<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
AMENDMENT NO. 1
ON
FORM 10-Q/A
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarterly Period Ended June 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 Identification No.)
Incorporation or Organization)
2 Federal Street, Billerica, 01821
Massachusetts (Zip Code)
(Address of Principal Executive
Offices)
(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:
<TABLE>
<CAPTION>
Shares outstanding
Title of Class at August 10, 1998
-------------- ------------------
<S> <C>
Common Stock, $0.01 par value 16,299,990
</TABLE>
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- -------------------------------------------------------------------------------
<PAGE>
PERITUS SOFTWARE SERVICES INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
Part I. Financial Information ----
<C> <S> <C>
Item 1. Financial Statements
Consolidated Balance Sheet as of June 30, 1998 and December
31, 1997................................................... 3
Consolidated Statement of Operations for the Three and Six
Months Ended June 30, 1998 and 1997........................ 4
Consolidated Statement of Cash Flows for the Six Months
Ended June 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.................................. 11
<CAPTION>
Part II. Other Information
<C> <S> <C>
Item 1. Legal Proceedings........................................... 22
Item 6. Exhibits and Reports on Form 8-K............................ 22
Signatures.................................................. 24
</TABLE>
The Registrant hereby amends its Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1998, as amended, by restating Part I.
Financial Information, Item 1. Financial Statements, and Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations, Part
II. Other Information, Item 1. Legal Proceedings and Item 6. Exhibits and
Reports on Form 8-K, Exhibit 11. Statement re Computation of Net Income (loss)
per common share, and Exhibit 27. Restated Financial Data Schedule, in their
entirety.
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PERITUS SOFTWARE SERVICES, INC.
CONSOLIDATED BALANCE SHEET
(In thousands, except share-related data)
(Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
ASSETS 1998* 1997*
------ -------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents............................... $ 5,285 $11,340
Short-term investments.................................. 4,000 3,000
Accounts receivable, net of allowance for doubtful
accounts of $445 and $95, respectively and including
amounts receivable from related parties of $944 and
$289, respectively..................................... 9,397 12,627
Costs and estimated earnings in excess of billings on
uncompleted contracts, including amounts on uncompleted
contracts with related parties of $171 and $250,
respectively........................................... 2,783 2,547
Prepaid expenses and other current assets............... 1,595 710
------- -------
Total current assets................................... 23,060 30,224
Property and equipment, net.............................. 5,521 3,859
Intangibles and other assets, net........................ 5,220 5,787
------- -------
$33,801 $39,870
======= =======
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<S> <C> <C>
Current liabilities:
Current portion of capital lease obligations............ $ 91 $ 51
Current portion of long-term debt....................... 292 292
Accounts payable........................................ 970 1,650
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................. 1,114 976
Deferred revenue........................................ 1,747 2,818
Other accrued expenses and current liabilities.......... 2,836 3,506
------- -------
Total current liabilities.............................. 7,050 9,293
Capital lease obligations................................ 347 144
Long-term debt........................................... 123 269
------- -------
Total liabilities...................................... 7,520 9,706
------- -------
Minority interest in majority-owned subsidiary........... 147 159
------- -------
Stockholders' equity:
Common stock, $.01 par value; 50,000,000 shares
authorized; 16,283,735 and 15,361,800 shares issued and
outstanding at June 30, 1998 and December 31, 1997,
respectively........................................... 163 154
Additional paid-in capital.............................. 105,056 103,808
Accumulated deficit..................................... (79,012) (73,815)
Note receivable from stockholder........................ -- (58)
Cumulative translation adjustment....................... (73) (84)
------- -------
Total stockholders' equity............................. 26,134 30,005
------- -------
$33,801 $39,870
======= =======
</TABLE>
- --------
* Restated -- See Note 7.
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 share-related data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
June 30, June 30,
--------------- ---------------
1998* 1997 1998* 1997
------- ------ ------- ------
<S> <C> <C> <C> <C>
Revenue:
Outsourcing services, including $1,034,
$978, $2,248, and $1,953 from related
parties, respectively...................... $ 2,793 $3,044 $ 5,415 $5,563
License, including $277, $0, $277, and $0
from related parties, respectively......... 3,754 4,643 7,839 8,787
Other services, including $317, $0, $317,
and $0 from related parties, respectively.. 4,536 1,295 7,262 2,491
------- ------ ------- ------
Total revenue.............................. 11,083 8,982 20,516 16,841
------- ------ ------- ------
Cost of revenue:
Cost of outsourcing services, including
$421, $592, $1,134 and $965 from related
parties, respectively...................... 1,896 2,358 4,007 4,403
Cost of license............................. 510 148 1,046 275
Cost of other services, including $56, $0,
$56, and $0 from related parties,
respectively............................... 2,632 1,036 5,085 2,325
------- ------ ------- ------
Total cost of revenue...................... 5,038 3,542 10,138 7,003
------- ------ ------- ------
Gross profit............................... 6,045 5,440 10,378 9,838
------- ------ ------- ------
Operating expenses:
Sales and marketing......................... 3,266 2,035 6,375 3,418
Research and development.................... 2,001 1,969 5,045 3,603
General and administrative.................. 1,301 875 3,048 1,800
Restructuring charge........................ 1,439 -- 1,439 --
------- ------ ------- ------
Total operating expenses................... 8,007 4,879 15,907 8,821
------- ------ ------- ------
Income (loss) from operations............... (1,962) 561 (5,529) 1,017
Interest income (expense), net............... 185 (7) 345 20
------- ------ ------- ------
Income (loss) before income taxes and
minority interest in majority-owned
subsidiary................................. (1,777) 554 (5,184) 1,037
Provision for income taxes................... 25 124 25 172
------- ------ ------- ------
Income (loss) before income taxes and
minority interest in majority-owned
subsidiary................................. (1,802) 430 (5,209) 865
Minority interest in majority-owned
subsidiary.................................. 37 (8) (12) 21
------- ------ ------- ------
Net income (loss).......................... (1,839) 438 (5,197) 844
Accrual of cumulative dividends on Series A
and B redeemable convertible preferred
stock....................................... -- 444 -- 675
Accretion to redemption of redeemable common
stock rights................................ -- 31 -- 57
------- ------ ------- ------
Net income (loss) available to common
stockholders................................ $(1,839) $ (37) $(5,197) $ 112
======= ====== ======= ======
Net income (loss) per common share:
Basic....................................... $ (0.11) $(0.01) $ (0.32) $ 0.02
======= ====== ======= ======
Diluted..................................... $ (0.11) $(0.01) $ (0.32) $ 0.01
======= ====== ======= ======
Weighted average common shares outstanding:
Basic....................................... 16,179 6,000 16,082 5,944
======= ====== ======= ======
Diluted..................................... 16,179 6,000 16,082 8,531
======= ====== ======= ======
</TABLE>
- --------
* Restated--See Note 7.
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>
Six Months
Ended June 30,
----------------
1998* 1997
------- -------
<S> <C> <C>
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Cash flows from operating activities:
Net income (loss)........................................... $(5,197) $ 844
Adjustments to reconcile net income (loss) to net cash used
for operating activities:
Depreciation and amortization.............................. 1,660 495
Minority interest in majority-owned subsidiary............. (12) 21
Changes in assets and liabilities, net of effects from
acquisitions:
Accounts receivable....................................... 3,230 (3,833)
Costs and estimated earnings in excess of billings on
uncompleted contracts.................................... (236) 224
Unbilled license revenue from related parties............. -- 400
Prepaid expenses and other current assets................. (885) (475)
Other assets.............................................. (52) 10
Accounts payable.......................................... (680) 427
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................... 138 (52)
Deferred revenue.......................................... (1,071) (2,255)
Other accrued expenses and other current liabilities...... (670) 123
------- -------
Net cash used for operating activities.................. (3,775) (4,071)
------- -------
Cash flows from investing activities:
Purchase of short-term investments......................... (1,000) --
Investments in consolidated subsidiary..................... -- (111)
Purchases of property and equipment........................ (2,415) (779)
------- -------
Net cash used for investing activities.................. (3,415) (890)
------- -------
Cash flows from financing activities:
Proceeds from long-term debt............................... -- 200
Principal payments on long-term debt....................... (146) (105)
Principal payments on capital lease obligations............ (45) (34)
Proceeds from exercise of stock options.................... 1,001 23
Proceeds from sale of common stock......................... 256 --
Proceeds from payment of note receivable from stockholder.. 58 --
------- -------
Net cash provided by financing activities............... 1,124 84
------- -------
Effects of exchange rates on cash and cash equivalents...... 11 (38)
------- -------
Net decrease in cash and cash equivalents................... (6,055) (4,915)
Cash and cash equivalents, beginning of period.............. 11,340 7,388
------- -------
Cash and cash equivalents, end of period.................... $ 5,285 $ 2,473
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS:
Cash paid for income taxes................................. $ 78 $ --
Cash paid for interest..................................... 34 109
</TABLE>
- --------
* Restated--See Note 7.
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
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 described in Note 7,
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 audited consolidated financial statements and related notes included in
the Company's 1997 Annual Report on Form 10-K. The operating results for the
three and six months ended June 30, 1998 are not necessarily indicative of the
results to be expected for the full year ending December 31, 1998.
2. Legal Proceedings
The Company and certain of its officers and directors were 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 complaints principally alleged 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 alleged a 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 named Montgomery Securities, Inc., Wessels, Arnold &
Henderson, and H.C. Wainwright & Co., Inc. as defendants. The complaints
further alleged that certain officers and/or directors of the Company sold
stock in the open market during the class periods and sought 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.
On January 8, 1999, the plaintiffs filed a Consolidated Amended Complaint
applicable to all previously filed actions. The Consolidated Amended Complaint
alleges a class period of October 22, 1997 through October 26, 1998 and
principally claims that the Company, two of its former officers and its
president violated federal securities laws by purportedly making false and
misleading statements (or omitting material information) concerning the MDI
acquisition and the Company's revenue during the proposed class period,
thereby allegedly causing the value of the Company's stock to be artificially
inflated. Previously stated claims against the Company and its underwriters
alleging violations of the federal securities laws as a result of purportedly
inadequate or incorrect disclosure in connection with the Company's initial
public offering are not included in the Consolidated Amended Complaint.
Although the Company believes that it has meritorious defenses to the claims
made in the Consolidated Amended Complaint and intends to contest the action
vigorously, an adverse resolution of the lawsuit 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 Consolidated
Amended Complaint.
6
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Restructuring Charge
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 primarily 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 and support costs for a discontinued
product. The amounts accrued to and charged against restructuring costs during
the second quarter of 1998 and the composition of the remaining balance at
June 30, 1998 were as follows:
<TABLE>
<CAPTION>
Balance Balance
March 31, Q2 1998 Q2 1998 June 30,
1997 Accrual Charges 1998
--------- ------- ------- --------
(in thousands)
<S> <C> <C> <C> <C>
Provision for severance and benefit
payments to terminated employees.......... $-- $ 947 $(526) $421
Provisions related to closure of
facilities................................ -- 327 -- 327
Other...................................... -- 165 (41) 124
--- ------ ----- ----
Total.................................... $-- $1,439 $(567) $872
=== ====== ===== ====
</TABLE>
4. 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 six months ended June 30, 1998 and 1997, the Company's
comprehensive income (loss) was as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
1998* 1997 1998* 1997
----------- -------- ----------- --------
<S> <C> <C> <C> <C>
Net income (loss)............... $(1,839,000) $438,000 $(5,197,000) $844,000
Cumulative translation
adjustment..................... 14,000 (31,000) 11,000 (38,000)
----------- -------- ----------- --------
$(1,825,000) $407,000 $(5,186,000) $806,000
=========== ======== =========== ========
</TABLE>
- --------
* Restated--See Note 7.
5. 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
7
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 earnings per share amounts for all periods presented herein, as
required.
6. Recently Issued Accounting Standards
In October 1997, the Accounting Standards Executive Committee ("AcSEC") of
the American Institute of Certified Public Accountants ("AICPA") issued
Statement of Position ("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 is
effective for transactions entered into during fiscal years beginning after
December 15, 1997. On March 18, 1998, the FASB cleared a new SOP that provides
for the one-year deferral of certain provisions of SOP 97-2 pertaining to its
requirements for what constitutes vendor-specific evidence of the fair value
of multiple elements included in an arrangement. It is AcSEC's stated
intention to immediately begin a project to consider whether guidance is
needed on any restrictions that should be placed on what constitutes evidence
of fair value and, if so, what the guidance should be. Because of the
uncertainties with respect to the outcome of any such project, the Company
believes that the impact of the deferred provisions of SOP 97-2 on its
financial position or results of operations upon expiration of the one-year
deferral period is not currently determinable. However, the Company believes
that those provisions of SOP 97-2 that have not been deferred and, therefore,
were effective as of January 1, 1998, have not materially affected its
financial position or results of operations.
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.
7. Subsequent Events
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, the Company determined that the Company's results of operations for the
quarterly periods ended March 31, 1998 and June 30, 1998 and the year ended
December 31, 1997 required 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
8
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 SOP 97-2, issued by the 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 restatement
for the year ended December 31, 1997 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 has restated its 1997 results to remove the $592,000
of revenue involved and has not recorded this revenue in any subsequent period.
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 results of operations for the quarterly periods ended March 31,
1998 and June 30, 1998 and the year ended December 31, 1997 (in thousands,
except per share-related data):
<TABLE>
<CAPTION>
Quarterly Periods Ended
----------------------------
Year Ended
March 31, 1998 June 30, 1998 December 31, 1997
-------------- ------------- -----------------
<S> <C> <C> <C>
As previously reported:
Revenue....................... $10,150 $11,830 $ 40,301
Loss from operations.......... (2,775) (1,102) (67,582)
Net loss...................... (2,566) (979) (66,910)
Basic and diluted net loss per
share........................ $ (0.16) $ (0.06) $ (6.97)
<CAPTION>
Quarterly Periods Ended
----------------------------
Year Ended
March 31, 1998 June 30, 1998 December 31, 1997
-------------- ------------- -----------------
<S> <C> <C> <C>
As restated:
Revenue....................... $ 9,433 $11,083 $ 39,709
Loss from operations.......... (3,567) (1,962) (68,174)
Net loss...................... (3,358) (1,839) (67,490)
Basic and diluted net loss per
share........................ $ (0.21) $ (0.11) $ (7.03)
</TABLE>
Company Status
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 in the years
ended December 31, 1997 and 1998, which raises doubt about its ability to
continue as a going concern. The Company's cash flow requirements depend on the
results of future operations and 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. 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.
9
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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. There are no amounts outstanding under the
revolving credit facility and the Company has provided cash collateral for all
amounts outstanding under the equipment financing agreement and for a $300,000
standby letter of credit issued by the bank. 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.
In-Process Research and Development
In the fourth quarter of 1997, the Company expensed $70,800,000 relating to
in-process research and development in connection with the acquisition of MDI
during 1997. During 1998, the Company 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 this in-process research and development.
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.
Disposition of Majority-owned Subsidiary
In July 1998, the Company divested all of its interest in Persist, S.A.
("Persist"), the Company's majority owned Spanish subsidiary, for $600,000
cash less adjustments for certain inter-company balances then outstanding.
Accordingly, the results of operations of Persist will no longer be
consolidated with the results of the Company. As a result of this transaction,
Persist became wholly owned by the former minority shareholders. During the
six months ended June 30, 1998, Persist had revenues of $1,090,000.
10
<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 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 for the IBM mainframe and AS/400 platforms, from American Premier
Underwriters, Inc. ("APU"). In 1998 the Company further emphasized its
products and services by selling and providing direct delivery of year 2000
renovation services.
The Company derives its revenue from software maintenance outsourcing
services, software and methodology licensing and other services (including
direct delivery of year 2000 renovation services) sold directly to end users
or indirectly via value added integrators and distributors, and its clients
included 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,
through value added integrators operating worldwide and through international
distributors in Canada, Europe and Japan.
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, the Company determined that the Company's results of operations for the
quarterly periods ended March 31, 1998 and June 30, 1998 and the year ended
December 31, 1997 required 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 restatement for the year
ended December 31, 1997 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 has restated its 1997 results to remove the $592,000 of revenue
involved and has not recorded this revenue in any subsequent period.
11
<PAGE>
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 results of operations for the quarterly periods ended March 31,
1998 and June 30, 1998 and the year ended December 31, 1997 (in thousands,
except per share-related data):
<TABLE>
<CAPTION>
Quarterly Periods Ended
----------------------------
Year Ended
March 31, 1998 June 30, 1998 December 31, 1997
-------------- ------------- -----------------
<S> <C> <C> <C>
As previously reported:
Revenue....................... $10,150 $11,830 $ 40,301
Loss from operations.......... (2,775) (1,102) (67,582)
Net loss...................... (2,566) (979) (66,910)
Basic and diluted net loss per
share........................ $ (0.16) $ (0.06) $ (6.97)
<CAPTION>
Quarterly Periods Ended
----------------------------
Year Ended
March 31, 1998 June 30, 1998 December 31, 1997
-------------- ------------- -----------------
<S> <C> <C> <C>
As restated:
Revenue....................... $ 9,433 $11,083 $ 39,709
Loss from operations.......... (3,567) (1,962) (68,174)
Net loss...................... (3,358) (1,839) (67,490)
Basic and diluted net loss per
share........................ $ (0.21) $ (0.11) $ (7.03)
</TABLE>
In-Process Research and Development
In the fourth quarter of 1997, the Company expensed $70,800,000 relating to
in-process research and development in connection with the acquisition of MDI
during 1997. During 1998, the Company 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 this in-process research and development.
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.
Three Months Ended June 30, 1998 Compared to Three Months Ended June 30, 1997
Revenue
Total revenue increased 23.4% to $11,083,000 in the three months ended June
30, 1998 from $8,982,000 in the three months ended June 30, 1997. This
increase in revenue was due to an increase in year 2000 renovation sources
performed by the Company using the Auto Enhancer/2000 software and the Vantage
YR2000 products. During the three months ended June 30, 1998, one customer
generated 22.8% of total revenue. International revenue increased 107.4% to
$1,178,000 in 1998 from $568,000 in 1997. On July 20, 1998, the Company
divested its entire interest in its majority owned Spanish subsidiary, Persist
S.A. ("Persist") for cash of $600,000 less adjustments for certain inter-
company balances then outstanding. The former minority shareholders of Persist
now own all of that entity. Persist and value added integrators, distributors,
and end users generated 37.6% and 62.4%, respectively of the Company's
international revenue in the three months ended June 30, 1998. Persist
generated substantially all of the Company's international revenue in 1997.
Outsourcing Services
Outsourcing services revenue decreased 8.2% to $2,793,000 in the three
months ended June 30, 1998 from $3,044,000 in the three months ended June 30,
1997. The decrease in outsourcing services revenue in absolute dollars was
primarily attributable to 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
decreased to 25.2% in the three months ended June 30, 1998 from 33.9% in the
three months ended June 30, 1997. The decrease in outsourcing services revenue
as a percentage of total revenue reflects the increased contribution of
license and other services revenue to total revenue during the three months
ended June 30, 1998 when compared to the
12
<PAGE>
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
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 $3,754,000 in the three months ended June 30, 1998 or
33.9% of total revenue, compared to $4,643,000, or 51.7% of total revenue, in
the three months ended June 30, 1997. The decrease in license revenue for the
three months ended June 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.
Other Services
Other services revenue increased 250.3% to $4,536,000 in the three months
ended June 30, 1998 from $1,295,000 in the three months ended June 30, 1997.
As a percentage of total revenue, other services revenue was 40.9% in the
three months ended June 30, 1998 and 14.4% in the three months ended June 30,
1997. The increase in other services revenue in absolute dollars was primarily
attributable to an increase in year 2000 renovation services performed by
Company personnel using the Company's year 2000 products.
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 19.6% to
$1,896,000 in the three months ended June 30, 1998 from $2,358,000 for the
three months ended June 30, 1997. Cost of outsourcing services revenue as a
percentage of outsourcing services revenue decreased to 67.9% in the three
months ended June 30, 1998 from 77.5% in the three months ended June 30, 1997.
The decrease in costs 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 $510,000 in the three months ended June
30, 1998, or 13.6% of license revenue compared to $148,000 or 3.2% of license
revenue, in the three months ended June 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 154.1% to $2,632,000 in the three
months ended June 30, 1998 from $1,036,000 in the three months ended June 30,
1997. Cost of the services revenue as a percentage of other services revenue
decreased to 58.0% in the three months ended June 30, 1998 from 80.0% in the
three months ended June 30, 1997. Costs increased in absolute dollars in the
three months ended June 30, 1998 due to additional staffing the Company
required to support the demand for the Company's year 2000 renovation
services.
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
13
<PAGE>
activities. Sales and marketing expenses increased 60.5% to $3,266,000 in the
three months ended June 30, 1998 from $2,035,000 in the three months ended
June 30, 1997. As a percentage of total revenue, sales and marketing expenses
increased to 29.5% in the three months ended June 30, 1998 from 22.7% in the
three months ended June 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 to
$2,001,000 in the three months ended June 30, 1998 from $1,969,000 in the
three months ended June 30, 1997. As a percentage of total revenue, research
and development expenses decreased to 18.1% in the three months ended June 30,
1998 from 21.9% in the three months ended June 30, 1997.
General and Administrative
General and administrative expenses consist primarily of salaries and
related costs for the finance and accounting, human resources, legal services,
information systems and other administrative departments of the Company, as
well as legal and accounting expenses and the amortization of intangible
assets associated with the Vista acquisition. General and administrative
expenses increased 48.7% to $1,301,000 in the three months ended June 30, 1998
from $875,000 in the three months ended June 30, 1997. As a percentage of
total revenue, general and administrative expenses increased to 11.7% in the
three months ended June 30, 1998 from 9.7% in the three months ended June 30,
1997. The increase in general and administrative expenses in absolute dollars
was primarily due to additions to the Company's administrative staff to
support growth, higher professional fees and increases in other general
corporate expenses as well as increased costs associated with being a publicly
traded company.
Restructuring Charge
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, by recording a non-recurring charge of $1,439,000 in
the three months ended June 30, 1998, consisting primarily of severance
payments associated with the termination of approximately 48 employees, costs
associated with closing two research and development and outsourcing service
centers, and support costs for a discontinued product.
Interest Income (Expense), Net
Interest income (expense), 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 $185,000 in the three
months ended June 30, 1998 compared to interest expense, net of $7,000 in the
three months ended June 30, 1997. This change in interest income, net was
primarily attributable to increased interest income from increased cash
balances resulting from the Company's initial public offering in July 1997.
Provision for Income Taxes
The Company's income tax provision was $25,000 and $124,000 in the three
months ended June 30, 1998 and 1997, respectively. The provision in 1998
reflects potential 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
14
<PAGE>
subsidiary decreased to a loss of $37,000 in the three months ended June 30,
1998 from income of $8,000 in the three months ended June 30, 1997. This
change was the result of the increased profitability of Persist. At June 30,
1998 and 1997, the Company held a 63.0% equity interest in Persist.
Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997
Revenue
Total revenue increased 21.8% to $20,516,000 in the six months ended June
30, 1998 from $16,841,000 in the six months ended June 30, 1997. This increase
in revenue was primarily due to an increase in year 2000 renovation services
performed by the Company using the Auto Enhancer/2000 software and Vantage
YR2000 products. During the six months ended June 30, 1998, one customer
generated 12.3% of total revenue. International revenue increased 138.6% to
$3,102,000 in the six months ended June 30, 1998 from $1,300,000 in the six
months ended June 30, 1997. On July 20, 1998, the Company divested its entire
interest in its majority owned Spanish subsidiary, Persist S.A. ("Persist")
for cash of $600,000 less adjustments for certain inter-company balances then
outstanding. The former minority shareholders of Persist now own all of that
entity. Persist and value added integrators, distributors, and end users
generated 35.1% and 64.9%, respectively of the Company's international revenue
in the six months ended June 30, 1998. Persist generated substantially all of
the Company's international revenue in the six months ended June 30, 1997.
Outsourcing Services
Outsourcing services revenue decreased 2.7% to $5,415,000 in the six months
ended June 30, 1998 from $5,563,000 in the six months ended June 30, 1997. The
decrease in outsourcing services revenue in absolute dollars was primarily
attributable to 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 26.4% in the six months ended June 30, 1998 from 33.0% in
the six months ended June 30, 1997. The decrease in outsourcing revenue as a
percentage of total revenue reflects the increased contribution of license and
renovation services revenue to total revenue during the six months ended June
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 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 $7,839,000 in the six months ended June 30, 1998 or
38.2% of total revenue, compared to $8,787,000, or 52.2% of total revenue, in
the six months ended June 30, 1997. The decrease in license revenue for the
six months ended June 30, 1998 was primarily attributable to the decrease in
the delivery of licensed software to additional end users.
Other Services
Other services revenue increased 191.5% to $7,262,000 in the six months
ended June 30, 1998 from $2,491,000 in the six months ended June 30, 1997. As
a percentage of total revenue, other services revenue was 35.4% in the six
months ended June 30, 1998 and 14.8% in the six months ended June 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.
15
<PAGE>
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 9.0% to $4,007,000
in the six months ended June 30, 1998 from $4,403,000 for the six months ended
June 30, 1997. Cost of outsourcing services revenue as a percentage of
outsourcing services revenue decreased to 74.0% in the six months ended June
30, 1998 and from 79.1% in the six months ended June 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 $1,046,000 in the six months ended June
30, 1998, or 13.3% of license revenue compared to $275,000 or 3.1% of license
revenue, in the six months ended June 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 118.7% to $5,085,000 in the six
months ended June 30, 1998 from $2,325,000 in the six months ended June 30,
1997. Cost of the services revenue as a percentage of other services revenue
decreased to 70.0% in the six months ended June 30, 1997 from 93.3% in the
three months ended June 30, 1997. Costs increased in absolute dollars in the
six months ended June 30, 1998 due to additional staffing the Company required
to support the demand from the Company's year 2000 renovation products and
services.
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 86.5% to $6,375,000 in the six months
ended June 30, 1998 from $3,418,000 in the six months ended June 30, 1997. As
a percentage of total revenue, sales and marketing expenses increased to 31.1%
in the six months ended June 30, 1998 from 20.3% in the three months ended
June 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 40.0%
to $5,045,000 in the six months ended June 30, 1998 from $3,603,000 in the six
months ended June 30, 1997. As percentage of total revenue, research and
development expenses increased to 24.6% in six months ended June 30, 1998 from
21.4% in the six months ended June 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
16
<PAGE>
year 2000 products and services and mass change technologies, including an
increase in staffing effected through new hires and internal transfers.
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 69.3% to $3,048,000 in the six months ended June 30, 1998 from
$1,800,000 in the six months ended June 30, 1997. As a percentage of total
revenue, general and administrative expenses increased to 14.9% in the six
months ended June 30, 1998 from 10.7% in the six months ended June 30, 1997.
The increase in general and administrative expenses in absolute dollars was
primarily due to additions to the Company's administrative staff to support
growth, higher professional fees and increases in other general corporate
expenses as well as increased costs associated with being a publicly traded
company.
Restructuring Charge
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, by recording a non-recurring charge of $1,439,000 in
the three months ended June 30, 1998, consisting primarily of severance
payments associated with the termination of approximately 48 employees, costs
associated with closing two research and development and outsourcing service
centers and support costs for a discontinued product.
Interest Income (Expense), Net
Interest income (expense), 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 $345,000 in the six
months ended June 30, 1998 compared to interest income, net of $20,000 in the
six months ended June 30, 1997. This change in interest income, net was
primarily attributable to increased interest income from increased cash
balances resulting from the Company's initial public offering.
Provision for Income Taxes
The Company's income tax provision was $25,000 and $172,000 in the six
months ended June 30, 1998 and 1997, respectively. The provision in the six
months ended June 30, 1998 reflects potential 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 income of $12,000 in the six months ended June 30, 1998 from a
loss of $21,000 in the six months ended June 30, 1997. This change was the
result of the decreased profitability of Persist. As of June 30, 1998 and
1997, the Company held a 63.0% equity interest in 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 were $5,285,000 and
$11,340,000 at June 30, 1998 and December 31, 1997, respectively. The
Company's working capital was $16,010,000 and $20,931,000 at June 30,
17
<PAGE>
1998 and December 31, 1997, respectively. The Company's operating activities
used cash of $3,775,000 and $4,071,000 during the six months ended June 30,
1998 and 1997, respectively. The Company's use of cash during the six months
ended June 30, 1998 was primarily caused by net loss of $5,197,000 less non-
cash depreciation and amortization expense of $1,660,000, an increase in
prepaid expenses and other current assets of $885,000 and a decrease in
accounts payable, deferred revenue and other accrued expenses and current
liabilities of $2,421,000. These uses of cash were partially offset by a
decrease in accounts receivable of $3,230,000.
The Company used cash of $3,415,000 and $890,000 for investing activities
during the six months ended June 30, 1998 and 1997, respectively. Investing
activities in the six months ended June 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 develop its infrastructure.
The Company's financing activities provided cash of $1,124,000 and $84,000
during the six months ended June 30, 1998 and 1997, respectively. Financing
activities in the six months ended June 30, 1998 primarily reflect proceeds
from the exercise of stock options.
In September 1996, the Company obtained a revolving line of credit facility
from a bank which bears interest at the bank's prime rate plus 0.5% (9.00% at
June 30, 1998). The Company has obtained approval of amendments of its credit
facility providing for among other terms, renewal and increase of its line of
credit. Maximum borrowing under this line of credit, as amended, is $5,000,000
and is limited to 75% of certain receivables plus 50% of cost and estimated
earnings in excess of billings on uncompleted contracts, as defined by the
line of credit agreement. The line of credit expires and all borrowings are
payable in full on June 30, 1999. In addition to this line of credit, the
Company also entered into an equipment financing agreement in September 1996.
Under this agreement, the bank agreed to provide up to $1,500,000 for the
purchase of certain equipment (as defined by the agreement) through June 30,
1997. Ratable principal and interest payments are payable during the period
July 1, 1997 through June 1, 2000, and bear interest at the bank's prime rate
plus 1% (9.50% at June 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 June 30, 1998, the Company was in compliance with
such financial covenants as waived or amended, there were no borrowings
outstanding, and $5,000,000 remained available, under the revolving credit
facility and $415,000 was outstanding under the equipment financing agreement.
To date, the Company has not invested in derivative securities or any other
financial instruments that involve a high level of complexity or risk. Excess
cash has been, and the Company contemplates that it will continue to be
invested in interest-bearing, investment grade securities.
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 in the years
ended December 31, 1997 and 1998, which raises doubt about its ability to
continue as a going concern. The Company's cash flow requirements depend on
the results of future operations and 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. 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.
18
<PAGE>
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. There are no amounts outstanding under the
revolving credit facility and the Company has provided cash collateral for all
amounts outstanding under the equipment financing agreement and for a $300,000
standby letter of credit issued by the bank. 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 on the sale of assets may no 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 of 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 financing
would adversely impact the Company's ability to continue as a going concern.
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 American Institute of Certified Public Accountants issued Statement of
Position ("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 is effective for
transactions entered into during fiscal years beginning after December 15,
1997. On March 18, 1998, the Financial Accounting Standards Board ("FASB")
cleared a new SOP that provides for the one-year deferral of certain
provisions of SOP 97-2 pertaining to its requirements for what constitutes
vendor specific evidence of the fair value of multiple elements included in an
arrangement. It is AcSEC's stated intention to immediately begin a project to
consider whether guidance is needed on any restrictions that should be placed
on what constitutes evidence of fair value and, if so, what the guidance
should be. Because of the uncertainties with respect to the outcome of any
such project, the Company believes that the impact of the deferred provisions
of SOP 97-2 on its financial position or results of operations upon expiration
of the one-year deferral period is not currently determinable. However, the
Company believes that those provisions of SOP 97-2 that have not been deferred
and, therefore, were effective as of January 1, 1998, have not materially
affected its financial position or results of operations.
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
19
<PAGE>
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.
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, the Company's quarterly revenue, expenses and operating results
have varied significantly in the past and are likely to vary significantly
from quarter to quarter in the future. A significant portion of the Company's
revenue in any quarter is typically derived from a limited number of large
client transactions. In addition, the sales cycle associated with these
transactions is lengthy and is subject to a number of uncertainties, including
clients' budgetary constraints, the timing of clients' budget cycles and
clients' internal approval processes. Accordingly, the timing of significant
transactions is unpredictable and, as a result, the Company's revenue and
results of operations for any particular period are subject to significant
variability. The complexity of certain projects and the requirements of
generally accepted accounting principles can also result in a deferral of
revenue recognition, in whole or in part, on a particular contract during a
quarter, even though the contract has been executed or payment has actually
been received by the Company. Quarterly fluctuations may also result from
other factors such as new product and service introductions or announcements
of new products and services by the Company's competitors, changes in the
Company's or its competitors' pricing policies, changes in the mix of
distribution channels through which the Company's products and services are
sold, the timing and nature of sales and marketing expenses, changes in
operating expenses, the financial stability of major clients, changes in the
demand for software maintenance products and services, foreign currency
exchange rates and general economic conditions.
The Company began an assessment of certain of its internal computer hardware
and software in connection with the year 2000 problem and expects to complete
its assessment of such hardware and software in 1998. The Company expects that
its business systems installed in 1997 will be year 2000 compliant through
upgrades and
20
<PAGE>
maintenance thereto. The Company expects that costs related to providing that
its internal computer hardware and software will be year 2000 compliant will
not be material to the financial condition or results of operations of the
Company and are not expected to be significant.
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.
21
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company and certain of its officers and directors were 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 complaints principally alleged 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 alleged a 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 named Montgomery Securities, Inc., Wessels, Arnold &
Henderson, and H.C. Wainwright & Co., Inc. as defendants. The complaints
further alleged that certain officers and/or directors of the Company sold
stock in the open market during the class periods and sought 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.
On January 8, 1999, the plaintiffs filed a Consolidated Amended Complaint
applicable to all previously filed actions. The Consolidated Amended Complaint
alleges a class period of October 22, 1997 through October 26, 1998 and
principally claims that the Company, two of its former officers and its
president violated federal securities laws by purportedly making false and
misleading statements (or omitting material information) concerning the MDI
acquisition and the Company's revenue during the proposed class period,
thereby allegedly causing the value of the Company's stock to be artificially
inflated. Previously stated claims against the Company and its underwriters
alleging violations of the federal securities laws as a result of purportedly
inadequate or incorrect disclosure in connection with the Company's initial
public offering are not included in the Consolidated Amended Complaint.
Although the Company believes that it has meritorious defenses to the claims
made in the Consolidated Amended Complaint and intends to contest the action
vigorously, an adverse resolution of the lawsuit 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 Consolidated
Amended Complaint.
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.
<TABLE>
<C> <S>
*Exhibit 10.1. Employment Agreement dated as of May 18, 1998 between the
Company and Richard Wilkie
*Exhibit 10.2. Employment Agreement dated as of May 18, 1998 between the
Company and Peter Espinosa
*Exhibit 10.3. Promissory Note of Peter Espinosa payable to the Company
dated May 29, 1998
</TABLE>
22
<PAGE>
<TABLE>
<C> <S>
*Exhibit 10.4. Service Agreement dated as of November 18, 1997 by and
between the Company and Great American Insurance Company
**Exhibit 11. Statement re computation of per share earnings
**Exhibit 27. Restated Financial Data Schedule
</TABLE>
- --------
* Previously filed with the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1998, as filed with the Securities and
Exchange Commission on August 14, 1998.
** Restated in its entirety as filed with this Amendment No.1 on Form 10-Q/A
for the quarterly period ended June 30, 1998.
(b) Reports on Form 8-K
None.
23
<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: January 20, 1999
Peritus Software Services, Inc.
By: /s/ John D. Giordano
-------------------------------
John D. Giordano Vice President,
Finance and Chief Financial
Officer
(Principal Financial Officer)
24
<PAGE>
Peritus Software Services, Inc.
Amendment No. 1 on Form 10-Q/A
For the Quarterly Period Ended June 30, 1998
Exhibit Index
<TABLE>
<CAPTION>
Exhibit No. Description
--------------- --------------------------------------------------------------
<C> <S>
*Exhibit 10.1. Employment Agreement dated as of May 18, 1998 between the
Company and Richard Wilkie
*Exhibit 10.2. Employment Agreement dated as of May 18, 1998 between the
Company and Peter Espinosa
*Exhibit 10.3. Promissory Note of Peter Espinosa payable to the Company dated
May 29, 1998
*Exhibit 10.4. Service Agreement dated as of November 18, 1997 by and between
the Company and Great American Insurance Company
**Exhibit 11. Statement re computation of net income (loss) per common share
**Exhibit 27. Restated Financial Data Schedule
</TABLE>
- --------
* Previously filed with the Company's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1998, as filed with the Securities and
Exchange Commission on August 14, 1998.
** Restated in its entirety as filed with this Amendment No. 1 on Form 10-Q/A
for the quarterly period ended June 30, 1998.
25
<PAGE>
Exhibit 11
Peritus Software Services, Inc.
Statement re computation of net income (loss) per common share
(in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months
June 30, Ended June 30,
------------------- ---------------
1998* 1997 1998* 1997
--------- -------- ------- ------
<S> <C> <C> <C> <C>
Net income (loss), as reported........... $ (1,839) $ 438 $(5,197) $ 844
Preferred stock preference items:
Accrual of cumulative dividends on
Series A and Series B redeemable
convertible preferred stock........... -- (444) -- (675)
Accretion to redemption of redeemable
common stock rights................... -- (31) -- (57)
--------- -------- ------- ------
Total preferred stock preference
items............................... -- (475) -- (732)
--------- -------- ------- ------
Net income (loss) attributable to common
stockholders............................ $ (1,839) $ (37) $(5,197) $ 112
--------- -------- ------- ------
Weighted average shares outstanding--
Basic................................... 16,179 6,000 16,082 5,944
Adjustments thereto:
Shares attributable to common stock
equivalents........................... -- -- -- 2,587
--------- -------- ------- ------
Weighted average shares outstanding--
Diluted................................. 16,179 6,000 16,082 8,531
========= ======== ======= ======
Net income (loss) per share:
Basic.................................. $ (0.11) $ (0.01) $ (0.32) $ 0.02
========= ======== ======= ======
Diluted................................ $ (0.11) $ (0.01) $ (0.32) $ 0.01
========= ======== ======= ======
</TABLE>
- --------
* Restated--See Note 7 to the Unaudited Consolidated Financial Statements.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS<F1>
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 5,285
<SECURITIES> 4,000
<RECEIVABLES> 9,842
<ALLOWANCES> (445)
<INVENTORY> 0
<CURRENT-ASSETS> 23,060
<PP&E> 9,074
<DEPRECIATION> (3,553)
<TOTAL-ASSETS> 33,801
<CURRENT-LIABILITIES> 7,050
<BONDS> 0
0
0
<COMMON> 163
<OTHER-SE> 25,971
<TOTAL-LIABILITY-AND-EQUITY> 33,801
<SALES> 20,516
<TOTAL-REVENUES> 20,516
<CGS> 10,138
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 15,907
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 345
<INCOME-PRETAX> (5,184)
<INCOME-TAX> 25
<INCOME-CONTINUING> (5,209)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 12
<NET-INCOME> (5,197)
<EPS-PRIMARY> (0.32)
<EPS-DILUTED> (0.32)
<FN>
<F1> RESTATED - SEE NOTE 7 TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
</FN>
</TABLE>
