<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
AMENDMENT NO. 1
ON
FORM 10-Q/A
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
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)
Two 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 November 7, 1997
-------------- -------------------
<S> <C>
Common Stock, $.01 par value 13,170,356
</TABLE>
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<PAGE>
PERITUS SOFTWARE SERVICES INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
Part I. Financial Information ----
<C> <S> <C>
Item 1. Financial Statements
Consolidated Balance Sheet as of September 30, 1997 and
December 31, 1996.......................................... 3
Consolidated Statement of Operations for the Three and Nine
Months Ended September 30, 1997 and 1996................... 4
Consolidated Statement of Cash Flows for the Nine Months
Ended September 30, 1997 and 1996.......................... 5
Notes to Unaudited Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................. 10
<CAPTION>
Part II. Other Information
<C> <S> <C>
Item 1. Legal Proceedings........................................... 20
Item 6. Exhibits and Reports on Form 8-K............................ 20
Signatures.................................................. 21
</TABLE>
The Registrant hereby amends its Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1997, 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 Pro forma Net Income (loss) per Common Share, and Exhibit
27. Restated Financial Data Schedule, in their entirety as follows.
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,
ASSETS 1997* 1996
------ ------------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents.......................... $46,292 $ 7,388
Accounts receivable, net of allowance for doubtful
accounts of $45 and $30, respectively, and
including amounts receivable from related parties
of $114 and $260, respectively.................... 5,969 4,163
Costs and estimated earnings in excess of billings
on uncompleted contracts, including amounts on
uncompleted contracts with related parties of $160
and $562, respectively............................ 1,619 2,195
Unbilled license revenue from related party........ -- 1,400
Prepaid expenses and other current assets.......... 570 119
------- -------
Total current assets.............................. 54,450 15,265
Property and equipment, net......................... 2,486 1,970
Other assets........................................ 670 490
------- -------
$57,606 $17,725
======= =======
<CAPTION>
LIABILITIES, REDEEMABLE STOCK AND STOCKHOLDERS'
EQUITY
-----------------------------------------------
<S> <C> <C>
Current liabilities:
Current portion of capital lease obligations....... $ 53 $ 74
Current portion of long-term debt.................. 225 225
Accounts payable................................... 912 497
Billings in excess of costs and estimated earnings
on uncompleted contracts.......................... 726 902
Deferred revenue................................... 1,382 3,262
Other accrued expenses and current liabilities..... 2,486 2,087
------- -------
Total current liabilities......................... 5,784 7,047
Capital lease obligations........................... 157 201
Long-term debt...................................... 425 1,337
------- -------
Total liabilities................................. 6,366 8,585
------- -------
Minority interest in consolidated subsidiary........ 170 155
------- -------
Redeemable convertible preferred stock, no par
value:
Series A--1,903,525 shares authorized, issued and
outstanding at issuance
Cost plus accretion and accrued dividends
(liquidation preference $7,281)................... -- 5,912
Series B--1,818,182 shares authorized, issued and
outstanding at issuance
Cost plus accretion and accrued dividends
(liquidation preference $6,000)................... -- 6,107
Redeemable common stock right....................... -- 268
------- -------
-- 12,287
------- -------
Stockholders' equity:
Common stock, $.01 par value; 50,000,000 and 0
shares authorized, respectively; 13,162,236 and 0
shares issued and outstanding, respectively....... 132 --
Class A common stock, no par value; 0 and
13,295,000 shares authorized, respectively; 0 and
6,033,614 shares issued and outstanding,
respectively...................................... -- 2,207
Class B non-voting common stock, no par value; 0
and 275,000 shares authorized, respectively; 0 and
101,196 shares issued and outstanding,
respectively...................................... -- 164
Additional paid-in capital......................... 56,461 --
Accumulated deficit................................ (5,397) (5,593)
Note receivable from stockholder................... (58) (58)
Cumulative translation adjustment.................. (68) (22)
------- -------
Total stockholders' equity (deficit).............. 51,070 (3,302)
------- -------
$57,606 $17,725
======= =======
</TABLE>
- --------
* Restated -- See Note 5.
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,
-------------- ---------------
1997* 1996 1997* 1996
------ ------ ------- -------
<S> <C> <C> <C> <C>
Revenue:
Outsourcing services, including $959, $1,325,
$2,912 and $3,770 from related parties,
respectively................................ $2,979 $2,611 $ 8,542 $ 7,369
License...................................... 3,957 2,424 12,744 2,469
Other services................................ 1,716 610 4,207 1,715
------ ------ ------- -------
Total revenue............................... $8,652 $5,645 $25,493 $11,553
------ ------ ------- -------
Cost of revenue:
Cost of outsourcing services including $615,
$517, $1,580 and $1,510 from related
parties, respectively....................... $2,444 $1,977 $ 6,847 $ 6,410
License...................................... 155 40 430 40
Cost of other services....................... 1,280 816 3,605 1,994
------ ------ ------- -------
Total cost of revenue....................... 3,879 2,833 10,882 8,444
------ ------ ------- -------
Gross profit.................................. 4,773 2,812 14,611 3,109
------ ------ ------- -------
Operating expenses:
Sales and marketing.......................... 2,197 668 5,615 2,051
Research and development..................... 1,975 1,506 5,578 4,267
General and administrative................... 1,053 763 2,853 2,218
------ ------ ------- -------
Total operating expenses.................... 5,225 2,937 14,046 8,536
------ ------ ------- -------
Income (loss) from operations............... (452) (125) 565 (5,427)
Interest (expense) income, net................ 462 (77) 482 (176)
------ ------ ------- -------
Income (loss) before estimated income taxes
and minority interest....................... 10 (202) 1,047 (5,603)
Provision for (benefit from) estimated income
taxes........................................ (68) (1) 104 (205)
Minority interest in consolidated subsidiary.. (6) 5 15 (15)
------ ------ ------- -------
Net income (loss)........................... 84 (206) 928 (5,383)
Accrual of dividends of Series A and B
preferred stock.............................. -- 182 675 395
Accretion to redemption value of redeemable
stock........................................ -- 53 57 125
------ ------ ------- -------
Net income (loss) available to common
stockholders............................... $ 84 $ (441) $ 196 $(5,903)
====== ====== ======= =======
Net income (loss) per common share:
Basic........................................ $ 0.01 $(0.08) $ 0.02 $ (1.01)
====== ====== ======= =======
Diluted...................................... $ 0.01 $(0.08) $ 0.02 $ (1.01)
====== ====== ======= =======
Weighted average common shares outstanding:
Basic........................................ 12,432 5,878 8,107 5,860
====== ====== ======= =======
Diluted...................................... 14,280 5,878 11,466 5,860
====== ====== ======= =======
Pro forma net income (loss) per share:
Basic........................................ $ 0.01 $(0.03) $ 0.09 $ (0.74)
====== ====== ======= =======
Diluted...................................... $ 0.01 $(0.03) $ 0.07 $ (0.74)
====== ====== ======= =======
Pro forma average shares outstanding:
Basic........................................ 12,432 7,782 10,602 7,237
====== ====== ======= =======
Diluted...................................... 14,280 7,782 13,961 7,237
====== ====== ======= =======
</TABLE>
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* Restated -- See Note 5.
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,
----------------
1997* 1996
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)........................................... $ 928 $(5,383)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization.............................. 797 613
Minority interest in consolidated subsidiary............... 15 19
Non-cash employee compensation............................. -- 118
Changes in assets and liabilities, net of effects from
acquisition:
Accounts receivable....................................... (1,806) 43
Costs and estimated earnings in excess of billings on
uncompleted contracts.................................... 235 680
Unbilled license revenue from related parties............. 1,741 (1,400)
Prepaid expenses and other current assets................. (451) 175
Other assets.............................................. 37 27
Accounts payable.......................................... 415 (136)
Billings in excess of costs and earnings on uncompleted
contracts................................................ (176) 226
Deferred revenue.......................................... (1,880) 238
Other accrued expenses and current liabilities............ 405 691
Deferred income taxes..................................... -- (186)
------- -------
Net cash provided by (used in) operating activities...... 260 (4,275)
------- -------
Cash flows from investing activities:
Cash of business acquired for common stock, net of costs
paid in cash............................................... -- 174
Investment in subsidiary.................................... (272) --
Purchases of property and equipment......................... (1,262) (926)
------- -------
Net cash used in investing activities.................... (1,534) (752)
------- -------
Cash flows from financing activities:
Proceeds from short-term borrowings, net of repayments...... -- 536
Proceeds from long-term debt................................ 200 450
Principal payments on long-term debt........................ (1,112) (211)
Principal payments on capital lease obligations............. (65) (73)
Proceeds from issuance of common stock, net of issuance
costs...................................................... 41,201 6
Proceeds from sale of redeemable convertible preferred stock
and redeemable common stock, net of issuance costs......... -- 5,408
Treasury stock acquired..................................... -- (531)
------- -------
Net cash provided by financing activities................ 40,224 5,585
------- -------
Effects of exchange rates on cash and cash equivalents....... (46) (21)
------- -------
Net increase in cash and cash equivalents.................... 38,904 537
Cash and cash equivalents, beginning of period............... 7,388 264
------- -------
Cash and cash equivalents, end of period..................... $46,292 $ 801
======= =======
Supplemental disclosures of cash flows:
Cash paid for income taxes.................................. $ 60 $ --
Cash paid for interest...................................... 142 213
</TABLE>
- --------
* Restated -- See Note 5.
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 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 Registration Statement on Form S-1,
Registration No. 333-27087. In the opinion of management, the accompanying
consolidated financial statements contain all adjustments, which other than
the restatement adjustments described in Note 5, 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 Registration
Statement on Form S-1, Registration No. 333-27087. The operating results for
the three and nine months ended September 30, 1997 are not necessarily
indicative of the results to be expected for the full year ending December 31,
1997.
2. 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 ("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 dilutive, potential common stock including convertible
preferred stock and outstanding stock options. The Company adopted SFAS No.
128 during 1997 and has restated earnings per share amounts for all periods
presented herein, as required.
As described in Note 3, all outstanding shares of the Company's redeemable
convertible preferred stock converted to shares of the Company's common stock
upon the closing of the initial public offering. The pro forma basic and
diluted net income (loss) per share information included in the accompanying
consolidated statement of operations for the three and nine month periods
ended September 30, 1997 reflects the impact of such conversion as of the
beginning of the period or date of issuance, if later, using the if-converted
method.
3. Capital Stock
On July 8, 1997, the Company closed its initial public offering of 4,025,000
shares of common stock, 2,800,000 of which were sold by the Company and the
balance by selling stockholders, at a public offering price of $16 per share.
The proceeds to the Company from the offering, net of offering expenses, were
approximately $40,664,000. The Company used a portion of the net proceeds to
repay a secured subordinated note payable. The Company plans to use the
remaining proceeds for the acquisition of Millennium Dynamics, Inc. (see Note
5) and for research and development, working capital and general corporate
purposes. In connection with closing the initial public offering, all
outstanding shares of Series A and B preferred stock and Class B common stock
automatically converted into 3,822,903 shares of common stock, and the
redeemable common stock right automatically terminated.
6
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Recently Issued Accounting Standards
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." 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 will require
that an enterprise display an amount representing total comprehensive income
for the period. SFAS No. 130 will be effective for the Company's year ending
December 31, 1998. Adoption of SFAS No. 130 is for presentation only and will
not affect the Company's financial position 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 year ending December 31, 1998 and will not affect the Company's
financial position or results of operations.
In October 1997, the Accounting Standards Executive Committee 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. SOP 97-2 supersedes
SOP 91-1 (also entitled "Software Revenue Recognition") and is effective for
transactions entered into during fiscal years beginning after December 15,
1997. The Company will be required to adopt SOP 97-2 for its fiscal year
ending December 31, 1998. The Company has determined that SOP 97-2 will not
affect the Company's financial position or results of operations.
5. Subsequent Events
Restatement of 1997 Quarterly 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 auditors, PricewaterhouseCoopers
LLP, the Company determined that the Company's results of operations for the
quarterly period ended September 30, 1997 required restatement. The
restatement 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 has restated 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.
In the opinion of management, all adjustments necessary to revise the third
quarter 1997 financial statements have been recorded. Below is a summary of
the results of operations for the quarterly period ended September 30, 1997
(in thousands, except per share-related data):
7
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
<TABLE>
<CAPTION>
Quarterly
Period Ended
September 30,
1997
-------------
<S> <C>
As previously reported:
Revenue................................................... $9,852
Income from operations.................................... 748
Net income................................................ 1,166
Basic net income per share................................ $ 0.09
Diluted net income per share.............................. $ 0.08
As restated:
Revenue................................................... $8,652
Loss from operations...................................... (452)
Net income................................................ 84
Basic and diluted net income per share.................... $ 0.01
</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.
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.
Acquisition of MDI and In-Process Research and Development
In December, 1997, the Company acquired substantially all of the assets and
certain liabilities of Millennium Dynamics, Inc. ("MDI"), a wholly-owned
subsidiary of American Premier Underwriters, Inc. ("APU"). MDI provides
software tools for a broad range of mainframe and midrange platforms and
languages
8
<PAGE>
PERITUS SOFTWARE SERVICES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and consultation services that enable organizations to address their "year 2000
problem". Upon completion of the acquisition, the Company paid $30 million in
cash and issue 2,175,000 unregistered shares of its common stock to APU, and
MDI's assets and certain of its liabilities were transferred to the Company.
The Company accounted for the acquisition as a purchase under APB No. 16, with
all assets acquired and liabilities assumed being recorded at their fair values
at the date of closing.
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 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.
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.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Peritus Software Services, Inc. ("Peritus" or the "Company") was founded in
1991 to address the growing market for managing and maintaining the installed
base of software in organizations. The Company focused its efforts on the
delivery of software maintenance outsourcing services until 1995, when it
began to devote significant resources to the development of software tools
addressing the problems associated with mass changes to application systems
and their associated databases, particularly the year 2000 problem. In 1996,
the Company began licensing its AutoEnhancer/2000 software, which was designed
to address the year 2000 problem, to value added integrators and directly to
end users. In 1996, the Company expanded its research and development efforts
through the acquisition of Vista Technologies Incorporated, a developer of
computer-aided engineering software ("Vista"). During the quarter ended
September 30, 1997, the Company expanded its product offering 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.
The Company derives its revenue from software maintenance outsourcing
services, software and methodology licensing and other services sold directly
to end users or indirectly via value added integrators and distributors, and
its clients include primarily Fortune 1000 companies and similarly sized
business and government organizations worldwide. The Company's products and
services are marketed through its direct sales force, both domestically and in
Spain, through value added integrators operating worldwide and through
international distributors in Canada, Italy and Japan.
On July 8, 1997, the Company closed its initial public offering of 4,025,000
shares of common stock, 2,800,000 of which were sold by the Company and the
balance by selling stockholders, at a price of $16 per share. The proceeds to
the Company from the offering, net of offering expenses, were approximately
$40,664,000. The Company used $500,000 of the net proceeds to repay a secured
subordinated note payable. The Company plans to use the remaining proceeds for
the acquisition of Millennium Dynamics, Inc. ("MDI"), research and
development, and working capital and general corporate purposes. In connection
with closing the initial public offering, all outstanding shares of Series A
and B preferred stock and Class B common stock automatically converted into
3,822,903 shares of common stock, and the redeemable common stock right
automatically terminated.
Restatement of 1997 Quarterly 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 auditors, PricewaterhouseCoopers
LLP, the Company determined that the Company's results of operations for the
quarterly period ended September 30, 1997 required restatement. The
restatement 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 has restated 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.
10
<PAGE>
In the opinion of management, all adjustments necessary to revise the third
quarter financial statements have been recorded. Below is a summary of the
results of operations for the quarterly period ended September 30, 1997 (in
thousands, except per share-related data):
<TABLE>
<CAPTION>
Quarterly
Period Ended
September 30,
1997
-------------
<S> <C>
As previously reported:
Revenue................................................... $9,852
Income from operations.................................... 748
Net income................................................ 1,166
Basic net income per share................................ $ 0.09
Diluted net income per share.............................. $ 0.08
As restated:
Revenue................................................... $8,652
Loss from operations...................................... (452)
Net income................................................ 84
Basic and diluted net income per share.................... $ 0.01
</TABLE>
Acquisition of MDI and In-Process Research and Development
In December 1997, the Company acquired substantially all of the assets and
certain liabilities of MDI, a wholly owned subsidiary of American Premier
Underwriters, Inc. ("APU"). MDI provides software tools for a broad range of
mainframe and midrange platforms and languages and consultation services that
enable organizations to address their "year 2000 problem". Upon completion of
the acquisition, the Company paid $30 million in cash and issue 2,175,000
unregistered shares of its common stock to APU, and MDI's assets and certain
of its liabilities were transferred the Company. The Company accounted for the
acquisition as a purchase under APB No. 16, with all assets acquired and
liabilities assumed being recorded at their fair values at the date of
closing.
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 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 September 30, 1997 Compared to Three Months Ended September
30, 1996
Revenue
Total revenue increased 53.3% to $8,652,000 in the three months ended
September 30, 1997 from $5,645,000 in the three months ended September 30,
1996. This increase was primarily due to the licensing of the Company's
AutoEnhancer/2000 software, as well as from increases in other services
revenue and, to a lesser extent, outsourcing services revenue. International
revenue increased 21.5% to $801,000 in the three months ended September 30,
1997 from $659,000 in the three months ended September 30, 1996. A majority of
all of the Company's international revenue for the three months ended
September 30, 1997 and 1996 was attributable to revenue generated by Persist,
S.A. ("Persist"), the Company's majority-owned Spanish subsidiary.
Outsourcing Services. Outsourcing services revenue increased 14.1% to
$2,979,000 in the three months ended September 30, 1997 from $2,611,000 in the
three months ended September 30, 1996. As a percentage of total revenue,
outsourcing services revenue decreased to 34.4% in the three months ended
September 30, 1997 from 46.3% in the three months ended September 30, 1996.
The increase in outsourcing services revenue in absolute dollars was primarily
attributable to the addition of two new outsourcing contracts in late 1996 and
one in 1997 and was partially offset by the recognition of lesser amounts of
revenue under the percentage-of
11
<PAGE>
completion method on existing outsourcing contracts that were in their later
phases. The decrease in outsourcing services revenue as a percentage of total
revenue reflects the greater contribution of license revenue to total revenue
during the three months ended September 30, 1997 when compared to the same
three months in 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.
License. License revenue was $3,957,000 in the three months ended September
30, 1997 or 45.7% of total revenue. The Company recognized $2,424,000 in
license revenue in the three months ended September 30, 1996 or 42.9% of total
revenue. The increase in license revenue for the three months ended September
30, 1997 was primarily attributable to the delivery of licensed software to
additional end users and to increased license fees from value added
integrators.
Other Services. Other services revenue increased 181.3% to $1,716,000 in the
three months ended September 30, 1997 from $610,000 in the three months ended
September 30, 1996. As a percentage of total revenue, other services revenue
was 19.8% in the three months ended September 30, 1997 compared to 10.8% in
the three months ended September 30, 1996. The increase in other services
revenue in absolute dollars was primarily attributable to an increase in
consulting, training and client support services relating to the Company's
year 2000 products and services.
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 increased 23.6% to $2,444,000 in the three months ended September 30,
1997 from $1,977,000 for the three months ended September 30, 1996. Cost of
outsourcing services revenue increased as a percentage of outsourcing services
revenue to 82.0% in the three months ended September 30, 1997 from 75.7% in
the three months ended September 30, 1996. The increase in the cost of
outsourcing services revenue as a percentage of outsourcing services revenue
was due primarily to the addition of resources necessary to provide services
under new outsourcing contracts.
Cost of License Revenue. Cost of license revenue consists primarily of
salaries, benefits and related overhead costs associated with license-related
materials packaging and freight. Cost of license revenue was $155,000 in the
three months ended September 30, 1997, or 3.9% of license revenue. Cost of
license revenue was $40,000 in the three months ended September 30, 1996. 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.
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
56.9% to $1,280,000 in the three months ended September 30, 1997 from $816,000
in the three months ended September 30, 1996. Cost of other services revenue
as a percentage of other services revenue decreased to 74.6% in the three
months ended September 30, 1997 from 133.8% in the three months ended
September 30, 1996. Costs exceeded revenues in the three months ended
September 30, 1996 primarily as a result of expected overruns on one
significant pilot engagement, which subsequently became a significant product
license. Costs increased in absolute dollars in the three months ended
September 30, 1997 due to additional staffing in the Company's client support,
training and consulting organizations related to additional customers for the
Company's year 2000 products and services.
Operating Expenses
Sales and Marketing. Sales and marketing expenses consist primarily of
salaries, commissions and related overhead costs for Company personnel; sales
referral fees to third parties; advertising programs; and other
12
<PAGE>
promotional activities. Sales and marketing expenses increased 228.9% to
$2,197,000 in the three months ended September 30, 1997 from $668,000 in the
three months ended September 30, 1996. As a percentage of total revenue, sales
and marketing expenses increased to 25.4% in the three months ended September
30, 1997 from 11.8% in the three months ended September 30, 1996. 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 launch of the Company's AutoEnhancer/2000 software in
late 1996. The Company intends to increase the amount of expenditures for
sales and marketing in 1997, both domestically and internationally.
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 31.1% to $1,975,000 in the three months ended
September 30, 1997 from $1,506,000 in the three months ended September 30,
1996. As a percentage of total revenue, research and development expenses
decreased to 22.8% in the three months ended September 30, 1997 from 26.7% in
the three months ended September 30, 1996. The increase in research and
development expenses in absolute dollars was primarily attributable to
increased staffing for the product development efforts for the Company's year
2000 products and services and mass change technologies, including an increase
in staffing effected through new hires and internal transfers. The Company
intends to employ additional research and development staff and therefore
anticipates that research and development expenses will continue to increase
in absolute dollars in 1997.
General and Administrative. General and administrative expenses consist
primarily of salaries and related costs for the finance and accounting, human
resources, legal services, information systems and other administrative
departments of the Company, as well as legal and accounting expenses and the
amortization of goodwill associated with the Vista acquisition. General and
administrative expenses increased 38.0% to $1,053,000 in the three months
ended September 30, 1997 from $763,000 in the three months ended September 30,
1996. As a percentage of total revenue, general and administrative expenses
decreased to 12.2% in the three months ended September 30, 1997 from 13.5% in
the three months ended September 30, 1996. The increase in general and
administrative expenses in absolute dollars was primarily due to additions to
the Company's administrative staff to support growth, higher professional fees
and increases in other general corporate expenses. The Company anticipates
that general and administrative expenses will increase in absolute dollars in
1997 in part due to increased costs associated with being a publicly held
company.
Interest Income (Expense), Net. Interest income (expense), net is primarily
composed of interest income from cash balances and interest expense on debt.
The Company had interest income, net of $462,000 in the three months ended
September 30, 1997 compared to interest expense, net of $77,000 in the three
months ended September 30, 1996. This change in interest income (expense), net
was primarily attributable to increased interest income from increased cash
balances resulting from the Company's initial public offering.
Provision For (Benefit From) Income Taxes. The Company recorded an income
tax benefit of $68,000 in the three months ended September 30, 1997 and a
benefit of $1,000 in the three months ended September 30, 1996. The benefit
was the result of the Company's expected utilization in 1997 of previously
generated net operating loss carryforwards, which was partially offset by
international taxes obligations.
Minority Interest in Consolidated Subsidiary. The minority interest in
consolidated subsidiary represents the equity interest in the operating
results of Persist, the Company's majority-owned Spanish subsidiary, held by
stockholders of Persist other than the Company. The minority interest in
consolidated subsidiary increased to income of $6,000 in the three months
ended September 30, 1997 from a loss of $5,000 in the three months ended
September 30, 1996. This change was the result of the decreased profitability
of Persist. At September 30, 1997 and 1996, the Company held a 63.7% equity
interest in Persist.
13
<PAGE>
Nine Months Ended September 30, 1997 Compared to Nine Months Ended September
30, 1996
Revenue
Total revenue increased 120.7% to $25,493,000 in the nine months ended
September 30, 1997 from 11,553,000 in the nine months ended September 30,
1996. This increase was primarily due to an increase in the licensing of the
Company's AutoEnhancer/2000 software, as well as from increases in other
services revenue and, to a lesser extent, outsourcing services revenue.
International revenue increased 62.7% to $2,101,000 in the nine months ended
September 30, 1997 from $1,291,000 in the nine months ended September 30,
1996. Substantially all of the Company's international revenue for the nine
months ended September 30, 1997 and 1996 was attributable to revenue generated
by Persist.
Outsourcing Services. Outsourcing services revenue increased 15.9% to
$8,542,000 in the nine months ended September 30, 1997 from $7,369,000 in the
nine months ended September 30, 1996. As a percentage of total revenue,
outsourcing services revenue decreased to 33.5% in the nine months ended
September 30, 1997 from 63.8% in the nine months ended September 30, 1996. The
increase in outsourcing services revenue in absolute dollars was primarily
attributable to the addition of two new outsourcing contracts in late 1996 and
one in 1997 and was partially offset by the recognition of lesser amounts of
revenue under the percentage-of-completion method on existing outsourcing
contracts that were in their later phases. The decrease in outsourcing
services revenue as a percentage of total revenue reflects the increased
contribution of license revenue to total revenue during the nine months ended
September 30, 1997 when compared to the same period in the prior year.
License. License revenue was $12,744,000 in the nine months ended September
30, 1997 or 50.0% of total revenue, compared to $2,469,000 or 21.4% of total
revenue in the nine months ended September 30, 1996. The Company's license
revenue in the nine months ended September 30, 1997 was primarily attributable
to the delivery of licensed software to additional end users and to increased
license fees from value added integrators.
Other Services. Other services revenue increased 145.3% to $4,207,000 in the
nine months ended September 30, 1997 from $1,715,000 in the nine months ended
September 30, 1996. As a percentage of total revenue, other services revenue
was 16.5% in the nine months ended September 30, 1997 compared to 14.8% in the
nine months ended September 30, 1996. The increase in other services revenue
in absolute dollars was primarily attributable to an increase in consulting,
training and client support services relating to the Company's year 2000
products and services.
Cost of Revenue
Cost of Outsourcing Services Revenue. The cost of outsourcing services
revenue increased 6.8% to $6,847,000 in the nine months ended September 30,
1997 from $6,410,000 in the nine months ended September 30, 1996. Cost of
outsourcing services revenue decreased as a percentage of outsourcing services
revenue to 80.2% in the nine months ended September 30, 1997 from 87.0% in the
nine months ended September 30, 1996. The decrease in the cost of outsourcing
services revenue as a percentage of outsourcing services revenue was due
primarily to the re-deployment in late 1996 of underutilized resources to
research and development and support activities, partially offset by the
addition of resources necessary to provide services under the new outsourcing
contracts.
Cost of License Revenue. Cost of license revenue was $430,000 in the nine
months ended September 30, 1997, or 3.4% of license revenue. Cost of license
revenue was $40,000 in the nine months ended September 30, 1996, or 1.6% of
license revenue. The increase in cost of revenue in absolute dollars was
primarily attributable to the addition of employees and related resources to
support additional end users and value added integrators.
Cost of Other Services Revenue. Cost of other services revenue increased
80.8% to $3,605,000 in the nine months ended September 30, 1997 from
$1,994,000 in the nine months ended September 30, 1996. Cost of other services
revenue as a percentage of other services revenue decreased to 85.7% in the
nine months ended September 30, 1997 from 116.3% in the nine months ended
September 30, 1996. Cost of other services revenue
14
<PAGE>
increased in absolute dollars due to additional staffing in the Company's
client support training and consulting organization related to increased
customers of the Company's year 2000 products and services. Costs exceeded
revenue in the nine months ended September 30, 1996 primarily as a result of
expected cost overruns on one significant pilot engagement, which subsequently
became a significant product license.
Operating Expenses
Sales and Marketing. Sales and marketing expenses increased 173.8% to
$5,615,000 in the nine months ended September 30, 1997 from $2,051,000 in the
nine months ended September 30, 1996. As a percentage of total revenue, sales
and marketing expenses increased to 22.0% in the nine months ended September
30, 1997 from 17.8% in the nine months ended September 30, 1996. The increase
in expenses in absolute dollars was primarily attributable to increased
staffing, commissions, including an increase in sales referral fees to third
parties, and promotional activities in conjunction with the launch of the
Company's AutoEnhancer/2000 software in late 1996.
Research and Development. Research and development expenses increased 30.7%
to $5,578,000 in the nine months ended September 30, 1997 from $4,267,000 in
the nine months ended September 30, 1996. As a percentage of total revenue,
research and development expenses decreased to 21.9% in the nine months ended
September 30, 1997 from 36.9% in the nine months ended September 30, 1996. The
increase in research and development expenses in absolute dollars was
primarily attributable to increased staffing for the product development
efforts for the Company's year 2000 products and services and mass change
technologies, including an increase in staffing effected through new hires and
internal transfers.
General and Administrative. General and administrative expenses increased
28.6% to $2,853,000 in the nine months ended September 30, 1997 from
$2,218,000 in the nine months ended September 30, 1996. As a percentage of
total revenue, general and administrative expenses decreased to 11.2% in the
nine months ended September 30, 1997 from 19.2% in the nine months ended
September 30, 1996. The increase in general and administrative expenses in
absolute dollars was primarily due to additions to the Company's
administrative staff, higher professional fees and increases in other general
corporate expenses related to being a publicly held company.
Interest Income (Expense), Net. Interest income, net of $482,000 in the nine
months ended September 30, 1997 compares to interest expense, net of $176,000
in the nine months ended September 30, 1996. This change was primarily
attributable to increased interest income from increased cash balances
relating to the Company's initial public offering, as well as to decreased
interest expense on lesser borrowings by the Company.
Provision For (Benefit From) Income Taxes. The Company recorded an income
tax provision of $104,000 in the nine months ended September 30, 1997 versus a
benefit of $205,000 in the nine months ended September 30, 1996. The provision
was the result of an increase in taxable income and international taxes, which
was substantially offset by the Company's expected utilization in 1997 of
previously generated net operating loss carryforwards.
Minority Interest in Consolidated Subsidiary. The minority interest in
consolidated subsidiary increased to loss of $15,000 in the nine months ended
September 30, 1997 from income of $15,000 in the nine months ended September
30, 1996. This change was the result of the increased profitability of
Persist. At September 30, 1997 and 1996, the Company held a 63.7% equity
interest in Persist.
Liquidity and Capital Resources
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, advance payments for services from clients and
internally generated cash flows. The Company's cash balances were $46,292,000
and $7,388,000 at September 30, 1997 and December 31, 1996, respectively. The
Company's working capital was
15
<PAGE>
$48,666,000 and $8,218,000, at September 30, 1997 and December 31, 1996,
respectively. On July 8, 1997, the Company closed an initial public offering
of 4,025,000 shares (2,800,000 of which were offered by the Company and the
balance by selling stockholders) of common stock at a price of $16.00 per
share. The net proceeds to the Company from the offering after deducting
offering expenses were approximately $40,664,000. The Company plans to use
such proceeds for repayment of certain existing indebtedness, research and
development, working capital and general corporate purposes and possible
acquisitions, including the acquisition of MDI.
The Company's operating activities provided cash of $260,000 and used cash
of $4,275,000 during the nine months ended September 30, 1997 and September
30, 1996, respectively. The Company's generation of cash during the nine
months ended September 30, 1997 was primarily caused by net income of $928,000
plus non-cash depreciation and amortization expense of $797,000 and a decrease
in unbilled license revenue from related parties of $1,741,000. These
increases were partially offset by an increase in accounts receivable of
$1,806,000 and a decrease in deferred revenue of $1,880,000.
The Company used cash of $1,534,000 and $752,000 for investing activities
during the nine months ended September 30, 1997 and September 30, 1996,
respectively. Investing activities have consisted principally of the
acquisition of property and equipment, most notably computer equipment and
software to support the growing employee base and corporate infrastructure.
Although the Company has no significant commitments for capital expenditures
in 1997, the Company expects to continue to purchase property and equipment to
further develop its infrastructure.
The Company's financing activities provided cash of $40,224,000 and
$5,585,000 during the nine months ended September 30, 1997 and 1996,
respectively. The 1997 period includes the net proceeds of the Company's July
8, 1997 initial public offering. In March 1996, the Company raised aggregate
net proceeds of $5,408,000 in private placements of the Company's convertible
preferred stock and common stock. Net proceeds from the sales of such shares
were used for the Company's general working capital needs, to make scheduled
debt payments and for treasury stock acquisitions. The Company believes that
the net proceeds from the sale of common stock in its initial public offering,
together with cash generated from operations and existing cash balances and
advances available under its revolving credit line agreement will be adequate
to finance its capital requirements through 1997, including the cash portion
of the MDI acquisition. To the extent that such amounts are insufficient to
finance the Company's capital requirements, the Company will be required to
raise additional funds through equity or debt financing. No assurance can be
given that such financing will be available on terms acceptable to the Company
and, if available, such financing may result in further dilution to the
Company's stockholders and higher interest expense.
In May 1995, the Company issued a secured subordinated note payable for
approximately $924,000 with a face value of $1,000,000 and interest payable at
10% per annum. The note is subordinate to any bank debt and is collateralized
by a second security interest in all of the assets of the Company. In
addition, the note carries a prepayment premium and contains various
restrictive covenants including, but not limited to, minimum earnings and
limitations on certain interest coverage, debt and equity ratios. The note
also included warrants with an ascribed value of approximately $76,000 for the
purchase of up to 312,500 shares of Common Stock for $1.60 per share. These
warrants were exercised in July 1997. In July 1997, the Company used $500,000
of the net proceeds of the initial public offering to repay the note in full.
In September 1996, the Company obtained a revolving line of credit facility
from a bank which bears interest at the bank's prime rate plus 0.5% (9.0% at
September 30, 1997). The maximum borrowing under this line of credit is
$3,500,000 and is limited to 75% of certain receivables plus 50% of costs and
estimated earnings in excess of billings on uncompleted contracts, as defined
by the line of credit agreement. The line of credit, which was extended on
June 20, 1997, expires and all borrowings are payable in full on June 30,
1998. In addition to this line of credit, the Company also entered into an
equipment financing agreement in September 1996. Under this agreement, the
bank agreed to provide up to $1,500,000 for the purchase of certain equipment
(as defined by the agreement) through June 30, 1997. Ratable principal and
interest payments are payable during the period July 1, 1997 through June 1,
2000, and bear interest at the bank's prime rate plus 1% (9.5% at
16
<PAGE>
September 30, 1997). Both of these agreements require the Company to comply
with certain financial covenants and are secured by all of the assets of the
Company. As of September 30, 1997, there were no borrowings outstanding, and
$3,500,000 remained available, under the revolving credit facility and
$650,000 was outstanding under the equipment financing agreement.
On October 22, 1997, the Company entered into a purchase and sale agreement
to acquire through its wholly-owned subsidiary, Twoquay, Inc., substantially
all of the assets and certain liabilities of MDI, a wholly-owned subsidiary of
APU. MDI provides software tools for a broad range of mainframe and midrange
platforms and languages and consultation services that enable organizations to
address their "year 2000 problem". Upon completion of the acquisition, the
Company will pay $30 million in cash and issue 2,175,000 unregistered shares
of its common stock to APU, and MDI's assets and certain of its liabilities
will be transferred to the Company. The Company will account for the
acquisition as a purchase under APB No. 16, with all assets acquired and
liabilities assumed being recorded at their fair values at the date of
closing. The acquisition is subject to certain regulatory approvals and is
expected to close during the fourth quarter of 1997.
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.
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 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 financing would adversely impact the Company's ability to continue
as a going concern.
To date, the Company has not invested in derivative securities or any other
financial instruments that involve a high level of complexity or risk. Cash
has been and the Company contemplates that it will continue to be invested in
interest-bearing, investment grade securities.
Accounting Pronouncements
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This statement establishes standards for the reporting and display of
comprehensive income and its components. Comprehensive
17
<PAGE>
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 will require that an enterprise display an amount representing total
comprehensive income for the period. SFAS No. 130 will be effective for the
Company's year ending December 31, 1998. Adoption of SFAS No. 130 is for
presentation only and will not affect the Company's financial position 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 year ending December 31, 1998 and will not affect the Company's
financial position or results of operations.
In October 1997, the Accounting Standards Executive Committee 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. SOP 97-2 supersedes
SOP 91-1 (also entitled "Software Revenue Recognition") and is effective for
transactions entered into during fiscal years beginning after December 15,
1997. The Company will be required to adopt SOP 97-2 for its fiscal year
ending December 31, 1998. The Company has determined that SOP 97-2 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 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 Registration Statement on Form S-1, Registration No. 333-27087,
filed with the Securities and Exchange Commission in connection with its
recent initial public offering, 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, limited protection of proprietary rights, rapid technological
change, dependence on key personnel, risks associated with international
operations and offshore 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, and the operating difficulties and expenditures
associated with acquisitions including the Company's acquisition of MDI.
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'
18
<PAGE>
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.
19
<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 0-22647.
Exhibit 11.* Statement re computation of per share earnings
Exhibit 27.* Restated Financial Data Schedule
- --------
* Restated in its entirety as filed with this Amendment No. 1 on Form 10-Q/A
for the quarterly period ended September 30, 1997.
(b) Reports on Form 8-K:
None.
20
<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)
21
<PAGE>
Peritus Software Services, Inc.
Exhibit Index
<TABLE>
<CAPTION>
Exhibit No. Description
----------- --------------------------------------------------------
<C> <S>
11* Statement re Computation of Net Income (Loss) per Common
Share and Pro forma Net Income (Loss) per Common Share
27* Restated Financial Data Schedule
</TABLE>
- --------
* Restated in its entirety as filed with this Amendment No. 1 on Form 10-Q/A
for the quarterly period ended September 30, 1997.
22
<PAGE>
EXHIBIT 11
Peritus Software Services, Inc.
Statement re Computation of Net Income (Loss) Per Common Share and
Pro Forma Net Income (Loss) Per Common Share
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ----------------------
1997* 1996 1997* 1996
---------- --------- ---------- -----------
<S> <C> <C> <C> <C>
Net income (loss), as reported... $ 84,000 $(206,000) $ 928,000 $(5,383,000)
Preferred stock preference items:
Accrual of cumulative dividends
on Series A and Series B
redeemable convertible
preferred stock............... -- 182,000 675,000 385,000
Accretion to redemption value
of Series A and Series B
redeemable convertible
preferred stock............... -- 33,000 -- 84,000
Accretion to redemption value
of redeemable common stock
rights........................ -- 20,000 57,000 41,000
---------- --------- ---------- -----------
Total preferred stock
preference items............ -- 235,000 732,000 520,000
---------- --------- ---------- -----------
Net income (loss) attributable to
common stockholders............. 84,000 (441,000) 196,000 (5,903,000)
========== ========= ========== ===========
Basic weighted average common
stock outstanding............... 12,432,000 5,878,000 8,107,000 5,860,000
========== ========= ========== ===========
Basic net income (loss) per
share........................... $ 0.01 $ (0.08) $ 0.02 $ (1.01)
========== ========= ========== ===========
Diluted weighted average shares
outstanding:
a. shares attributable to
common stock outstanding..... 12,432,000 5,878,000 8,107,000 5,860,000
b. shares attributable to
common stock options and
warrants..................... 1,848,000 -- 3,359,000 --
========== ========= ========== ===========
14,280,000 5,878,000 11,466,000 5,860,000
========== ========= ========== ===========
Diluted net income (loss) per
share........................... $ 0.01 $ (0.08) $ 0.02 $ (1.01)
========== ========= ========== ===========
Net income (loss)................ $ 84,000 $(206,000) $ 928,000 $(5,383,000)
Pro forma basic weighted average
shares outstanding:
a. shares attributable to
common stock outstanding..... 12,432,000 5,878,000 8,107,000 5,860,000
b. shares attributable to
redeemable convertible
preferred stock.............. -- 1,904,000 2,495,000 1,377,000
========== ========= ========== ===========
12,432,000 7,782,000 10,602,000 7,237,000
========== ========= ========== ===========
Pro forma basic net income (loss)
per share....................... $ 0.01 $ (0.03) $ 0.09 $ (0.74)
========== ========= ========== ===========
Pro forma diluted weighted
average shares outstanding:
a. shares attributable to
common stock outstanding..... 12,432,000 5,878,000 8,107,000 5,860,000
b. shares attributable to
redeemable convertible
preferred stock.............. -- 1,904,000 2,495,000 1,377,000
c. shares attributable to
common options and warrants.. 1,848,000 -- 3,359,000 --
========== ========= ========== ===========
14,280,000 7,782,000 13,961,000 7,237,000
========== ========= ========== ===========
Pro forma diluted net income
(loss) per share................ $ 0.01 $ (0.03) $ 0.07 $ (0.74)
========== ========= ========== ===========
</TABLE>
<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
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS<F1>
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 46,292
<SECURITIES> 0
<RECEIVABLES> 6,014
<ALLOWANCES> 45
<INVENTORY> 0
<CURRENT-ASSETS> 54,450
<PP&E> 4,604
<DEPRECIATION> 2,118
<TOTAL-ASSETS> 57,606
<CURRENT-LIABILITIES> 5,784
<BONDS> 0
0
0
<COMMON> 132
<OTHER-SE> 50,938
<TOTAL-LIABILITY-AND-EQUITY> 57,606
<SALES> 25,493
<TOTAL-REVENUES> 25,493
<CGS> 10,882
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 14,046
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (482)
<INCOME-PRETAX> 1,047
<INCOME-TAX> 104
<INCOME-CONTINUING> 943
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (15)
<NET-INCOME> 928
<EPS-PRIMARY> .02
<EPS-DILUTED> .02
<FN>
<F1> RESTATED - SEE NOTE 5 TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
</FN>
</TABLE>
