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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(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, 1999
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: 0-26613
================================================================================
BLUESTONE SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 22-2964141
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
1000 BRIGGS ROAD
MT. LAUREL, NEW JERSEY 08054
(Address of principal executive offices, including zip code)
(856) 727-4600
(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 /X/ No / /
The registrant has not been subject to such filing requirements for the
past 90 days, as it closed its initial public offering on Form S-1 on September
29, 1999.
As of November 8, 1999, there were 18,006,770 shares of the registrant's
Common Stock outstanding.
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INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
UNAUDITED BALANCE SHEET AS OF SEPTEMBER 30, 1999
AND BALANCE SHEET AS OF DECEMBER 31, 1998.
UNAUDITED STATEMENTS OF OPERATIONS FOR THE THREE
AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998.
UNAUDITED STATEMENTS OF CASH FLOWS FOR THE NINE
MONTHS ENDED SEPTEMBER 30, 1999 and 1998.
NOTES TO UNAUDITED FINANCIAL STATEMENTS.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
ITEM 5. OTHER INFORMATION.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
SIGNATURES
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
BLUESTONE SOFTWARE, INC.
BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
---- ----
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ..................... $ 71,197 $ 2,535
Accounts receivable, net ...................... 3,958 3,370
Prepaid expenses and other .................... 323 149
-------- --------
Total current assets ............................. 75,478 6,054
Property and equipment, net ...................... 1,406 1,449
Other assets ..................................... 49 33
-------- --------
$ 76,933 $ 7,536
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Line of credit ................................ $ 512 $ 473
Current portion of long-term debt ............. 437 357
Accounts payable .............................. 1,195 1,094
Accrued wages ................................. 1,225 579
Other accrued expenses ........................ 2,808 477
Due to related parties ........................ 28 189
Deferred revenues ............................. 1,492 3,223
-------- --------
Total current liabilities ........................ 7,697 6,392
Long-term debt ................................... 543 876
Subordinated notes due to related parties ........ 500 1,000
Mandatorily redeemable convertible preferred stock -- 17,415
Stockholders' equity (deficit):
Common stock .................................. 18 3
Common stock warrants ......................... 1,900 --
Deferred stock-based compensation ............. (1,218) --
Additional paid-in capital .................... 98,452 12
Accumulated deficit ........................... (30,959) (18,162)
-------- --------
Total stockholders' equity (deficit) ............. 68,193 (18,147)
-------- --------
$ 76,933 $ 7,536
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
3
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BLUESTONE SOFTWARE, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues:
Software license fees ....................... $ 3,147 $ 1,354 $ 7,874 $ 2,546
Services .................................... 856 1,029 2,721 2,735
Third party products and related services ... -- 114 -- 1,046
-------- -------- -------- --------
Total revenues .............................. 4,003 2,497 10,595 6,327
Cost of revenues:
Software license fees ....................... 54 113 210 209
Services .................................... 945 1,192 3,412 3,270
Third party products and related services ... -- 73 -- 607
-------- -------- -------- --------
Total cost of revenues ...................... 999 1,378 3,622 4,086
-------- -------- -------- --------
Gross profit ................................ 3,004 1,119 6,973 2,241
Operating expenses:
Sales and marketing ......................... 4,515 2,930 10,701 6,678
Product development ......................... 1,219 704 3,087 1,608
General and administrative .................. 989 666 3,113 1,615
Amortization of stock-based compensation .... 85 -- 197 --
-------- -------- -------- --------
Total operating expenses .................... 6,808 4,300 17,098 9,901
-------- -------- -------- --------
Operating loss .............................. (3,804) (3,181) (10,125) (7,660)
Interest income (expense), net ................. 113 42 (1,035) 9
-------- -------- -------- --------
Net loss ....................................... (3,691) (3,139) (11,160) (7,651)
Accretion of preferred stock redemption value .. (857) (269) (1,636) (577)
-------- -------- -------- --------
Net loss available to common stockholders ...... $ (4,548) $ (3,408) $(12,796) $ (8,228)
======== ======== ======== ========
Basic and diluted net loss per share:
Net loss per share .......................... $ (0.93) $ (1.12) $ (3.48) $ (2.72)
Accretion of preferred stock redemption value (0.22) (0.09) (0.51) (0.20)
-------- -------- -------- --------
$ (1.15) $ (1.21) $ (3.99) $ (2.92)
======== ======== ======== ========
Shares used in computing net loss per share . 3,968 2,815 3,204 2,814
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
4
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BLUESTONE SOFTWARE, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------
1999 1998
---- ----
<S> <C> <C>
Operating activities:
Net loss ................................................................... $(11,160) $ (7,651)
Adjustments to reconcile net loss to net cash used in operating activities-
Depreciation and amortization .............................................. 447 486
Provision for doubtful accounts ............................................ 206 7
Issuance of Bridge loan warrants ........................................... 1,100 --
Amortization of stock-based compensation ................................... 197 --
Issuance of common stock options to non-employees .......................... 191 --
Changes in operating assets and liabilities
Accounts receivable ........................................................ (794) (743)
Prepaid expenses and other assets .......................................... (190) 81
Accounts payable and accrued expenses ...................................... 3,077 712
Deferred revenues .......................................................... (1,731) (635)
-------- --------
Net cash used in operating activities ...................................... (8,657) (7,743)
Investing activities:
Purchases of property and equipment ........................................ (404) (1,082)
Financing activities:
Net proceeds from (repayments of) line of credit ........................... 39 (888)
Proceeds from long-term debt ............................................... -- 939
Repayments of long-term debt ............................................... (253) (57)
Proceeds from issuance of preferred stock, net ............................. 23,060 11,238
Restricted cash ............................................................ -- 400
Issuance of common stock, net of offering expenses ......................... 54,816 --
Net advances from (repayments to) related party ............................ (161) 343
Proceeds from exercise of common stock options ............................. 222 --
-------- --------
Net cash provided by financing activities .................................. 77,723 11,975
-------- --------
Net increase in cash and cash equivalents ..................................... 68,662 3,150
Cash and cash equivalents, beginning of period ................................ 2,535 2,330
-------- --------
Cash and cash equivalents, end of period ...................................... $ 71,197 $ 5,480
======== ========
Supplemental cash flow information:
Cash paid for interest ..................................................... $ 773 $ 109
Non-cash investing and financing activities:
Conversion of related party subordinated note to common stock ............... $ 500 --
Conversion of preferred stock and all accrued dividends thereon
to common stock........................................................... $ 41,310 --
</TABLE>
The accompanying notes are an integral part of these statements.
5
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BLUESTONE SOFTWARE, INC.
NOTES TO FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The accompanying unaudited financial statements have been prepared by
the Company and, in the opinion of management, include all adjustments
(consisting only of normal recurring adjustments) necessary for the fair
presentation of results for the interim periods presented. These financial
statements and notes included herein should be read in conjunction with the
Company's audited financial statements and notes for the year ended December
31, 1998 included in the Company's Registration Statement on Form S-1 that
was declared effective by the Securities and Exchange Commission on September
23, 1999. The results of operations for the interim periods presented are not
necessarily indicative of the results to be expected for any subsequent
quarter or for the entire year ending December 31, 1999.
Note 2. Net loss per share
The Company follows SFAS No. 128, "Earnings Per Share," which requires a
dual presentation of "basic" and "diluted" earnings per share ("EPS") on the
face of the statements of operations. Basic EPS is computed by dividing net
income (loss) by the weighted average number of shares of common stock
outstanding for the period. Diluted EPS includes the dilutive effect, if any,
from the potential exercise or conversion of securities like stock options,
which would result in the issuance of additional shares of common stock. For the
three and nine months ended September 30, 1998 and 1999, the impact of stock
options was not considered as their effect on EPS would be anti-dilutive.
Note 3. Initial Public Offering
On September 29, 1999, the Company completed an initial public offering
of 4,000,000 shares of its common stock, .001 par value per share. The
Company received proceeds of $54.8 million, net of underwriting discounts and
offering expenses. Upon closing of the offering, all of the Company's
then-outstanding redeemable convertible preferred stock and the accrued
dividends thereon were converted into 10,493,481 shares of common stock.
Additionally, the Company's Board of Directors authorized a 1 for 3.2 reverse
stock split of its common stock to be effected immediately prior to the
offering. The reverse stock split has been retroactively reflected in the
accompanying financial statements.
Note 4. New Commitments
On October 29, 1999, the Company entered into a seven and a half-year lease
with a realty company for facilities in Lester, Pennsylvania. This lease is
secured by a $600,000 letter of credit. The Company expects to relocate certain
departments to this facility during the first quarter of 2000.
During November 1999, the Company entered into a master lease agreement
with an equipment leasing company that provides for an equipment lease line
of up to $1,000,000. Borrowings on the lease line will be secured with a
letter of credit equal to 60% of the outstanding balance.
Note 5. Recent Pronouncements
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 is effective for fiscal years
beginning December 31. 1997, SFAS No. 130 establishes standards for the
reporting and display of comprehensive income in a set of financial statements.
Comprehensive income is defined as the change in net assets of a business
enterprise during a period from transactions generated from non-owner sources.
It includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners. The Company has no other
comprehensive income items, therefore, the adoption of SFAS No. 130 had no
impact on the financial statements.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 applies to all public companies and is effective for fiscal years beginning
after December 15, 1997. SFAS No. 131 requires that business segment financial
information be reported in the financial statements utilizing the management
approach. The management approach is defined as the manner in which management
organizes the segments within the enterprise for making operating decisions and
assessing performance. Management believes the Company operates in one business
segment, therefore, the adoption of SFAS No. 131 had no impact on the financial
statements.
In March 1998, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") 98-1, "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." The Company
adopted SOP 98-1 in January 1999. The adoption had no material effect on the
Company's financial position or results of operations.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations should be read in conjunction with our Financial
Statements and Notes thereto as of
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December 31, 1998 and 1997 and for each of the years ended December 31, 1998,
1997 and 1996, included in our S-1 Registration Statement filed with the
Securities and Exchange Commission in conjunction with our initial public
offering of common stock.
The information in this discussion contains forward-looking statements.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause our actual results, performance or achievements or
industry results to be materially different from any future results, performance
or achievements expressed or implied by these forward-looking statements. Such
factors include those described in "Risk Factors." The forward-looking
statements included in this report may prove to be inaccurate. In light of
the significant uncertainties inherent in these forward-looking statements, you
should not consider this information to be a guarantee by us or any other person
that our objectives and plans will be achieved.
OVERVIEW
We are a leading provider of software for enterprise interaction
management, which enables businesses to extend information over the World Wide
Web in a controlled manner and to support high volumes of users and
interactions. Our flagship product, Sapphire/Web, is a framework for JAVA Web
application servers and is currently in Release 6. In 1998, we decided to focus
on internally developed software products and curtail the licensing and services
related to third party products. Beginning in March 1998, we increased our sales
and marketing efforts and hired new management. We hired a significant number of
sales personnel throughout the country in order to develop a nationwide presence
and generate increased revenue. The positioning and feature set of the
Sapphire/Web product was shifted from a low-cost development tool to an
enterprise-wide software solution for Internet applications. For the year ended
December 31, 1998, the Sapphire/Web products and related services generated
approximately $7.0 million in revenues, while third party products and related
services contributed approximately $1.1 million. In January 1999, we released
Bluestone XML-Server, which represents a new generation of specialized Web
application server focused on Internet commerce. In May 1999, Release 6 of
Sapphire/Web was made generally available.
We generate revenue from two principal sources: license fees for our
software products and professional services and support revenue derived from
consulting, training and maintenance services related to our software products.
SOFTWARE LICENSE FEES. Typically, our customers pay an up-front, one-time
fee for a perpetual license of our software. The amount of the fee is based on
the number of developer seats and server interactions. A pricing model based on
the number of processors within a server is also available. We also sell annual
and multi-year licenses, primarily to independent software vendors. We generally
require a written license contract that typically provides for an initial
payment within 30-60 days of contract signing. Certain multi-year license
contracts contain payment terms that extend beyond one year. Pursuant to the
American Institute of Certified Public Accountants' Statement of Position 97-2,
any amounts due under contract beyond one year are not deemed to be fixed and
determinable and therefore are deferred and recognized as revenue when the
payments become due.
Prior to 1998, software licenses were principally the result of direct
sales to end-users. Beginning in 1998, we began to focus on channel marketing.
This has resulted in significant sales of products sold through independent
software vendors, resellers and systems integrators. We believe that these
alliances have helped to maximize our exposure in the marketplace. Furthermore,
we have experienced, and expect to continue to experience, significant variation
in the size of individual licensing transactions, ranging from small sales of
perpetual developer licenses to large, multi-year licensing arrangements with
independent software vendors.
We generally recognize license fee revenue when a formal agreement exists,
delivery of the product has occurred, no production, modification, customization
or implementation obligations remain, the license fee is deemed fixed and
determinable and collectibility is probable. Revenue from arrangements with
distributors and resellers is not recognized until our product is delivered to
the end-user.
During the three months ended September 30, 1999, two of our customers
individually accounted for greater than 10% of our total product and services
revenues. During the nine months ended September 30, 1999, two of our
customers individually accounted for greater than 10% of our total product
and services revenues. Our top 10 customers represented 80% and 60% of total
revenues in the three and nine months ended September 30, 1999, respectively.
In the future, we expect to continue to have individual customers account for
a significant portion of our revenues during a given period.
SERVICES REVENUE. Services revenue consists principally of revenue derived
from consulting services provided to customers during implementation and
integration of our software products, training of customers' employees and fees
for ongoing maintenance, which consists of customer technical support services
and unspecified product upgrades/enhancements on a when-and-if-available basis.
Consulting and training services are typically delivered on a time and material
basis and are typically completed within one month following license contract
signing. Consulting services generally consist of simple installations and
configurations. We recognize services revenue as the services are performed.
Maintenance revenue is generally invoiced in advance and is recognized ratably
over the term of the maintenance agreement, which is generally 12 months.
COST OF SOFTWARE LICENSE FEES. Cost of software license fees consists
primarily of the costs
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associated with the purchase of product CDs and related documentation and
duplication costs.
COST OF SERVICES. Cost of services consist primarily of salary and benefit
costs of our consulting, support and training organizations, and are expensed
when incurred. Additionally, from time to time we engage outside consultants to
meet peaks in customer demand.
SALES AND MARKETING. We license our products primarily through our indirect
channels and direct sales force. Sales and marketing expenses consist primarily
of personnel costs, commissions to employees, office facilities, travel and
promotional events such as trade shows, advertising and public relations
programs.
PRODUCT DEVELOPMENT. We maintain an in-house development staff to enhance
our existing products and to develop new ones. Product development expenditures
are generally charged to operations as incurred. Statement of Financial
Accounting Standards No. 86 requires the capitalization of certain software
development costs subsequent to the establishment of technological feasibility.
We establish technological feasibility upon the completion of a working model.
To date, we have expensed all software development costs due to the minimal
level of development costs incurred subsequent to the establishment of
technological feasibility.
GENERAL AND ADMINISTRATIVE. General and administrative expenses include our
personnel and other costs of our finance, human resources and information
services activities.
STOCK-BASED COMPENSATION. The amount by which the fair market value of our
common stock exceeded the exercise price of stock options on the date of grant
is recorded as deferred compensation and is amortized to stock-based
compensation expense as the options vest.
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1998
SOFTWARE LICENSE FEES
License fees were $3.1 million and $1.4 million for the three months ended
September 30, 1999 and 1998, respectively. This increase of 132.4% was primarily
due to an increased presence in the market, as well as an increase in the amount
of license revenue per customer during the third quarter of 1999 versus the same
period during 1998.
SERVICES REVENUE
Services revenue was $856,000 and $1.0 million for the three months
ended September 30, 1999 and 1998, respectively, a decrease of 16.8%.
Services revenue decreased between the two periods due to a strategic change
in the use of our professional staff. By the beginning of 1999, the main
focus of the services organization had shifted to concentrate on short-term,
installation-type engagements, usually less than two weeks in duration,
rather than long-term implementation activities. These implementation
activities are now performed primarily by systems integrators with which we
have strategic alliances.
THIRD PARTY PRODUCTS AND RELATED SERVICES REVENUE
Third party products and related services revenue was zero and $114,000 for
the three months ended September 30, 1999 and 1998, respectively. This decrease
was due to our decision in 1998 to curtail the licensing and services related to
third party products so that we could focus on our proprietary products.
GROSS MARGIN-LICENSE FEES
Our license fee gross margin increased to 98.3% for the three months ended
September 30, 1999 from 91.7% for the same period in 1998. This increase was
primarily due to the increase in the amount of license revenue per customer
during the third quarter of 1999, while there was a decrease in the amount of
duplication and printing costs.
GROSS MARGIN-SERVICES REVENUE
Our services gross margin improved to (10.4)% for the three months ended
September 30, 1999 from (15.8)% for the same period in 1998. This is
primarily due to the increased utilization of our services personnel, as well
as an increase in our sales price for services. Our services gross margin
remained negative in 1999 primarily due to the hiring and training of
additional personnel to support our growing installed base of customers and
anticipated increases in future revenues. We believe our services gross
margin will likely decrease over the next several quarters as we continue to
hire personnel to support our growing base of customers.
SALES AND MARKETING
Sales and marketing expenses were $4.5 million and $2.9 million for the
three months ended September 30, 1999 and 1998, respectively, an increase of
54.1%. Of this increase, $499,000 was due to increases in payroll and related
costs, $152,000 in recruiting costs and $99,000 in travel costs as a result of
the growth in the number of sales personnel, $295,000 was due to increased trade
show and public relations expenses, and $414,000 was due to increased
commissions expense as a result of higher sales volume. We have increased our
spending on sales and marketing because we believe that our sales and marketing
efforts are essential for us to increase our market position and our product
acceptance. The average number of sales and marketing employees for the three
months ended September 30, 1999 was 64 compared to 54 for the three months ended
September 30, 1998. We also incurred increases in variable marketing expenses
due to increased trade show participation, direct mail campaigns and
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advertising in order to increase market awareness and gain market acceptance of
our products. These costs as a percentage of revenue were 112.8% and 117.3% for
the three months ended September 30, 1999 and 1998, respectively.
PRODUCT DEVELOPMENT
Product development expenses were $1.2 million and $704,000 for the three
months ended September 30, 1999 and 1998, respectively, an increase of 73.2%.
These costs as a percentage of revenue were 30.5% and 28.2% for the three months
ended September 30, 1999 and 1998, respectively. These increases were associated
with the development of our new products, Sapphire/Web Release 6 and the
Bluestone XML Suite. We believe that our product development investment is
essential for us to maintain our market and technological competitiveness. The
increase was primarily due to an increase in payroll and related costs of
$439,000. Average development headcount for the three months ended September 30,
1999 and 1998 was 34 and 25, respectively.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $989,000 and $666,000 for the
three months ended September 30, 1999 and 1998, respectively, an increase of
48.5% over the three months ended September 30, 1998. This increase was
primarily due to payroll and related costs resulting from the addition of
personnel to support the growth of our business. General and administrative
expenses as a percentage of revenue were 24.7% and 26.7% for the three months
ended September 30, 1999 and 1998, respectively.
AMORTIZATION OF STOCK-BASED COMPENSATION
Amortization of stock-based compensation was $85,000 and zero for the three
months ended September 30, 1999 and 1998, respectively. Deferred compensation of
$1.4 million arose due to the issuance of stock options at exercise prices below
the fair market value of our common stock for accounting purposes relative to
the hiring of key employees and directors during the second quarter of 1999.
Deferred compensation is included as a component of stockholders' equity and is
being amortized by charges to operations over the vesting periods of the
options. As of September 30, 1999, we had an aggregate of $1.2 million of
deferred compensation to be amortized through June 30, 2003.
INTEREST INCOME (EXPENSE), NET
Net interest income was $113,000 and $42,000 for the three months ended
September 30, 1999 and 1998, respectively, an increase of 169.0%. The additional
interest was due to higher than average cash balances during the recent quarter
resulting from the Series C preferred stock financing in May 1999 yielding $25
million in gross proceeds as compared to the Series B preferred stock financing
in April 1998 yielding $14.4 million in gross proceeds.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1998
SOFTWARE LICENSE FEES
License fees were $7.9 million and $2.5 million for the nine months
ended September 30, 1999 and 1998, respectively. This increase of 209.3% was
primarily due to a shift in our product position from a low-priced
development tool to a high-end, high-priced enterprise software solution.
This change in product position has resulted in increased revenues per
customer. Additionally, we were able to concentrate solely on our
Sapphire/Web products and services once we curtailed our graphical user
interface product line in April 1998. In addition, we received payment under
an extended license fee arrangement with one customer in February 1999, which
accounted for approximately $1.9 million of our license fee revenue during
the nine months ended September 30, 1999. We also had another customer
account for greater than 10% of our total product revenue during the nine
months ended September 30, 1999.
SERVICES REVENUE
Services revenue was $2.7 million for the nine months ended September
30, 1999 and 1998. Services revenue remained relatively constant between the
two periods due to a strategic change in the use of our professional staff.
By the beginning of 1999, the main focus of the services organization had
shifted to concentrate on short-term, installation-type engagements, usually
less than 2 weeks in duration, rather than long-term implementation
activities. These implementation activities are now performed primarily by
systems integrators with which we have strategic alliances.
THIRD PARTY PRODUCTS AND RELATED SERVICES REVENUE
Third party products and related services revenue was zero and $1.0 million
for the nine months ended September 30, 1999 and 1998, respectively. This
decrease was due to our decision in 1998 to curtail the licensing and services
related to third party products so that we could focus on our proprietary
products.
GROSS MARGIN-LICENSE FEES
Our license fee gross margin increased to 97.3% for the nine months ended
September 30, 1999 from 91.8% for the same period in 1998. This increase was
primarily due to the increase in revenue per
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customer. Our focus on positioning the product as an enterprise-wide solution
has increased the revenue associated with each sale, while the cost of sales for
the product has remained relatively decreased as we have reduced our printing
and duplication costs associated with our products and related documentation.
GROSS MARGIN-SERVICES REVENUE
Our services gross margin decreased to (25.4)% for the nine months ended
September 30, 1999 from (19.6)% for the same period in 1998. This was primarily
due to the hiring and training of additional services personnel in advance of
anticipated services revenue growth.
SALES AND MARKETING
Sales and marketing expenses were $10.7 million and $6.7 million for the
nine months ended September 30, 1999 and 1998, respectively, an increase of
60.2%. Of this increase, $1.4 million was due to increases in payroll and
related costs, $370,000 of recruiting costs and travel costs as a result of the
growth in the number of sales personnel, $678,000 was due to increased
advertising and trade show expenses, and $671,000 was due to increased
commissions expense as a result of higher sales volume. We have increased our
spending on sales and marketing because we believe that our sales and marketing
efforts are essential for us to increase our market position and our product
acceptance. The average number of sales and marketing employees for the nine
months ended September 30, 1999 was 54 compared to 46 for the nine months ended
September 30, 1998. We also incurred increases in variable marketing expenses
due to increased channels and customer marketing, direct mail campaigns and
public relations expenses in order to increase market awareness and gain market
acceptance of our products. These costs as a percentage of revenue were 101.0%
and 105.5% for the nine months ended September 30, 1999 and 1998, respectively.
PRODUCT DEVELOPMENT
Product development expenses were $3.1 million and $1.6 million for the
nine months ended September 30, 1999 and 1998, respectively, an increase of
92.0%. This is primarily due to increased payroll and related costs of $1.2
million. These costs as a percentage of revenue were 29.1% and 25.4% for the
nine months ended September 30, 1999 and 1998, respectively. These increases
were associated with the development of our new products, Sapphire/Web Release 6
and the Bluestone XML Suite. We believe that our product development investment
is essential for us to maintain our market and technological competitiveness.
Average development headcount for the nine months ended September 30, 1999 and
1998 was 30 and 19, respectively.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $3.1 million and $1.6 million for
the nine months ended September 30, 1999 and 1998, respectively. Included in
expenses for the nine months ended September 30, 1999 were $577,000 for
severance and consulting costs. The severance costs were related to the
termination of certain executives, and the consulting costs were based upon the
fair value of options issued to outside consultants. Excluding these costs, our
general and administrative expenses were $2.5 million, an increase of 57.0% over
the nine months ended September 30, 1998. This increase was primarily due to
payroll and related costs resulting from the addition of personnel to support
the growth of our business. General and administrative expenses as a percentage
of revenue were 29.4% and 25.5% for the nine months ended September 30, 1999 and
1998, respectively. Excluding these severance and consulting costs, the expenses
as a percentage of revenue decreased to 23.9%.
AMORTIZATION OF STOCK-BASED COMPENSATION
Amortization of stock-based compensation was $197,000 and zero for the nine
months ended September 30, 1999 and 1998, respectively. Deferred compensation of
$1.4 million arose due to the issuance of stock options at exercise prices below
the fair market value of our common stock for accounting purposes relative to
the hiring of key employees and the appointment of directors during the second
quarter of 1999. Deferred compensation is included as a component of
stockholders' equity and is being amortized by charges to operations over the
vesting periods of the options. As of September 30, 1999, we had an aggregate of
$1.2 million of deferred compensation to be amortized through June 30, 2003.
INTEREST INCOME (EXPENSE), NET
Net interest expense was $1.0 million for the nine months ended September
30, 1999 and income was $9,000 for the nine months ended September 30, 1998.
This increase was due to the issuance of warrants to purchase 137,608 shares of
common stock at the weighted exercise price of $2.06 per share in connection
with the issuance of convertible subordinated bridge notes. Original issue
discount interest cost of $1.1 million was recorded during the second quarter of
1999 based upon the fair value of the warrants at the dates of issuance. The
warrants are recorded as a component of stockholders' equity.
LIQUIDITY AND CAPITAL RESOURCES
In September 1999, we completed the initial public offering of 4,000,000
shares of our common stock, realizing net proceeds from the offering of $54.8
million. Prior to the offering, we financed our operations and met our capital
expenditure requirements primarily through sales of preferred stock, bank loans,
equipment loans and funds generated from operations. From April 1997 through
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May 1999, we raised approximately $41.6 million of venture capital funding in
order to expand the sales and marketing and product development efforts of the
business. As of September 30, 1999 our primary sources of liquidity consisted of
cash of approximately $71.2 million and $1.2 million of available borrowings
under our $1.75 million revolving line of credit, which is secured by
substantially all of our assets. As of September 30, 1999, the balance
outstanding on our line of credit was $512,000. Borrowings under the line of
credit were subject to a borrowing base of 80% of eligible domestic accounts
receivable and interest on our line of credit was payable monthly at rates of
prime plus .75%.
Net cash used for operating activities was $8.7 and $7.7 million for the
nine months ended September 30, 1999 and 1998. Included in net loss for the nine
months ended September 30, 1999 were non-cash items as follows: depreciation of
$447,000, issuance of bridge loan warrants of $1.1 million, issuance of options
to purchase common stock to consultants of $197,000 and charges of $191,000 to
operating expense for the issuance of options to purchase common stock that were
issued at an exercise price below fair market value. The cash used for operating
activities in 1999 was attributable primarily to net losses $11.2 million,
offset by the above non-cash items, and $7.7 million for the nine months ended
September 30, 1999 and 1998, respectively.
Net cash used in investing activities was $404,000 and $1.1 million for the
nine months ended September 30, 1999 and 1998. The cash used in investing
activities related primarily to purchases of computers and software for internal
use.
Net cash provided by financing activities amounted to $77.7 million and
$12.0 million for the nine months ended September 30, 1999 and 1998. During the
nine months ended September 30, 1998, net proceeds of $11.2 million was provided
from the sale of Series B preferred stock to certain venture capital investors
and $939,000 was provided from borrowings under the available equipment line. In
May 1999, we sold 9,191,176 shares of Series C preferred stock for net proceeds
of $23.1 million, $1.35 million of which was comprised of the conversion of
indebtedness under bridge financing incurred earlier in 1999. In September 1999,
we completed our initial public offering of 4,000,000 for net proceeds of $54.8
million. Additionally, we received proceeds of $222,000 from the exercise of
common stock options and made repayments of $253,000 of long-term debt and
$161,000 to related parties.
On October 29, 1999, we entered into a seven and a half year lease with a
realty company for facilities in Lester, Pennsylvania. This lease is secured by
a $600,000 letter of credit. We expect to relocate certain departments to this
facility during the first quarter of 2000 and estimate that capital
expenditures, including leasehold improvements, furniture and equipment, of
approximately $1.2 million will be required related to the operation of this
facility.
During November 1999, the Company entered into a master lease agreement
with an equipment leasing company that provides for an equipment lease line
of up to $1,000,000. Borrowings on the lease line will be secured with a
letter of credit equal to 60% of the outstanding balance.
We anticipate that we will continue to expand our sales operations
throughout the U.S., as well as internationally, within the next 12 months and,
therefore, we expect to incur increases in our sales and marketing expenditures.
We also expect to incur increases in our product development expenditures as we
continue to enhance our product offerings. These expenditures are expected to
use significant amounts of our cash resources. However, we believe that our
existing capital resources are sufficient to meet our capital requirements for
the next 12 months.
YEAR 2000 ISSUES
GENERAL. Year 2000 issues relate to computer programs or hardware that have
date-sensitive software or embedded chips that may recognize a date using "00"
as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculation causing disruption of operations, including, among
other things, a temporary inability to process transactions, send invoices or
engage in other normal business activities.
The term "computer programs and hardware" includes accounting, data
processing and telephone/PBX systems, in addition to other miscellaneous
systems. These systems may contain imbedded technology, which complicates our
identification, assessment, remediation and testing efforts.
STATE OF READINESS. We have designed the current versions of our software
products to be Year 2000 compliant, and do not anticipate any Year 2000 issues
related to these products. However, some older versions of our software products
that we no longer sell may not be Year 2000 compliant. Any customers using an
older version of one of our products that is not Year 2000 compliant may need to
update to a newer product, apply available patches or discontinue using the
software prior to January 1, 2000.
We have performed an assessment of the Year 2000 readiness of our
information technology systems, including the hardware and software we use to
provide and deliver our products. Our testing to date has included our major
infrastructure items, hardware platforms, telephone, voice mail and operating
systems. All of the tested systems are compliant. Desktop computing, servers,
switching and routing platforms have been inventoried and tested with only minor
upgrades necessary to one router family. All personal computer systems have been
tested and, where necessary, upgraded. By July 1999, we had largely completed
the implementation of Year 2000 compliant internal computer applications for our
main financial and order processing systems.
We completed a Year 2000 simulation on our internal systems and software
during the first quarter of 1999. Any discrepancies noted were corrected.
Another testing cycle was completed during
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the third quarter of 1999 to ensure that systems that were determined to be
non-compliant are remedied. It was determined that no significant upgrades will
need to be made to the Company's existing systems or software because of Year
2000 compliance issues. No information technology projects have been delayed or
deferred by our Year 2000 compliance program.
As of January 1999, all third party vendors who provide us with systems or
software were contacted and provided us with written assurances of their
product's compliance. We have incorporated any recommended changes and upgrades
wherever necessary. We have not used any independent verification or validation
processes to verify the Year 2000 compliance of our third party vendors. In the
event that one or more of our significant vendors or service providers are not
Year 2000 compliant, due to undetected or embedded system components or
technology, we believe that our results of operations will not be materially
adversely affected and that our relationships with customers, vendors and others
will not be materially adversely affected.
We have also sought assurances of Year 2000 compliance from our material
providers of items other than information technology and we have received the
necessary responses regarding their compliance. We have not received
notification from any vendor indicating that they are not Year 2000 compliant.
COST AND RISK. We have funded our Year 2000 compliance efforts from our
cash flow from operations and we have not incurred any significant costs to
date related to Year 2000 issues and do not expect the cost of future Year
2000 issues to be material. Furthermore, we believe that Year 2000 issues
will not pose significant operational problems for us. However, if all Year
2000 issues are not properly identified or if Year 2000 issues that are
identified are not assessed, remediated and tested in a timely fashion, the
Year 2000 issue may adversely impact our results of operations or adversely
affect our relationships with customers, vendors or others. Also, we may
experience operational difficulties caused by undetected errors or defects in
embedded technologies that we use in our internal systems. Additionally, we
cannot predict whether the Year 2000 issues of third parties will have a
material adverse impact on our systems or results of operations.
The costs and completion dates of our Year 2000 identification, assessment,
remediation and testing efforts are based upon management's best estimates,
which were derived using numerous assumptions regarding future events. We have
not used any independent verification or validation process to assure the
reliability of our risks and costs estimates. These estimates may prove to be
inaccurate and actual results could differ materially from those currently
anticipated. Specific factors that could cause these material differences
include, but are not limited to, the ability to identify, assess, remediate and
test all relevant products and services purchased from or by third parties and
other similar uncertainties. In addition, variability of definitions of
"compliance with Year 2000," and the myriad of different products and services,
and combinations thereof, used by our customers in connection with our products
may lead to claims against us which we cannot currently estimate. The aggregate
cost of defending and resolving such claims, if any, may adversely impact our
results of operations.
Year 2000 issues may affect the purchasing patterns of current and
potential customers in a variety of ways. Many companies are expending
significant resources to replace or remedy their current hardware and software
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to purchase software products such as those offered by us.
Furthermore, our customers could be forced to postpone installations of our
products due to dedication of resources to their own Year 2000 issues. We do not
believe that there is any practical way to ascertain the extent of, and have no
plan to address problems associated with, any reduction in purchasing resources
of our customers. Any resulting reduction could have a material adverse effect
on our business.
To date, there has been no material negative impact on our financial
condition or operations as a result of our Year 2000 compliance program.
CONTINGENCIES. We are continuing with our analysis of the operational
problems and costs that would be reasonably likely to result from our failure
and the failure of certain third parties to complete efforts necessary to
achieve Year 2000 compliance on a timely basis. Although based on the
analysis to date, we do not expect any material system failures, we intend to
backup all mission critical data prior to January 1, 2000 and, to the extent
that there are material system failures, we intend to roll-back the system
dates and restore functionality of the affected systems as soon as possible.
RISK FACTORS
THIS SECTION HIGHLIGHTS SPECIFIC RISKS WITH RESPECT TO AN INVESTMENT IN OUR
BUSINESS. INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. WE ALSO
CAUTION YOU THAT THIS REPORT INCLUDES FORWARD-LOOKING STATEMENTS THAT ARE BASED
ON MANAGEMENT'S BELIEFS AND ASSUMPTIONS AND ON INFORMATION CURRENTLY AVAILABLE
TO MANAGEMENT.
WE HAVE HAD RECENT LOSSES AND MAY INCUR FUTURE LOSSES THAT MAY DEPRESS OUR STOCK
PRICE.
We have incurred significant net losses since 1996, including losses of
approximately $3.8 million and $11.6 million for the years ended December 31,
1997 and 1998, respectively and $11.2 million for the nine months ended
September 30, 1999. Our losses have resulted in an accumulated deficit of
approximately $31.0 million as of September 30, 1999. Any significant shortfall
of revenues in relation to our expectations or any material delay of customer
orders would have an immediate adverse effect on our business, operating results
and financial condition. We may not be profitable in
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any future period. Our future operating results will depend on many factors,
including:
- the overall growth rate for the markets in which we compete;
- the level of market acceptance of, and demand for, our software
products;
- the level of product and price competition;
- our ability to establish strategic marketing relationships, develop
and market new and enhanced products, and control costs;
- our ability to expand our direct sales force and indirect distribution
channels;
- our ability to integrate acquired businesses and product lines;
- our ability to develop and maintain awareness of our brands; and
- our ability to attract, train and retain consulting, technical and
other key personnel.
LACK OF GROWTH OR DECLINE IN INTERNET USAGE OR THE LACK OF ACCEPTANCE OF
COMMERCE CONDUCTED VIA THE INTERNET COULD BE DETRIMENTAL TO OUR FUTURE OPERATING
RESULTS.
Our products enhance companies' ability to transact business and conduct
operations utilizing the Internet. Therefore, our future sales and any future
profits are substantially dependent upon the widespread acceptance and use of
the Internet as an effective medium of commerce by consumers and businesses.
Rapid growth in the use of the Internet and other online services is a recent
development and we are unsure whether that acceptance and use will continue to
develop or that a sufficiently broad base of consumers will adopt and continue
to use the Internet and other online services as a medium of commerce. To be
successful, we must rely on consumers and businesses, who have historically used
traditional means of commerce to purchase products, accepting and utilizing new
ways of conducting business and exchanging information over the Internet.
In addition, the Internet may not be accepted as a viable commercial
marketplace for a number of reasons, including potentially inadequate
development of the necessary network infrastructure or delayed development of
enabling technologies and Web performance improvements. If the Internet
continues to experience significant growth in the number of users, frequency of
use or an increase in bandwidth requirements, the Internet's infrastructure may
not be able to support the demands placed upon it. In addition, the Internet
could lose its viability due to delays in the development or adoption of new
standards and protocols required to handle increased levels of Internet
activity, or due to increased governmental regulation. If Congress, or other
governing bodies both within and outside the United States, decides to alter
materially the current approach to, and level of, regulation of the Internet, we
may need to adapt our technology. Any required adaptation could cause us to
spend significant amounts of time and money. If use of the Internet does not
continue to grow or grows more slowly than expected, if the infrastructure for
the Internet does not effectively support growth that may occur, if government
regulations change, or if the Internet does not become a viable commercial
marketplace, our business could suffer.
WE DEPEND ON OUR SAPPHIRE/WEB PRODUCTS AND IF THE MARKET FOR THESE PRODUCTS DOES
NOT CONTINUE TO GROW, OUR BUSINESS COULD BE MATERIALLY ADVERSELY AFFECTED.
Software license revenues from our Sapphire/Web software were $3.4 million
or 42% of total revenues in 1998 and $7.9 million or 74% of total revenues in
the first nine months of 1999. We expect to continue to be dependent upon the
Sapphire/Web software products in the future, and any factor adversely affecting
the market for Web application server software in general, or our software in
particular, would adversely affect our ability to generate revenues. The market
for Web application server software is competitive, highly fragmented and
characterized by rapid technological change. Our future financial performance
will depend in large part on the successful development, introduction and
customer acceptance of our new products and product enhancements in a timely and
cost effective manner. We expect to continue to commit significant resources to
market and further develop the Sapphire/Web software products and enhance the
brand awareness of Sapphire/Web products. The market for our software may not
continue to grow or may grow at a slower rate than we expect. Furthermore, the
market may not accept our products. If this market fails to grow or grows more
slowly than we anticipate, or if the market fails to accept our products, our
business could suffer.
IF THE MARKET'S ACCEPTANCE AND ADOPTION OF JAVA AND XML SERVER TECHNOLOGIES DOES
NOT CONTINUE, OUR FUTURE RESULTS MAY SUFFER.
Our Sapphire/Web product is 100% Pure JAVA. JAVA is a programming language
developed by Sun Microsystems. Therefore, the continued acceptance of our
products in the marketplace depends on JAVA's acceptance as a standard
programming language. If Sun Microsystems were to make significant changes to
the JAVA language or fail to correct defects and limitations in its products,
our ability to continue to improve and ship our products could be impaired. In
the future, our customers may also require the ability to deploy our products on
platforms for which technically acceptable JAVA implementations either do not
exist or are not available on commercially reasonable terms.
In January 1999, we introduced a product based on a document format for the
Web called XML, or extensible mark-up language. We cannot be sure that XML
technology will be adopted as a standard, that XML-based products will achieve
broad market acceptance, that our XML products will be accepted or that other
superior technologies will not be developed. The failure of XML technology to
become a standard or the failure of our XML products to achieve broad acceptance
could adversely affect our
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ability to generate revenues. The XML server technology is one of several
competing technologies used in information exchange and Internet commerce. We
intend to continue to invest substantial resources in our XML products.
INTENSE COMPETITION AND INCREASING CONSOLIDATION IN OUR INDUSTRY COULD CREATE
STRONGER COMPETITORS AND HARM OUR BUSINESS.
The market for our products is intensely competitive, highly fragmented,
characterized by rapid technological change and significantly affected by new
product introductions. Recent acquisitions of several of our competitors by
large software companies and other market activities of industry participants
have increased the competition in our market. Our competitors consist of a
number of private and public companies including, among others: BEA Systems
which acquired WebLogic; IBM; Microsoft; Oracle; and Sun Microsystems, which
acquired NetDynamics and the rights to Netscape's Application Server. In
addition, we face competition from in-house software developers who may develop
some or all of the functionality that our products provide. Many of our
competitors have longer operating histories, significantly greater financial,
technical, marketing and other resources, greater name recognition, a broader
range of products to offer and a larger installed base of customers than us, any
of which could provide them with a significant competitive advantage.
We expect to face increased competition in the future from our current
competitors. In addition, new competitors, or alliances among existing and
future competitors, may emerge and rapidly gain significant market share. We
also may face increased competition from existing large business application
software vendors that may broaden their product offerings to include Web
application server software. Their significant installed customer bases and
abilities to offer a broad solution and price these new products as incremental
add-ons to existing systems could provide them with a significant competitive
advantage.
OUR CUSTOMERS ARE CONCENTRATED AND THE LOSS OF ONE OF OUR LARGEST CUSTOMERS
COULD CAUSE OUR REVENUES TO DROP QUICKLY AND UNEXPECTEDLY.
Our top ten customers for the year ended December 31, 1998 and the nine
months ended September 30, 1999 in the aggregate accounted for approximately 39%
and 60%, respectively, of our revenues. One customer accounted for more than 10%
of our revenues for the year ended December 31, 1998 and two customers each
accounted for more than 10% of our revenues for the nine months ended September
30, 1999. We expect that a small number of customers will continue to account
for a substantial portion of revenues in any given quarter in the foreseeable
future, although it is unusual for the same customer to account for a
substantial amount of revenues in each of several quarters. As a result, our
inability to secure major customers during a given period or the loss of any one
major customer could cause our revenues to drop quickly and unexpectedly.
IF WE FAIL TO DEVELOP NEW PRODUCTS AND SERVICES IN THE FACE OF OUR INDUSTRY'S
RAPIDLY EVOLVING TECHNOLOGY, OUR FUTURE RESULTS MAY BE ADVERSELY AFFECTED.
Due to the recent emergence of the Internet and the Web as a forum for
conducting business, the market for Web application server systems in which we
participate is subject to rapid technological change, changing customer needs,
frequent new product introductions and evolving industry standards that may
render existing products and services obsolete. Our growth and future operating
results will depend in part upon our ability to enhance existing applications
and develop and introduce new applications or components that:
- meet or exceed technological advances in the marketplace;
- meet changing customer requirements;
- achieve market acceptance;
- integrate successfully with third party software; and
- respond to competitive products.
Our product development and testing efforts have required, and are expected
to continue to require, substantial investment. We may not possess sufficient
resources to continue to make the necessary investments in technology. In
addition, we may not successfully identify new software opportunities and
develop and bring new software to market in a timely and efficient manner. If we
are unable, for technological or other reasons, to develop and introduce new and
enhanced software in a timely manner, we may lose existing customers and fail to
attract new customers, resulting in a decline in revenues.
OUR STOCK PRICE MAY FLUCTUATE WIDELY.
Prior to our initial public offering in September 1999, there was no public
market for our common stock. The market price of our common stock could
fluctuate substantially due to:
- quarterly fluctuations in operating results;
- announcements of new products or product enhancements by us or our
competitors;
- technological innovations by us or our competitors;
- general market conditions or market conditions specific to our or our
customers'
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industries; and
- changes in earnings estimates or recommendations by analysts.
Stock prices of Internet-related companies have been highly volatile. Our
current stock price may not be indicative of the price that will prevail in the
trading market. In the past, following periods of volatility in the market price
of a company's securities, securities class action litigation has at times been
instituted against that company. If we become subject to securities litigation,
we could incur substantial costs and experience a diversion of management's
attention and resources.
THE UNPREDICTABILITY OF OUR QUARTERLY OPERATING RESULTS MAY ADVERSELY AFFECT THE
TRADING PRICE OF OUR COMMON STOCK.
Quarterly fluctuations in operating results may be caused by:
- changes in the growth rate of Internet usage;
- fluctuations in the demand for our products and services;
- the level of product and price competition in our markets;
- the timing and market acceptance of new product introductions and
upgrades by us or our competitors;
- our success in expanding our customer support and marketing and sales
organizations;
- the size and timing of individual transactions;
- delays in, or cancellations of, customer implementations;
- customers' budget constraints;
- the level of product development expenditures;
- our ability to control costs; and
- general economic conditions.
Many of these factors are not in our control. In addition, we also
experience seasonality which causes us to typically recognize a
disproportionately greater amount of our revenues for any fiscal year in our
fourth quarter and a disproportionately lesser amount in our first quarter, due
largely to sales force quota practices in the software industry and to customer
budgeting processes.
WE NEED TO MANAGE OUR GROWTH EFFECTIVELY OR WE MAY NOT SUCCEED.
We are a growing company. Our ability to manage our growth will depend in
large part on our ability to generally improve and expand our operational and
sales and marketing capabilities, to develop the management skills of our
managers and supervisors, many of whom have been employed by us for a relatively
short time, and to train, motivate and manage both our existing employees and
the additional employees that may be required. Additionally, we may not
adequately anticipate all of the demands that growth may impose on our systems,
procedures and structure. Any failure to adequately anticipate and respond to
these demands or manage our growth effectively would have a material adverse
effect on our future prospects.
THE DEVELOPMENT OF INTERNATIONAL OPERATIONS WILL CAUSE US TO FACE ADDITIONAL
RISKS.
We expect to expand our international operations and international sales
and marketing efforts, initially, by opening regional sales and support offices
in Europe and Asia Pacific within the next twelve months. We have limited
experience in marketing, selling and distributing our products and services
internationally. International operations, including operations in those regions
that we are targeting, are subject to the following risks:
- recessions in foreign economies;
- political and economic instability;
- fluctuations in currency exchange rates;
- difficulties and costs of staffing and managing foreign operations;
- potentially adverse tax consequences;
- reduced protection for intellectual property rights in some countries;
and
- changes in regulatory requirements.
OUR FAILURE TO MAINTAIN ONGOING SALES THROUGH A LIMITED NUMBER OF INDIRECT
CHANNELS MAY RESULT IN LOWER REVENUES.
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We derive a significant portion of our license revenues through a limited
number of independent software vendors, systems integrators, distributors and
resellers. Although we intend to increase our marketing and direct sales
efforts, we expect that a limited number of these indirect channels will
continue to account for a significant portion of our revenues in any given
quarter in the foreseeable future. To be successful, we must continue to foster
and maintain our existing indirect channels, as well as develop new
relationships. The loss of, or reduction in orders through, existing indirect
channels or the failure to develop new indirect channel relationships could
cause our revenues to decline and have a material adverse effect on our
business.
IF WE LOSE OUR KEY PERSONNEL, OR FAIL TO ATTRACT AND RETAIN ADDITIONAL
PERSONNEL, THE SUCCESS AND GROWTH OF OUR BUSINESS MAY SUFFER.
A significant portion of our senior management team has been in place for a
relatively short period of time. Our success will depend to a significant extent
on their ability to gain the trust and confidence of our other employees and to
work effectively as a team.
Our future success will also depend significantly on our ability to
attract, integrate, motivate and retain additional highly skilled technical,
managerial, sales, marketing, and services personnel. Competition for skilled
personnel is intense, and we may not be successful in attracting, motivating and
retaining the personnel required to grow and operate profitably. Failure to
attract, integrate, motivate and retain highly skilled personnel could adversely
affect our business, especially our ability to develop new products and enhance
existing products.
THE LENGTHY AND VARIABLE SALES CYCLES OF OUR SAPPHIRE/WEB PRODUCT COULD CAUSE
SIGNIFICANT FLUCTUATION IN OUR QUARTERLY RESULTS.
Our Sapphire/Web software is generally used for mission-critical or
enterprise-wide purposes and involves a significant commitment of resources by
our customers. A customer's decision to license our Sapphire/Web software
generally involves the evaluation of the available alternatives by a significant
number of personnel in various functional and geographic areas, each often
having specific and conflicting requirements. Accordingly, we typically must
expend substantial resources educating prospective customers about the value of
our Sapphire/Web software solutions. For these reasons, the length of time
between the date of initial contact with the potential customer and the
execution of a software license agreement typically ranges from three to six
months, and is subject to delays over which we have little or no control. As a
result, our ability to forecast the timing and amount of specific sales is
limited and the delay or failure to complete one or more large license
transactions could cause our operating results to vary significantly from
quarter to quarter.
THE FAILURE TO IMPLEMENT SUCCESSFULLY OUR SAPPHIRE/WEB SOFTWARE COULD RESULT IN
DISSATISFIED CUSTOMERS AND DECREASED SALES.
Implementation of our Sapphire/Web software often involves a significant
commitment of financial and other resources by our customers. The customer's
implementation cycle can be lengthy due to the size and complexity of their
systems and operations. In addition, our customers rely heavily on third party
systems integrators to assist them with the installation of the Sapphire/Web
software. Our failure or the failure of our alliance partners, our customers or
our third party integrators to implement successfully our Sapphire/Web software
could result in dissatisfied customers which could adversely affect our
reputation.
WE MAY REQUIRE FUTURE ADDITIONAL FUNDING TO STAY IN BUSINESS.
Over time, we may require additional financing for our operations.
Additionally, we periodically review other companies' product lines and
technologies for potential acquisition. Any material acquisitions or joint
ventures could require additional financing. This additional financing may not
be available to us on a timely basis if at all, or, if available, on terms
acceptable to us. Moreover, additional financing may cause dilution to existing
stockholders.
CAPACITY RESTRICTIONS COULD REDUCE THE DEMAND AND UTILITY OF OUR PRODUCTS.
Concurrency restrictions can limit Internet deployment and use capacity.
The boundaries of our Sapphire/Web software and Bluestone XML server capacity,
in terms of numbers of concurrent users or interactions, are unknown because, to
date, no customer or testing environment has reached these boundaries. The
Sapphire/Web software's or the Bluestone XML server's capacity boundaries may,
at some future time, be reached and, when reached, may be insufficient to enable
our customers to achieve their desired levels of information deployment and
exchange. We may lose customers or fail to gain new customers if either of the
Sapphire/Web software's or the Bluestone XML server's capacity boundary limits
the ability of our customers to achieve expected levels of information
deployment and exchange or Internet commerce transactions.
OUR LIMITED ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS COULD IMPAIR OUR
ABILITY TO COMPETE EFFECTIVELY.
Our success and ability to compete are substantially dependent on our
internally developed technologies and trademarks, which we protect through a
combination of copyright, trademark and trade secret laws, confidentiality
procedures and contractual provisions.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or obtain and use information that
we regard as proprietary. Policing unauthorized use of our products is difficult
and, though we are unable to determine the extent to which piracy of our
software products exists, we expect software piracy to be a problem. In
addition,
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the laws of some foreign countries do not protect our proprietary rights to the
same extent as the laws of the United States. Furthermore, our competitors may
independently develop technology similar to ours.
The number of intellectual property claims in our industry may increase as
the number of competing products grows and the functionality of products in
different industry segments overlaps. Although we are not aware that any of our
products infringe upon the proprietary rights of third parties, there can be no
assurance that third parties will not claim infringement by us with respect to
current or future products. Any of these claims, with or without merit, could be
time consuming to address, result in costly litigation, cause product shipment
delays or require us to enter into royalty or license agreements. These royalty
or license agreements might not be available on terms acceptable to us or at
all, which could have a material adverse effect on our business.
OUR FAILURE TO OBTAIN OR MAINTAIN THIRD PARTY LICENSES COULD HARM OUR BUSINESS.
We have in the past and may in the future, resell, under license, certain
third party software that enables our software to interact with other software
systems or databases. In addition, we license certain software technology used
to develop our software. The loss or inability to maintain any of these software
licenses could result in delays or reductions in product shipments until
equivalent software could be identified and licensed or compiled, which could
adversely affect our business.
WE MAY BE SUBJECT TO FUTURE PRODUCT LIABILITY CLAIMS AND OUR PRODUCTS'
REPUTATIONS MAY SUFFER.
Many of our installations involve projects that are critical to the
operations of our customers' businesses and provide benefits that may be
difficult to quantify. Any failure in a customer's system could result in a
claim for substantial damages against us, regardless of our responsibility for
the failure. Although our license agreements with our customers typically
contain provisions designed to limit contractually our liability for damages
arising from negligent acts, errors, mistakes or omissions, it is possible that
these provisions will not be enforceable in certain instances or would otherwise
not protect us from liability for damages. Although we maintain general
liability insurance coverage, this coverage may not continue to be available on
reasonable terms or at all, or may be insufficient to cover one or more large
claims.
We have entered into and plan to continue to enter into agreements with
strategic alliance partners whereby we license our software products for
integration with the alliance partners' software. If an alliance partner's
software fails to meet customer expectations or causes a failure in its
customer's systems, the reputation of our software products could be materially
and adversely affected even if our software products performed in accordance
with their functional specifications.
YEAR 2000 PROBLEMS MAY DISRUPT OUR BUSINESS.
Many currently installed computer systems and software products are
coded to accept only two digit entries in the date field. Beginning in the
year 2000, these date fields will need to accept four digit entries to
distinguish twenty-first century dates from twentieth century dates. As a
result, over the next several months, computer systems and/or software used
by many companies may need to be upgraded to comply with these "Year 2000"
requirements. Significant uncertainty exists in the software industry
concerning the potential effects associated with compliance. While our
software products are not time/date sensitive, many of the third party
software applications run by our customers are time/date sensitive. In
addition, we have resold third party software that may not be Year 2000
compliant.
We may experience unanticipated problems and costs caused by undetected
errors or defects in the software used in our internal systems related to the
Year 2000 transition. If our internal computer systems are not Year 2000
compliant then we or our customers may suffer system failures or miscalculations
that could cause disruptions of operations.
In addition, we believe that the purchasing patterns of customers and
potential customers may be affected by Year 2000 issues in a variety of ways.
Many companies are expending significant resources to correct or patch their
current software systems for Year 2000 compliance. These expenditures may result
in reduced funds available to purchase software products such as those offered
by us.
Our reasonable worst case scenarios include:
- exposure to potential business disruption and resulting claims,
whether with or without merit;
- temporary inability to process transactions internally, to send
invoices to vendors and customers or to engage in similar normal
business activities; and
- postponed or delayed sales because existing and potential customers
may choose to defer purchasing, or reduce funds available to purchase,
software products such as those offered by us.
Our insurance coverage may not cover or be adequate to offset these and
other business risks related to the Year 2000.
OUR EXECUTIVE OFFICERS AND DIRECTORS AND THEIR AFFILIATES OWN A LARGE PERCENTAGE
OF OUR VOTING STOCK AND WILL HAVE THE ABILITY TO MAKE DECISIONS THAT COULD
ADVERSELY AFFECT OUR STOCK PRICE.
17
<PAGE>
Currently, our executive officers, directors and their affiliates
beneficially own approximately 59% of the outstanding shares of common stock. As
a result, these stockholders are able to control all matters requiring
stockholder approval and, thereby, our management and affairs. Matters that
require stockholder approval include:
- election of directors;
- approval of mergers or consolidations; and
- sale of all or substantially all of our assets.
This concentration of ownership may delay, deter or prevent acts that would
result in a change of control of Bluestone, which in turn could reduce the
market price of our common stock.
OUR CHARTER AND BYLAWS AND DELAWARE LAW CONTAIN PROVISIONS THAT COULD DISCOURAGE
A TAKEOVER EVEN IF BENEFICIAL TO STOCKHOLDERS.
Our charter and our bylaws, in conjunction with Delaware law, contain
provisions that could make it more difficult for a third party to obtain control
of Bluestone even if doing so would be beneficial to stockholders. For example,
our charter provides for a classified board of directors and restricts the
ability of stockholders to call a special meeting. Our bylaws allow the board of
directors to expand its size and fill any vacancies without stockholder
approval.
FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS OUR STOCK PRICE.
The market price of our common stock could decline as a result of sales by
our existing stockholders or the perception that those sales may occur. These
sales could also make it more difficult for us to raise funds through equity
offerings in the future at a time and at a price that we think is appropriate.
The holders of a significant amount of our common stock, as well as the
holders of outstanding warrants, will be entitled to registration rights with
respect to their common stock or the common stock underlying their
convertible securities. If these holders, by exercising their registration
rights, cause a large number of securities to be registered and sold in the
public market, these sales could have an adverse effect on the market price
for our common stock. If we were to include, in a registration statement
initiated by us, shares held by these holders pursuant to the exercise of
their registration rights, these sales may have an adverse effect on our
ability to raise needed capital.
18
<PAGE>
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We develop our products in the U.S. and have sold them primarily in North
America. As a result, our financial results have not been affected by factors
such as changes in foreign currency exchange rates or weak economic conditions
in foreign markets. In the future, we expect to increase our international
operations which could increase our exposure to these factors.
Our future interest income will be sensitive to changes in the general
level of U.S. interest rates. However, we plan to invest our excess cash in
short-term, investment-grade, interest-bearing securities and we have concluded
that there is no material market risk exposure relating to these investments.
Part II. Other Information
Item 1. Legal Proceedings
None.
Item 2. Changes in securities and use of proceeds.
(c) Changes in securities and sale of unregistered securities
During the quarter ended September 30, 1999 and prior to the
closing of our initial public offering, we granted options to purchase
245,766 shares of our common stock at a weighted average exercise price
of $13.68 per share to our employees pursuant to the 1996 Incentive and
Non-Qualified Stock Option Plan, as amended. During this period, we
issued 73,353 shares of common stock to employees upon the exercise of
stock options at a weighted average exercise price of $2.87 per share.
These options and shares of common stock were issued by us in reliance
upon Rule 701 under the Securities Act of 1933 as amended (the
"Securities Act").
On September 15, 1999, we issued 218,750 shares of common stock upon
the conversion of a convertible note at a conversion price of $2.29 per
share. These shares were issued in reliance upon section 3(a)(9) of the
Securities Act.
Upon closing of the initial public offering, all of our
then-outstanding redeemable convertible preferred stock and the accrued
dividends thereon were converted into 10,493,481 shares of common stock.
The Company's Board of Directors also authorized a 1 for 3.2 reverse stock
split of its common stock to be effected immediately prior to the offering.
(d) Use of Proceeds
On September 29, 1999, we completed our initial public offering of our
common stock, .001 par value per share. The managing underwriters in the
offering were Deutsche Banc Alex.Brown, Soundview Technology Group, C.E.
Unterberg, Towbin and Legg Mason Wood Walker, Inc. The shares of common
stock sold in this offering were registered under the Securities Act of
1933, as amended, on a Registration Statement on Form S-1 (Reg. No.
333-82213). The Securities and Exchange Commission declared our
Registration Statement effective on September 23, 1999. The offering
commenced on September 24, 1999, on which date we sold all 4,000,000 shares
of common stock registered under the Registration Statement at a price of
$15.00 per share.
The aggregate price of the offering amount registered and sold was
$60 million. Net proceeds from the offering were $54.8 million after
deducting underwriting discounts of $4.2 million and offering expenses
of $1.0 million. None of the net proceeds of the offering were paid
directly or indirectly to any director or officer of Bluestone or their
associates, persons owning 10 percent or more of any class of equity
securities of Bluestone or an affiliate of Bluestone. As of September
30, 1999, we had not used any of the net proceeds of the offering.
We did not receive any proceeds from the exercise of the underwriters'
over-allotment option which was closed on October 13, 1999 with respect to
all 600,000 shares under such option at $15 per share. The following
information is provided about the selling stockholders that sold shares of
common stock
19
<PAGE>
pursuant to the over-allottment option:
<TABLE>
<CAPTION>
Selling Stockholder Shares Registered Aggregate Price
------------------- ----------------- ---------------
<S> <C> <C>
Mel Baiada 152,253 $ 2,283,795
General Electric Capital Corporation 158,000 2,370,000
P. Kevin Kilroy 70,000 1,050,000
P/A Fund, L.P. 66,860 1,002,900
APA Excelsior IV, L.P. 127,875 1,918,125
APA Excelsior IV/Offshore, L.P. 22,566 338,490
Patricof Private Investment Club, L.P. 2,446 36,690
</TABLE>
Item 3. Defaults upon senior securities.
None.
Item 4. Submission of matters to a vote of security holders.
During the quarter ended September 30, 1999, we solicited written
consents from the holders of our outstanding shares of capital stock on
the following items in anticipation of and in connection with our initial
public offering:
1. On August 20, 1999, (i) amended our 1996 Incentive and Non-Qualified
Stock Option Plan to increase by 1,100,000 the number of shares of common
stock available for issuance upon the exercise of stock options granted
or which may be granted under the plan, and (ii) we amended our
certificate of incorporation to increase the aggregated amount of
authorized shares of our capital stock by 1,100,000 shares in connection
with the foregoing amendment to the plan. These actions were authorized by
the partial written consent of 34,720,581 voting shares of our capital
stock, representing 82% of the total number of shares of capital stock
entitled to vote on such amendment.
2. On September 9, 1999, we amended our certificate of incorporation
to modify a provision regarding the automatic conversion of the then
outstanding shares of our preferred stock. This action was authorized by
the partial written consent of 39,700,714 voting shares of our capital
stock, representing 94% of the total number of shares of capital stock
entitled to vote on such amendment.
3. On September 23, 1999, we amended our certificate of incorporation to
authorize a 1-for-3.2 reverse-stock split of the then issued and
outstanding shares of our common stock to take effect immediately prior to
our initial public offering. This action was authorized by the partial
written consent of 34,720,581 voting shares of our capital stock,
representing 81% of the total number of shares of capital stock entitled to
vote on such amendment.
4. On September 29, 1999, we amended and restated our certificate of
incorporation to reflect the conversion of all previously outstanding
shares of our preferred stock and our stockholders' approval of certain
amendments to our bylaws and 1997 Incentive Plan. These actions were
authorized by the partial written consent of 40,318,266 voting shares of
our capital stock, representing 93% of the total number of shares of
capital stock entitled to vote on such amendment.
Item 5. Other Information.
None.
Item 6. Exhibits and reports on Form 8-K.
(a) Exhibits:
3.1 Amended and Restated Certificate of Incorporation (incorporated by
reference to Exhibit 3.3 to the Company's Registration Statement on
Form S-1 (Registration No. 333-82213)).
3.2 Amended and Restated Bylaws (incorporated by reference to Exhibit 3.4
to the Company's Registration Statement on Form S-1 (Registration No.
333-82213)).
27.1 Financial Data Schedule (in electronic format only).
(b) Reports on Form 8-K:
None.
SIGNATURES
20
<PAGE>
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.
BLUESTONE SOFTWARE, INC.
Dated: November 12, 1999 By: /s/ S. Craig Huke
-----------------------------------------
S. Craig Huke
SENIOR VICE-PRESIDENT AND
CHIEF FINANCIAL OFFICER
21
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 71,197
<SECURITIES> 0
<RECEIVABLES> 4,208
<ALLOWANCES> 250
<INVENTORY> 0
<CURRENT-ASSETS> 75,478
<PP&E> 3,138
<DEPRECIATION> 1,732
<TOTAL-ASSETS> 76,933
<CURRENT-LIABILITIES> 7,697
<BONDS> 0
0
0
<COMMON> 18
<OTHER-SE> 68,175
<TOTAL-LIABILITY-AND-EQUITY> 76,933
<SALES> 7,874
<TOTAL-REVENUES> 10,595
<CGS> 210
<TOTAL-COSTS> 3,622
<OTHER-EXPENSES> 17,098
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,035
<INCOME-PRETAX> (11,160)
<INCOME-TAX> 0
<INCOME-CONTINUING> (11,160)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,160)
<EPS-BASIC> (3.99)
<EPS-DILUTED> (3.99)
</TABLE>
