------
Weighted average shares outstanding-Basic.................. 16,294 12,432 16,121 8,107
Adjustments thereto:
Shares attributable to common stock equivalents........... - 1,848 - 3,359
-------- -------- -------- -------
Weighted average shares outstanding-Diluted................ 16,294 14,280 16,121 11,466
======== ======== ======== =======
Net income (loss) per share:
Basic..................................................... $ (0.99) $ 0.01 $ (1.32) $ 0.02
======== ======== ======== =======
Diluted................................................... $ (0.99) $ 0.01 $ (1.32) $ 0.02
======== ======== ======== =======
</TABLE>
*Restated - See Note 2 of the Unaudited Consolidated Financial
Statements for the quarterly period ended September 30, 1998.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF PERITUS SOFTWARE SERVICES, INC. FOR THE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998
<PERIOD-START> JUL-01-1998 JAN-01-1998
<PERIOD-END> SEP-30-1998 SEP-30-1998
<CASH> 4,004 4,004
<SECURITIES> 2,500 2,500
<RECEIVABLES> 6,299 6,299
<ALLOWANCES> (745) (745)
<INVENTORY> 0 0
<CURRENT-ASSETS> 2,956 2,956
<PP&E> 9,081 9,081
<DEPRECIATION> (3,842) (3,842)
<TOTAL-ASSETS> 20,929 20,929
<CURRENT-LIABILITIES> 9,555 9,555
<BONDS> 0 0
0 0
0 0
<COMMON> 163 163
<OTHER-SE> 9,866 9,866
<TOTAL-LIABILITY-AND-EQUITY> 20,929 20,929
<SALES> 5,293 25,809
<TOTAL-REVENUES> 5,293 25,809
<CGS> 4,851 14,989
<TOTAL-COSTS> 4,851 14,989
<OTHER-EXPENSES> 16,672 32,579
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> (95) (440)
<INCOME-PRETAX> (16,135) (21,319)
<INCOME-TAX> 0 25
<INCOME-CONTINUING> (16,135) (21,344)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 3 15
<NET-INCOME> (16,132) (21,329)
<EPS-PRIMARY> (.99) (1.32)
<EPS-DILUTED> (.99) (1.32)
</TABLE>
